What is Key Person Life Insurance?
Key Person Life Insurance or Key Person Disability Insurance can be used to give a business financial protection from financial loss due to the death, disability, or illness of a key individual whose skills, knowledge, or relationships are vital to the business. A claim on this insurance can provide a cash injection to offset the reduction in revenue or cover the debt obligations in a business.
If your business relies on a key individuals to drive the revenue or maintain the debts of the business, and their death, disablement or trauma would have a substantial effect on profits, Key Person Insurance is a consideration to provide financial support.
Who Is a Key Person?
A key person is someone whose continued association provides significant economic gain to the business. This could include:
- Business owners
- Managing directors
- Sales managers
- Financial controllers
- Technical experts
- High-profile individuals
Types of Key Person Insurance
At a high level, there are general two main reasons for getting key person insurance.
1. Capital Protection
Used to maintain the capital value of the business. It helps with:
- Preserving goodwill
- Maintaining credit standing
- Repaying loan accounts or external debts, and/pr
- Protecting personal guarantees
Debt Reduction/Guarantor Protection Insurance is a subset of capital purpose cover, ensuring business debts are repaid if a guarantor/key person dies or becomes disabled.
2. Revenue Protection
Used to stabilise business cash flow and profitability. It covers:
- Loss of revenue from the key person
- Recruitment and training costs
- Temporary staffing and overtime
- Morale and productivity impacts
You would need to work with professionals such as your accountant, lawyer and life insurance broker to understand this further and what cover is suitable and how it should be arranged based on your unique circumstances.
Determining the Level of Cover
Your accountant, together with your life insurance adviser can guide you on how much and what type of cover is needed. For example :
- Capital Cover: You may consider values based on business valuation, loan amounts, and goodwill.
- Revenue Cover: Often calculated as a multiple of the key person’s salary or contribution to revenue (e.g., 2 years of lost revenue).
Ownership structure
There are several different options on which legal entity can own any insurance, such as the business, self-ownership or an insurance trust. Careful consideration and advice is needed before making a decision in this regard.
Key differences from individual life insurance
- Owner and beneficiary: With key person insurance, the business commonly owns the life insurance policy and receives the benefit. With individual owned life insurance, the individual or their chosen beneficiary commonly owns the policy and receives the benefit.
- Purpose: The funds from a key person policy are commonly used for the business’s financial needs, while individual life insurance benefits are for the personal beneficiaries or the person themself.
Tax Treatment Summary
The specific arrangements of any cover you arrange need to be considered to understand the taxation implications. At a high/general level, the following is the common treatment.
Capital Purpose Cover :
- Premiums: Not deductible
- Proceeds: Not assessable (death), CGT may apply (TPD/trauma)
Revenue Purpose Cover :
- Premiums: Deductible
- Proceeds: Assessable income
Documentation
To substantiate the purpose and ensure correct tax treatment you should work with your lawyer and accountant to ensure you have suitable meeting minutes and file notes regarding the cover and other relevant documentation.
Hypothetical Example
Scenario: Dr. Brown’s Family Medical Practice
Business: A busy general practice in Sydney with 3 GPs, 2 nurses, and 5 admin staff.
Key Person: Dr A Brown — founder, senior GP, and the face of the clinic. She brings in 60% of the clinic’s revenue and has long-standing relationships with most patients.
The Event :
Dr. Brown is diagnosed with a terminal illness and passes away within months. The clinic faces:
- A sharp drop in patient bookings
- Loss of trust from long-term patients
- Revenue decline of nearly 50%
- Difficulty attracting a replacement GP of her calibre
How Key Person Insurance Helps
Policy: The clinic had a $1 million Key Person Life Insurance policy on Dr. Brown.
Payout Use:
- $300,000 to cover 6 months of operating expenses while revenue stabilises
- $200,000 for recruitment and relocation of a new senior GP
- $150,000 for marketing to retain and attract patients
- $350,000 to repay a business loan that Dr. Brown had personally guaranteed
Outcome
- The clinic remains open and retains most of its staff.
- A new GP is hired within 4 months.
- Patients are reassured by the continuity of care and communication.
- The business survives a potentially devastating loss.
Important Note. The information provided contains general information and examples and does not take into account your personal objectives, financial situation or needs. It is important, before deciding whether to act on any of the topics. that you consult a licensed or authorised financial adviser if you require financial advice that takes into account your personal circumstances. You should also review the Product Disclosure Statement (PDS) issued by each insurer before considering further. Note that the policy wording will differ from insurer to insure and loadings, exclusions and other limitations may apply by the insurer to each applicant on a case by case basis. Life insurance and Financial Advice services are provided by Experien Insurance Services Pty Ltd (EIS) ABN 99 128 678 937 and Experien Financial Services Pty Ltd (EFS) ABN 32 631 346 757. EIS and EFS are a Corporate Authorised Representative (No. 320626 and No. 1274354) Count Financial Limited ABN 19 001 974 625, AFSL 227232.
