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Key person insurance

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Business activities sometimes rely on a limited number of directors and employees, or even a single individual; the smooth running of the business would be seriously disrupted if they were unavailable or died, and could result in a financial risk that could harm the whole organization.

A business’s development and prosperity are often closely connected with key people: a director, scientist or high-level specialist, a technician, sales representative or even an external contributor can have a reputation, knowledge, experience or know-how that are difficult to recreate.

“Key person” cover is designed to provide compensation for the harm suffered by the business in the event of the individual they view as their “key person”, whose contribution they believe is essential to the business, becoming unavailable or dying.

The key person may be a director, scientist, technician, sales representative or even someone outside the business.

The prevention plan consists of the company paying in premiums designed to cover the risks of losses arising if the employee concerned should die. 

Should the insured event (death or incapacity of the insured person) occur, either:

  • The capital sum fixed when the policy was taken out will be paid; or
  • Compensation will be paid for the harm caused by the non-availability of the insured person; this is then a form of “business interruption” cover.
    An industrial, commercial or agricultural business can insure against death so that it has the necessary liquidity at a critical time to:
  • Cover a fall in sales,
  • Facilitate a reorganization,
  • Maintain its financial position and reassure bankers, suppliers and clients,
  • Relaunch the business, if necessary with the support of a rescue package.

The insured party whose loss would present a risk must be identified. It might, for example, be the person who:

  • Generates or is responsible for producing a significant share of the business’s sales;
  • Monitors the smooth running of all production departments;
  • Drives the business’s strategic direction, defines future development priorities, etc.

Hence the description “key person”. Insurers offer businesses term insurance policies to provide protection from the consequences of their absence. Individuals likely to fit this description should be identified based on each business’s specific circumstances.

In practice, it means examining the business’s organizational and operational arrangements, the legal relationship between the business and the “key person”, and the qualities and skills the employee possesses (knowledge and proficiency in an art, science or technique directly associated with the company’s objects). The most common situation is that of the individuals(s) who run small and medium-sized businesses.

Note: Insurance policies of this kind are exempt from deductions of 20%/31.25% on the capital paid in, liable to be deducted when the insured person dies.

“Key person” insurance is like an insurance policy taken out to benefit the business. It is the business that receives the payment if the insured employee dies. The named beneficiary cannot be changed with this type of insurance.

The insured risk relates to the monetary loss resulting from the death or disability of the person who is no longer able to work within the business.

The cover can be indemnity-based or for a fixed sum:

  • Indemnity: this covers the business’s operating losses based on its actual situation;
    The amount of capital guaranteed is based on its size, loss of earnings and the costs of finding and training the “key person” concerned;
  •  Fixed sum: the sum paid at the end of the policy is determined when it is taken out.
    Should the insured person die or become permanently disabled, the insurer will pay the insured capital to the business. In the case of temporary non-availability, the insurer will pay a daily or weekly indemnity.

In the case of a family business, for example, it may be sensible to safeguard the family’s assets in light of the amount of inheritance tax due, which can be very significant, maintain the balance within the family by producing a satisfactory split and appropriate division of powers, and give the person who takes over the business the means to ensure it survives and thrives over the long term.

Another type of policy will then come into play, sometimes known as a “partners” policy.

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