Protecting businesses from the impact of losing key personnel
What is Key Person Protection?
Key Person Protection involves using Whole of Life, Term life, TPD and/or Trauma insurance on the lives of the people whose death, retirement, total and permanent disablement or trauma would cause a business to suffer.
By providing a lump sum benefit on the occurrence of an insurable event, key person insurance can protect your client’s business from the impacts that the loss of a key person would have. Some of these ‘impacts’ include:
- The subsequent loss of key clients;
- A reduction in business growth and development; and
- Personnel replacement and training costs.
The business can use the proceeds of the plan to cover the costs associated with losing a key person and to provide much needed capital to help keep the business fully operational, before a suitable replacement can be found and/or the impact of the loss is nullified.
Why you should consider Key Person Protection
If your business lost a key person, even if only temporarily, the profitability and value of the business could be detrimentally affected. However, with key person protection, the business would be compensated for the adverse effects of having lost that person.
Key person protection would help the business by paying a benefit that would compensate for the loss of production and subsequent loss of revenue. The benefit would also provide the business with a “buffer” period, whereby they can find and train a suitable replacement without losing financially from the loss of the key person.
The Key Person Protection process
Below is a basic outline of the Key Person Protection process :
- Key personnel are identified by the business.
- The key person’s net worth to the business is estimated by considering how much the effect of losing that person would cost the business financially.
- The business takes out
insurance to protect from the impacts of losing their key personnel in
the form of life, TPD and trauma insurance, with a sum insured
determined by the estimation of the key person’s net worth to the business. - Premiums are paid by the business.
- When the claim is assessed, the business is paid a benefit in accordance with the sum insured.
Identifying your key people
A key person could be anyone who provides economic advantage, be it
through their relative skills and knowledge, their image or appeal to
consumers, access to capital or credit, or ability to organise human
resources efficiently and effectively. The loss of such a person from a
business could result in a significant impact on revenue or profits or
other financial aspects of a business, such as goodwill, capital
receipts, expenses, or access to credit and customers.
The identification of a key person is very important. A key person can
be defined in stating that, “the loss of that employee would result in
a significant loss of profits being derived by the employer during the
continuation of business operations subsequent to that loss”.
It is also important to note that certain persons cannot be regarded as
key persons. The loss of a person in a ‘one man’ or sole trader, single
operator type business, which could be expected to result in the
termination of the business, could not be regarded as a key person.
This is on the basis of an absence of a succession plan for the
survival of the business.
The need for key person cover is mainly evident in the small to
medium-sized business sector. Generally the larger the business, the
less vulnerable they are to the loss of one employee.
Depending
on their attributes and relationship with the business, key persons
could include, though are not limited to, the following examples :
- key sales staff, whose dynamic nature and competitive edge allow the business to stay focused on profitability targets;
- key technical specialists, whose knowledge allows the business to win new contracts; and
working directors.
Less obvious key persons may include :
- externals such as key suppliers of material or knowledge to the business; and
- silent partners who may be providing capital or whose standing ensures a supply of required finance or customers.
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