Key person insurance: Mastering the art of seamless business transition

Most businesses have key persons — people without whom the company could face financial or operational challenges and eventually cease to exist, thus impacting every employee. Such roles often include the top-level management or the C-suite. So, how can businesses protect such key persons?

‘Key person insurance’, also known as ‘key man/woman insurance’, is the most viable solution, according to many seasoned corporate advisors and prudent companies. As the name suggests, key person insurance is a life insurance policy that a company purchases for employees considered important to its business. The company pays the premiums and is the beneficiary of the policy. In the event of an untimely death, critical illness diagnosis, long-term disability, or life-threatening injury of the insured employee, the company receives a payout from the insurer. 

The need for key person insurance: A corporate perspective

Key person insurance can come in handy for organizations with a top-down approach to management, where important decisions are taken at the highest level and then communicated to subordinates. In such organizations, a decision-maker’s death can leave a leadership vacuum with operational and financial consequences. The payout from the insurer buys the company the much-needed time to fill the leadership void, cover any losses incurred, meet the costs of new recruitment, and get back on its feet. 

SMEs and niche businesses, which revolve around the decisions of the founding team, can benefit immensely from insuring the key persons. Such companies’ vision is embodied by the founders or owners, without whom the investors and creditors may lose confidence. A financial boost from the insurance payout can restore their confidence, at least in the near term, before strategic decisions can be taken to either continue or liquidate the business. Additionally, the payout can be used to clear outstanding liabilities, facilitate investor exit, and provide severance to employees. To that end, key person insurance can be viewed as a risk mitigation strategy by corporates, especially SMEs and niche businesses. 

Things to consider before purchasing key person insurance

One of the first actions that we advisors recommend to companies contemplating key person insurance is identifying employees they perceive to be critical to ongoing operations and revenue growth. That could be anyone, from the top-level management to the entry-level workforce, who is irreplaceable in the short term and without whom everything could come to a standstill. Once the company determines who meets those criteria, we dive into the nuances. 

The risks associated with the death and disability of key employees vary between industries. High-risk industries could invite higher premiums and more conditions. At an individual level, the person’s influence in the company, health, age, etc., are the considerations for underwriters and insurers to check for feasibility. A coverage value of at least 10 times the key person’s annual salary is recommended. That said, the coverage value can also be determined by analyzing the potential financial losses or the replacement costs in the event of the key person’s death. 

Different insurance types for specific corporate requirements

Another important decision for companies revolves around the selection of the insurance type most suitable for their specific risks. Broadly, key person insurance can be categorized as term and whole-life, each accompanying unique pros and cons. Term life, though typically cheaper than whole-life insurance, has no investment value. On the other hand, whole-life insurance can build cash values, enabling businesses to collateralize them for loans. Such products are more feasible for founders, who are bound to remain indefinitely with the company in most cases. In that scenario, a good whole-life policy can open up a new line of credit for the company. 

For companies seeking more flexibility, universal insurance can be a viable option due to adjustable premiums and death benefits and, most importantly, easy portability. Subject to certain conditions and considerations, universal life insurance policies can be transferred to the company, which can use the accrued cash values and boost liquidity. Lately, new insurance solutions have increasingly accompanied disability coverage, providing companies with a financial safety net in case the key person is incapacitated or unable to exercise their duties due to an accident, etc. Though disability coverage yields a lesser payout compared to death benefits, it is recommended due to the higher likelihood of disabilities than death. 

Key person insurance can be procured along with general liability, data breach, and commercial property insurance as part of a comprehensive risk mitigation strategy. General liability insurance protects the business from libel and false advertising, among other risks, while commercial property solutions provide financial relief if the office space witnesses fire incidents, theft, and more. Data breach insurance, in particular, is becoming increasingly critical for organizations pursuing digital transformation.

A comprehensive strategy involving these insurance solutions is recommended for family offices in the Middle East, which are exposed to multiple and evolving risks due to diversified businesses. As nearly 90% of private companies in nations like the UAE are family businesses, with their operational resilience and success tied to GDP growth, their comprehensive insurance protection is also a governmental priority.

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