2020 may not have been a good year for many businesses globally due to the pandemic but for Australia, there was nearly a 4% increase in the number of actively trading businesses. For any company, large or small, it is the personnel or key people whose skills and abilities keep the enterprise on the right track. Staff turnover, either from natural wastage or from unforeseen events such as ill health and accidents, can destabilise a company very quickly if a business continuity plan is not in place.
Replacing that person, whether temporary or on a permanent basis has cost implications. If this is not factored into the continuity or contingency plan, it will put an even greater strain on your profit margins. Fortunately, if the business does lose an integral employee, Key Person insurance can help your company carry on and thrive in the future.
What is the definition of a Key Person?
In essence, this is someone whose time away from the company would significantly affect the overall profitability of the business, and to be clear, this does not mean when they are on annual leave, for example. Their sudden absence means a loss of key skills, experience and knowledge that are paramount to the day to day running of the company. If they are guarantors for loans, this may also affect funding agreements with banks or loan companies, thus impacting the cash flow of the business.
A Key Person could be a highly skilled and specialised technician or engineer crucial to the production line or in a small business, the partners or founders of that business. These are the types of people to consider when arranging Key Man insurance.
What else defines a Key Person?
There are a number of areas to consider when reviewing who the key players are in the company. You can start by identifying areas of responsibility – for example, the finance department, look at who is a signatory for contracts or other legal documentation. Then look at whether the person manages key client accounts and depending on the list, it can help you further identify the importance of that individual to the business. Next, review the knowledge and skills to see if they can be covered by existing staff or if the company will have to buy in that expertise to continue to trade. Plus, there are the less quantifiable traits such as if the person is well respected and liked, would it cause a big upset in the team if they were not there? If this leads to destabilisation with other staff leaving, the need to get someone in place quickly to prevent further loss is crucial. Cost of temporary highly skilled agency staff is not going to be cheap so having insurance in place will help mitigate the potential loss.
What is Key Person insurance?
This is insurance that’s aimed at protecting businesses. In the situation where the key person is unable to work or tragically passes away, this insurance ensures that the company can continue to carry on. It works because it is a policy taken out by the company on the lives of key people or a key person who is named on the policy. The premiums are usually paid by the business in order to protect the life of a business. Depending on what is covered then, if a claim was to be submitted, it is the business that is in receipt of the insurance benefit. Key Person insurance would normally cover critical illness or trauma, permanent and total disability and death. It is important to discuss fully the requirements and needs of the organisation because some policies can offer income protection cover.
The insurance benefit would be normally paid out as a lump sum, which can be used for capital or revenue purposes. Funds can be targeted at covering costs which would be linked to losing the key person so training or recruitment costs, for example.
Can it be used for both revenue and capital costs at the same time?
This type of policy can be utilised for both capital and revenue purposes or just for revenue or capital, but this does depend on the business and their particular requirements and on the insurer. As business needs to change along with the requirements of the marketplace, it is sensible to set out exactly the main purpose of the key person policy and put this in writing. Then as part of the annual review of the business continuity planning process, revisit this policy on an annual basis.
· Capital requirements – if the key individual is the person typically responsible for the liability of the business, such as the owner of the business, the insurance for capital purposes is more suitable. The key person in this instance is someone who makes a significant contribution to the value and assets of the company.
· Revenue requirements – if the key individual is someone that the company relies heavily on to generate an income then insurance that covers revenue purposes would be more appropriate.
· Both- if cover is required for both capital and revenue then one policy covering both is available, but the business would need to set out in writing which portion of the premium relates to capital, and which relates to revenue. This is due to taxation requirements so if the business finds it difficult to apportion their requirements it may be prudent to consider having separate policies, one for revenue and one for capital.
Is it tax deductible?
As always, it is best to check with the relevant financial advisor. However, the Australian Tax Office has stated that premiums for revenue purposes can be deducted against tax. If the business makes a claim, the payment would be taken as income for the company and therefore taxation applies. On the other hand, premiums paid for Key Person insurance for capital requirements cannot be deducted against tax, but any pay out in the event of a claim is not treated as assessable income. What it may be subject to is Capital Gains Tax, so advice should be sought.
It takes time, effort and money to build up a business so in order to prolong the life of that business and for peace of mind, speak to the experts in Key Man insurance today.