Key Person Insurance
When running a business, it is vital to consider and plan for events that could adversely affect its success.
In particular, it is important to consider the implications to a business of the sudden death or serious illness of a vital employee – a keyperson in the business.
To minimise the financial impact of losing key employees a business needs Keyperson Insurance.
A Keyperson Insurance Policy can be purchased by the company on the life of the key employee to protect against the financial consequences of the death and/or serious illness of one of the key employees.
The employer pays the premiums and in the event of death of the insured, a cash sum is provided which will help to maintain the business and protect its future security.
A Keyperson is an employee on whose expertise, knowledge, management expertise and contacts are key to the continued financial success of the company.
Keyperson Insurance assists the survival of the company on death or diagnosis of a serious illness of a ‘key’ employee or shareholder by compensating that company for any anticipated financial loss in the event of either of these events.
Financial effects of death or diagnosis or a serious illness of a Keyperson
The death or diagnosis of a serious illness of a keyperson of a company could put that company in a financially unstable condition, in a number of ways.
- An interruption of business activity and a consequent reduction in profits.
- Bank loans on which the deceased gave a personal guarantee may be called in.
- The keyperson or his/her estate may be owed any loans made by him/her to the company.
- Banks and/or suppliers may reduce or withdraw credit facilities over worries about the future profitability of the business.
- The company will lose the individual’s expertise and business contacts
- The company may have to commit resources to find a suitable replacement. This may be a prolonged process where the individual has unique experience and expertise.
The purpose of Keyperson Insurance is not to improve the financial situation of the company and increase its value. It is meant to indemnify against loss of profits and repay loans on the death of a key individual.
Setting up Keyperson Insurance
The procedure to effecting Keyperson Insurance on the life of an individual is as follows:
- The decision to effect an insurance policy for the purpose of Keyperson insurance should be made and minuted at a board meeting. This resolution should clearly show that the intention of the company in effecting the policy is to protect against losses in the event of the death or serious illness of a Keyperson.
- The company effects a policy on the life of the Keyperson for the amount required to protect against losses. A director of the company signs the proposal form ‘For and on behalf of’ the company – ideally this should be a different person to the individual covered. The Company’s seal should be affixed to the proposal form over the signature of the director.
- On acceptance by the life office, the company pays the premiums and the Keyperson is on cover. A Keyperson financial questionnaire will generally be required by the life office before they will accept the policy.
Payment of Premiums:
The premiums are not necessarily admissable deductions for tax purposes. In order for the premiums to be tax deductible, all of the following conditions must be met:
- The relationship between policy owner and the life insured is that of employer and employee.
- The employee controls less than 15% of the ordinary shares in the company.
- The insurance policy has been effected for loss of profits only (e.g. not for loss of goodwill or to cover repayment of loans)
- The policy is short-term, i.e. the policy cannot extend beyond the employee’s likely period of service with the employer.
If the premiums are an allowable deduction for tax purposes, the proceeds will be liable to tax. If the premiums are not allowable deductions, the proceeds are not liabile to tax.
Note however, tha just because tax relief is not sought on premiums, it does not automatically follows that the proceeds will be tax free. It is therefore advisable that the company taking out the Keyperson Insurance writes to the Revenue Commissioners to clarify the position.
Quantifying the cover
Loss of Profits:
- The impact on profits of losing the keyperson’s expertise will need to be assessed. There are various approaches to calculating this e.g. a multiple of net profits or a multiple of the keyperson’s current annual remuneration. You are recommended to seek independent professional advice in assessing this.
- The cost of hiring a replacement should also be considered. The longer the recruitment process, the higher the cost to the company.
The sum insured can also cover any loans that the keyperson has made to the company, which will have to be repaid to his/her personal representative(s).
- Any company loans that the keyperson has personally guaranteed may have to be repaid and should also be considered.
In the same way as a company insures itself against loss of profits from damage to it’s plant and machinery, Keyperson insurance allows it to protect itself against financial stain from the loss of a person who is key to the business.