All About Key Person Life Insurance

by | Aug 1, 2019 | Leadership, Life Insurance

An infographic with the title "Key Person Insurance" in the center, surrounded by five icons connected by arrows. Clockwise from top right: gear with people, cloud with a lock, computer network, document and gear, and a person presenting charts related to key person insurance.

Most business owners are aware that among their staff, they have key players who upon their exit or death, the business would suffer huge losses. To help alleviate these losses, they go-ahead to purchase a key person or key man life insurance policy on the employee(s). In the event of their death or exit, the insurance company pays out a benefit to the business to cater for expected losses.

How It Works

When the ‘Keyman’ ceases to be an employee of an organization if the first employer has the Keyman policy, they are presented with four options:

  1. The employer can cease to pay for the premiums and as such, the policy will lapse.
  2. The employer may continue to pay the premiums which will enable him/her to recover the proceeds if a claim arises.
  3. The old employer can transfer the policy to the new employer if they have a mutual agreement between them.
  4. The insurer can assign it in favor of the keyman.

Eligibility requirements

To be eligible, the ‘keyman’ should not hold more than 50% of a company’s shares. Two, if the keyman and his/her family hold shares of the company together, they should be under 70%. Three, the employer should provide proof that the keyman plays a critical role in the company.

How Much is Assured?

The maximum sum that is assured is under 10 times the yearly compensation package of the keyman. Additionally, it is under 3x the company’s average gross profit for the former three years. Finally, It is lower of 5x the company’s average net profit in the former 3 years.

However, this insurance is not issued if the company’s turnover or profit is declining unless in special circumstances.

Insurance Policies That Can Be Bought As Keyman Insurance

Due to recent changes to the rules by IRDAI, only term insurance can be purchased as Keyman insurance. Earlier on, policies under endowment life insurance that had maturity benefits were also on the table.

On term insurance, the policy’s term coincides with the contract period or retirement age of the Keyman. Also, it does not allow for taking loans against the riders or policy.

With Keyman insurance in place, there is a lot of security accorded to employers or owners of companies against losses which is why it is popular. However, the cost of this insurance is not tax-deductible. This means that the premiums are paid using after-tax dollars. Also, the company is entitled to deducting the insurance premiums if they are thought to be part of the taxable income of the employee. In this case, the employee is the beneficiary.

Finally, during the passing away of the insured employee, the death benefit of the key man policy is paid out to the company free of income tax.