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 Key Person Planning 

Key person Insurance, also commonly known as keyman insurance, is an important form of business insurance.  In general, it can be described as an insurance policy taken out by a business to compensate that business for the “economic slippage” – financial losses that arise from the death or disability of a critical member of the business.

To put it simply, Key man Insurance is a standard life or disability insurance contract that is used to offset the loss of skills of the insured as a result of death, or disability.  The extent of loss is something that will need to be estimated.  There are tools we use to help estimate what the loss would be.  It may also be used to purchase a business interest from the key person. Key Person insurance does not indemnify the actual losses incurred but compensates with a fixed monetary sum as specified in the insurance policy contract.

Many businesses have a key person who is responsible for a significant portion of the profits, or has a unique and hard to replace skill set such as Intellectual Property that is vital to the organization.  An employer may purchase a key person insurance contract on the life or health of any employee whose knowledge, work or overall contribution uniquely valuable to the company.  The employer does this to offset the costs (such as hiring temporary help or recruiting a successor) and losses (such as a decreased ability to transact business until successors are trained or the insured is able to return) which the employer is likely to suffer in the event of the loss of a key person.

As key person insurance is more of a type of business risk type than an actual policy, the term is used somewhat loosely and may include other insurance used for other business purposes including:  1.  Buy/Sell Insurance (Shareholder Insurance); Debt Protection or Revenue Protection.

INSURABLE LOSSES

There are four categories of loss for which key person insurance can provide compensation:

  1. Losses related to the extended period when a key person is unable to work, to provide temporary personnel and, if necessary, to finance the recruitment and training of a replacement.
  2. Insurance to protect profits.  For example offsetting lost income from lost sales, losses resulting from delay or cancellation of any business project that the key person was involved in, loss of opportunity to expand, loss of specialized skills or knowledge.
  3. Insurance to protect shareholders or partnership interests.  Typically this is insurance to enable shareholder or partnership interests to be purchased by existing shareholders or partners.
  4. Insurance for anyone involved in guaranteeing business loans or banking facilities.  The value of insurance coverage is arranged to equal the value of the guarantee.

WHO CAN BE A KEY PERSON?

A key person can be anyone directly associated with the business whose loss can cause financial strain to the business.  For example, the person could be a director, of the company, a partner, a key sales person, key project manager, or someone with specific skills or knowledge especially valuable to the company.

KEY PERSON INSURANCE POLICY OWNERSHIP

Key Person Insurance policy contracts may be owned in a number of ways depending on the needs of the business.  It is common for a business to own the policy with claim proceeds being paid directly to the business.  There is no legislative or insurable requirement for the policy to be owned by a specific party or entity and there may be circumstances be it for taxation or policy continuation purposed where policies may be owned and paid for by the insured person directly, or owned by another individual.

TAXATION

Premiums are generally not deductible and proceeds are generally not taxable.  Differences will generally depend on ownership and beneficiary arrangements.

Northrup Burdt Insurance Services
4275 Executive Square, Ste. 400, La Jolla, CA  92037
Phone: 858-597-6700 | Fax: 858-597-6701
 

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