In our last blog article we discussed whether shareholders in a company ought to have life insurance policies to help protect the value of the shareholding in their business and look after their loved ones if one of them died. “Key-Man Insurance” is another option to help protect your business. In this article we will explain what it is, how it works and if it is useful for you to have this insurance in place for your business.
What is key-man insurance?
Key man insurance is a life policy that is taken out on an important employee within the company. Where there are several such personnel who are critical to the business, you can have life insurance on each of them if you wish. In small businesses this can be the owner(s), the founder(s), directors or senior managers. You should ask yourself:
- who is your most valuable player, and
- would your business still run as effectively without them if you suddenly lost them?
How does it work?
The business will:
- take out a life insurance policy on a key player (with their consent),
- pay the insurance premiums, and
- be the beneficiary of the policy.
If the individual dies or becomes critically sick (if applicable), the company receives a lump sum.
Who benefits from it?
The purpose of key man insurance is to help the business survive after a key player dies while part of the business or becomes critically sick (if you also have critical illness cover with the key man policy). The business can use the insurance proceeds:
- for any expenses that arise due to the illness or death (e.g. paying other staff to cover the ill or deceased employee’s duties until the ill employee is well again or until they can find a replacement), or
- to cover profits that are being lost which the critical employee used to generate.
Do I need key-man insurance?
Unlike the life insurance that we looked at in our last article (which pays out to the surviving shareholders, to help them buy out the shareholding of a deceased shareholder), key man insurance covers just one or more individuals who are important players in the business. If you feel that if a key person were to become long-term sick or to die that this would adversely affect your profits significantly, then you might want to consider taking out this type of insurance.
Where you have more than one owner of the business, it is even more important. Holding this sort of insurance makes it easier for the survivor(s) to:
- continue the business while you find a replacement, and
- even out the likely loss of profits this causes.
If you need any help in setting up such an arrangement, simply get in touch with us at Legalo.
Key-man insurance and shareholders agreements
The good news is you do not need to modify any existing shareholders agreement. However, as with our article on life insurance for shareholders, if you have more than one shareholder in the company, you will need a good shareholder s agreement in place whether you want to have key man insurance or not – if you still need one, take a look at our shareholders agreement template here, which will not need any modification regarding whether you have key man insurance.