Key Person insurance is an important form of business insurance. There is no legal definition for “key person insurance”. In general, it can be described as an insurance policy taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business. To put it simply, Key Person Insurance is a standard life insurance, TPD insurance or trauma insurance policy that is used for business succession or business protection purposes. The policy’s term does not extend beyond the period of the key person’s usefulness to the business. Key Person Insurance policies are usually owned by the business and the aim is to compensate the business for losses incurred with the loss of a key income generator and facilitate business continuity. Key person insurance does not indemnify the actual losses incurred but compensates with a fixed monetary sum as specified on the insurance policy.
Many businesses have a key person who is responsible for the majority of profits, or has a unique and hard to replace skill set such as Intellectual Property that is vital to the organization. An employer may take out a key person insurance policy on the life or health of any employee whose knowledge, work, or overall contribution is considered 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) which the employer is likely to suffer in the event of the loss of a key person.
Advantages of Key Person Insurance
- In case of death of a Key Person the company is paid money to cope up with the loss.
- In the USA, any business concern buying Key Person insurance for its employee can claim a deduction for the premium paid for the policy as a business expense under Section 37(1) of the Income Tax Act. Tax deductions may also apply in other countries.
- This policy can be used as either an extra super annuation benefit or an ex-gratia payment to the key employee during the service period. If the company receives the proceeds on maturity, then they may be taxable. (With recent changes in rules, only Term Plan is available under Key Person Insurance. Hence, there will not be any maturity benefit)
- No need of giving advanced intimation to the income tax authorities.
- The company can also raise loans on the policy from LIC. (On Term Plan, no loan is available)
- For the executives earning high salaries, this policy can be given as a hike in salary and saves income tax.
- It becomes a great help to the business for their tax planning.
- The directors can also safeguard their immediate family from getting affected by the vagaries of the industry and the various business cycles that the business has to encounter.
- Key Person Insurance policy helps to improve the retention of key human resources of the business.