Keyman Insurance vs Business Succession Planning

Published: July 25, 2013

Keyman insurance may be suitable for many businesses, particularly those who have one or more individuals whose continued association with the business, as a result of their investment, experience, technical expertise or connections, provide the business with a significant and direct economic gain. Such individuals can be identified as key persons.

Their loss from a business could result in a significant impact on revenue, profit or other financial aspects of a business e.g. goodwill, ability to repay debt and other expenses or access to credit, business contacts and customers.

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What is keyman insurance?

Keyman insurance is essentially life insurancetotal and permanent disability insurance (TPD) or trauma insurance policies taken out by a business on the life of a key person.

Where keyman insurance is taken out and a key person either departs the business or is unable to perform their duties due to an insurable event (death, disablement or a specified medical condition), the business can use the insurance proceeds to replace lost revenue, repay debt, cover additional expense items or inject required capital into the business.

This ensures that the business is supported financially until a replacement is found or other staff are trained to fulfill a particular role. Hence, key person insurance helps protect the financial stability of a business and reduces business risk.

It is important to understand the distinction between key person insurance or keyman insurance and insurance policies used for business succession planning.

Key person insurance is about protecting the ongoing viability of the business.

Business succession planning is about protecting the owner’s (and indirectly their family’s) personal investment in the business.

Who is a key person?

A key person is any person whose continued association with the business provides the business with a significant economic gain.

The term economic gain used in this context can mean any of the following:

  • increased sales and revenue
  • cost savings
  • increased profit
  • increased goodwill
  • ability to access finance, and
  • ability to access or retain customers.

Key persons can include employees, owners of the business, managing directors, even suppliers, generally those persons whose loss would have a significant impact on the financial viability of the business.

Common examples of an employee who may be a key person include:

  • a chief executive officer
  • a sales representative who has many contacts and has forged successful relationships with the business’s larger customers, and
  • a technical person who has a specialist skill that the business relies on to either attract customers or to ensure that its manufacturing process can continue to operate.

A key person does not even have to be an employee of the business. For example, an external supplier of a key component/part in the business’s own manufacturing process can be a key person of the manufacturing business, even if the supplier is not employed by the manufacturing business.

Similarly, a non-working shareholder, i.e. a silent partner, who puts up his personal assets as security for the loans of the business may also be considered to be a key person if the business relies on these guarantees to obtain loans.

One of the most important aspects when getting keyman insurance is making sure that the structure of your policy best suits your business and your needs. As each business is different, so is each keyman insurance policy.

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