Things to Consider Before Buying Key Person Insurance

Key person insurance (also known as keyman insurance) is an important type of cover for businesses that have personnel who play an invaluable role in the organisation (e.g. business partner or executive). The business will be compensated in the event that that person ceases to be a part of it due to serious injury, illness, or death. The compensation will be important in helping the business do anything from looking for a person to replace the former key person, hiring a person to fill in the vacancy on a temporary basis, meeting financial responsibilities (paying employees, suppliers, etc.) in case the business goes bankrupt due to the key person’s departure, as well as purchasing the shares from the family of the key person in the event of the person’s death.

This type of insurance is especially important to small businesses that may not be able to handle the impact of a loss of key personnel, especially when it comes to the financial aspect of the business. In general, however, any organisation that has employees that they consider valuable to their operations could benefit much from this insurance.

Before taking out key person insurance, it is important to consider a number of things. These things will help ensure that the policy being bought is something that meets the needs and circumstances of the organisation. These include:

1. The type of insurance to take out. The business has several options when it comes to the types of insurance to take out under key person insurance. These are: life cover, trauma cover, and disability cover. With life cover, benefit will be paid when the insured key person dies. Meanwhile, trauma benefit will be paid out in the event is diagnosed with a trauma condition listed in the policy (e.g. heart attack, stroke, cancer). Disability cover the benefit payment will be given out when the insured becomes incapacitated in the case of disability insurance.

2. The cover amount. It is also important to consider the benefit amount when taking out key person insurance. The figure ranges between $500,000 to $10 million although the actual amount would depend on a number of factors, such as the size of the business and the particulars of the person being insured.

3. The person to cover. Naturally, you have to elect a person to insure as well. In general, this type of insurance is often taken out to cover executives in the company or partners, since they play a very important role in the organisation. However, if you have other key personnel who will be difficult or costly to replace, consider electing them as well.

4. Revenue or Capital Purpose. A policy needs to be attributed to either a revenue or capital purpose. The Revenue purpose relates to protection against loss of revenue as a result of a key person no longer being able to contribute due to death, critical illness or total and permanent disability.

The capital purpose entitles a business to receive a benefit to help pay outstanding loans, other capital expenses that occur should a partner be forced to exit the business. 

If the Keyperson insurance is taken out for revenue purposes, which is typically owned by the business, then generally any claims are subject to taxation.

If Keyperson insurance is taken out for capital purposes the tax consideration depends on the policy ownership. For death claims where the beneficial owner is the company, then this is generally not assessable for tax purposes. Where the company is the beneficial owner for TPD or Trauma policy claims capital gains tax might apply. When owned by an individual, capital gains tax is generally not applied.  

As the tax considerations can be complex it pays to speak to the businesses accountant.  

5. Tax considerations.  Since this type of insurance is geared towards businesses, it’s inevitable for tax issues to come up, especially when a claim arises because it can be a substantial amount.

Are premiums tax deductible?

In terms of premiums being tax deductible if the main purpose of the policy is for revenue considerations, then the premiums paid are generally tax deductible. If a policy is for capital purposes, then it is generally not tax deductible.

Do I have to pay tax on claims?

When looking at tax implications the purpose of the policy (revenue or capital purpose) as well as the ownership of the policy (company or individual) is taken into account come claim time.

If the Keyperson insurance is taken out for revenue purposes, which is typically owned by the business, then generally any claims are subject to taxation.

If Keyperson insurance is taken out for capital purposes the tax consideration depends on the policy ownership. For death claims where the beneficial owner is the company, then this is generally not assessable for tax purposes. Where the company is the beneficial owner for TPD or Trauma policy claims capital gains tax might apply. When owned by an individual, capital gains tax is generally not applied.    

6. The Insurance Company. As with other types of insurance, it is also important that you compare insurance options as different providers have different pricing for particular sweet spots. This will help ensure that you are getting a policy that suits your purpose of taking out insurance, your budget, and other considerations you may have.

At Rate Detective we compare quotes from 9 insurance companies across Australia to help make the process of comparing quotes quick and easy on your end. To get started, make an inquiry and one of our qualified advisers will be in touch to discuss your requirements.

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Published on March 3-st, 2014 in Insurance
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.

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