Key Man Insurance
Today, rapid growth and development is taking place in almost every business sector of the country. This has resulted in great demand of technicians and experienced managers. Since these are the persons responsible for the growth and development of any business or company. The future progress of the business depends on the ability of the company to retain these experts. They are called as the key men of the business.
Who is a key man basically?
The key man is a person whose service pays off immensely and entirely for the success of the business. His contribution to the firm has the maximum value in the progress of the company. He is a technocrat with a special knowledge and skills and cannot be replaced easily. The company will have to spend immensely only on the training of the employees in order to replace the key man with someone with same efficiency. Thus the service of the key man contributes significantly to increase the profitability of the business.
The loss of key man either by his death or voluntary resignation can result in a sharp setback to the progress of the company. The loss cannot be easily overcome unless the company is able to replace the key man with a person of same capability. But this is a difficult job because there is a shortage of technicians and experienced managers. In course of time the company can develop a group of employees who can carry out the functions of the key man wholly or partially. But again this also will require time. In nutshell, it is not easy to replace a key man. So, in such case how the company’s loss can be compensated for the time unless it finds another suitable key man or any other alternative? Well, then here the concept of key man insurance becomes applicable.
What is key man insurance?
Key man insurance is a type of insurance proposed by a business firm or company to insure the life of its valuable and important employee or employees. The purpose of this insurance is to protect the business firm from the financial losses that are likely to occur due to either premature death or resignation of the key man.
The main idea behind the key man insurance is to insure the key man when he is working with the concerned company so that the loss occurred after his withdrawal can be compensated by the insured amount. Before proposing for the insurance of the key man the business or company has to work out two important estimates:
1) Monetary value of the loss that is likely to happen after the death or resignation of the key man.
2) A suitable insurance plan to insure the key man for the period until which the business firm considers his service as indispensable.
After these estimates are made, the company or the business firm then approaches the insurance company for insuring the life of the key man and pays the appropriate premium. Generally a term insurance plan for the period of 10-15 years is granted in key man insurance. The nomination and accident benefit are not allowed under key man insurance. The policy of key man insurance can be assigned only if the key man is resigning from the company.
Although under key man insurance the life of the key man is insured but the beneficiary and the proposer under this policy is the business firm or the company. The company insures the key man for its own benefit. The premium paid by the company for this policy is charged to the company’s revenue account. The relevant proposal form is also signed by the company’s authorized official. Hence the premium under the policy as well as the amount received under the policy is not considered as the benefits of the key man.
Claim payment under key man insurance:
The insured amount is treated as the income of the business in case of death or withdrawal of the key man. The amount is paid either in lump sum or in installments depending upon the impact of loss that the company faces on the withdrawal of the key man. Following two situations might be taken into consideration by the company while paying the claim:
a) If the loss occurred to the company is short lived and to be compensated immediately then the lump sum amount is paid. But this situation is very rare.
b) The loss of the key man leaves the impact over the company for several years and the financial loss that the company face needs to be compensated for the entire period till the replacement of the key man. For this, the insurance company pays the insured amount in variable or uniform installments for the required number of years.
If the key man resigns from the firm then the business firm surrenders the policy to obtain the surrender value as compensation of the financial loss. This surrender value is shown as the income of the business of that year. The surrender amount is very less than the sum assured and hence it does not compensate the total loss of the company and is considered as the partial reimbursement of the loss.
Important features of key man insurance:
1) The main feature of this insurance is that this type of insurance is given to compensate the loss of earnings and the cost of replacement of key man in case of the death of the key man.
2) All the business firms except the proprietary company are eligible for key man insurance.
3) The key man insurance cannot be given in following cases:
a) If the key man is the share holder of his concerned firm with a share of more than 25% of the capital of the firm.
b) If the family members of the key man are the owner of more than 50% shares of the firm’s capital.
c) If the key man is not educated.
d) The key man is a partner in a partnership firm.
Factors for deciding the amount for key man insurance:
The financial loss occurred to a business firm due to sudden death of key man and the cost of replacement of key man differs from firm to firm. It depends on the type of company and the key man’s contribution to the company. While deciding the amount for key man insurance following factors are taken into consideration:
1) The qualification of the key man.
2) The experience of the key man.
3) The different abilities and skills possessed by the key man.
4) The previous records of the key man.
5) The total service of the key man
6) Whether the company is having a single key man or more than one key man
Calculation of permissible amount for key man insurance:
The key man insurance is entirely related with the firm’s profitability. Following three methods are used to calculate the total amount permitted for key man insurance:
1) The total compensation package of the key man including the salary, bonus and all other perks are taken into account and the quantum of insurance is given ten times of this package.
2) The average gross profit of the company for the past three years is calculated and the quantum is given two times of this profit.
3) The average net profit of the company for the past three years is calculated and the quantum is given five times of the profit.
The insurance amount is calculated by taking into account all the three methods and the least amount of the obtained from the three methods is considered as the total permissible amount for key man insurance. If the company is having more than one key man then also the permissible amount is calculated by these three methods and the final amount does not exceed the limit arrived by these methods. It is therefore always beneficial for the company having more than one key man to insure all the key man at a time.
Documents to be submitted for key man insurance:
1) Proposal form duly signed by the authorized person of the company.
2) The moral hazard report filled by the sales manager of the company.
3) Special medical reports if applicable need to be submitted.
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