Key Person Insurance

 
Who is a Key Person?

 

A key person is a business owner or employee who is critical to the ongoing revenue and profitability of the business, or provides capital to the business.

 

Key people can hold all sorts of positions in a business organisation and are often identified by their level of remuneration. They can be in decision making roles, have direct responsibility for carrying out management directives, be a source of revenue for the business, or have a unique talent that is valuable to the business.

 

The biggest asset of most small to medium- sized businesses is the skills, experience and ideas of its people. A key person is someone who:

 

  • possesses unique business/leadership skills

  • has specialist skills and experience

  • has good business connections

  • is vital to the reputation/goodwill of the business

  • is responsible for significant productivity and/or earnings, or

  • is a guarantor for business loans.

 

Some questions that assist in identifying a key person

 

  • What financial impact to the business would the recruitment and/or training or replacement of the person have?

  • Does the person have contacts that bring in significant amounts of business or help ensure the smooth running of the business? Does the person generate ideas of value to the company (research & development)?

  • Would the loss of the person affect the business financially?

  • Does the person bring in money to the business?

  • Does the person save the business money?

  • How would the loss of the person affect profitability until a replacement is found?

  • Would the loss of the person affect the business' access to credit?

  • Would the loss of the person have an adverse effect on goodwill?

 

What is Key Person Insurance?

 

Key person insurance protects businesses from the loss of a key person whose capital, knowledge, client base or experience are vital to the company. For example, a company director, an employee with specialised skills, a salesperson who is responsible for providing a large portion of business revenue or a key supplier.

 

Key person insurance proceeds are used (amongst other things) to:

 

  • support the business financially until a replacement is found

  • train other staff to fulfill the key person’s role

  • assist with any costs associated with retraining, advertising or hiring a new employee, or

  • repay debt.

 

Hence, key person insurance assists with protecting the financial stability of a business and reduces business risk.

 

Why is key person insurance needed?

 

The purpose of key person insurance is to ensure the business can continue at the same level of operations/ profitability as it would normally had the death, disability or critical illness to a key person not occurred.

 

The death, disablement or critical illness of a key person could have some serious implications for the business, including:

 

  • pressure to sell or wind up an otherwise viable business

  • necessity to repay loans

  • foreign and hostile involvement in the control and operation of the business

  • creditors demanding payment

  • financial lenders withdrawing credit

  • customers going elsewhere

  • goodwill suffering

  • the need to hire a replacement employee.

 

The first step in counteracting any problems is to identify key people.

 

The second step is to develop strategies that minimise the risk, such as:

 

  • people retention strategies

  • Succession planning

  • insurance strategies.

 

Key person insurance compensates the business for any financial loss that may arise from the death, disability or trauma of a key person.

 

A financial loss may include:

 

  • reduction in profits

  • costs to replace the key person loss of ability to access business loans, and costs of unfinished projects.

 

Replacing the loss of a key person To cover the cost of replacing a key person, a business may:

 

  • realise personal funds/assets of the business owners

  • realise business assets

  • use business cash flow

  • borrow cash

  • self-insure, or

  • use insurance.

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 Two Mile Bay Pty Ltd is a Authorised Representative of Millennium3 Financial Services Pty Ltd. Australian Financial Services Licensee—Licence Number 244252. For Financial Services Products only. For Australian Residents Only. This information (including taxation) is general in nature and does not consider your individual circumstances or needs. Do not act until you seek professional advice and consider a Product Disclosure Statement.