Protecting your business through insurance is quite simple. Business owners will insure everything from equipment and physical stores, and in some cases, external elements like fires, natural disasters or social disturbances. One type of insurance most small and larger businesses ignore is key person insurance.
Only one in five South African small and medium-sized enterprises (SMEs) have adequate key person insurance to protect against the sudden loss of a vital employee, founder, or specialist. This coverage remains critically underutilised despite growing awareness of business vulnerability tied to specialised talent and intangible assets.
In today’s article, we look at what key person insurance is, how it works, what it covers and where to get the best cover for your business.
What is Key Person Insurance?
Key person insurance is a company-owned policy that protects a business from major financial loss if a vital employee, founder, or executive dies or becomes disabled. The company pays the fees and receives the cash payout to cover lost profits, pay debts, or hire a replacement.
How does Key Person Insurance Work?
Key person insurance is a type of life insurance policy designed to pay a business upon the death of the insured, as opposed to that person’s beneficiaries. The ‘key person’ could be a company owner or partner, or it could be a high-value employee such as someone with specialised knowledge or skills, or the person who brings in an outsized portion of the firm’s revenue.
The key person insurance policies are generally reserved for employees whose absence will be a financial burden to the business and will be difficult and expensive to replace. The policy provides funds that can help ensure business continuity if a key employee dies or becomes disabled, provided the policy has an additional disability rider.
Key person insurance is unique in that the business owns the policy and pays the premiums, so it’s a type of company-owned life insurance (COLI). However, before a COLI policy can be taken out on a key employee, life insurance companies require the written consent of the person being insured.
When to Consider Key Person Insurance Policy
In some cases, businesses will take out key person insurance because they are applying for funding, and the lender or investor requires key person life insurance as collateral. Other reasons for a business to take out this kind of coverage include:
- If the business is named after the owner or other key person (for example, a part or former owner).
- If the company is significantly linked to a person’s reputation, skillset, or financial viability, and that person’s death could jeopardise the business’s stability.
- If the loss of the key person could impact the company’s sales or finances, exposing the business to operational and financial risk.
- If you are the sole proprietor of a small business and want to provide an insurance payout that enables your heirs to close the company and pay off any debt.
- If the business is a partnership, and each partner wants funds to buy out the other’s shares in case of an untimely death. This is usually done as part of a written buy-sell agreement among the partners. In this case, key person insurance can protect the financial interests of partners by funding buyouts or ownership transfers in the event of a partner’s death.
Types of Key Person Insurance Policies
Before you take out insurance, you must consider which type your business needs. Consider the following:
Term Life Insurance
Term life insurance is more affordable for a healthy employee, but the coverage is temporary. Term policies last for a specific period of time that generally ranges from one year to 30 years. At the end of the policy period, you may be able to purchase another one. Yet, the premiums will be significantly higher due to age, and there is a chance the person will be uninsurable for health reasons, as factors such as the insured’s age, health, and lifestyle will influence the premium.
However, assuming the key person is not the business owner or partner, then term insurance may make sense because you can get a policy with a fixed period that lasts until the person’s expected retirement or separation date.
Permanent Life Insurance
Permanent life insurance has higher premiums but can provide additional benefits for businesses. Unlike term, these policies don’t expire as long as premiums continue to be paid. More significantly, permanent insurance builds cash value that the business can borrow against or withdraw from for future expenses.
Unlike bank loans, there is no credit application required when borrowing against a permanent policy, and the interest rates are usually lower. The loans don’t have to be repaid to the insurance company, but any outstanding balance will lower the death benefit.
Under permanent life insurance, there are two categories: whole life and universal life insurance.
Whole Life Insurance
Whole life insurance has a guaranteed premium that stays level for the duration of the policy, with an accumulating cash value, tax-efficient, at a predictable fixed interest rate. Some mutual companies will pay dividends for whole policies.
Universal Life Insurance
Universal life insurance can also build tax-efficient cash value while providing more flexibility. These policies let you vary premium payments within a certain range. Some policies will let you tie cash account growth to market investments, giving you more upside growth potential, along with exposure to market volatility and risk.
Key Insurance Providers in South Africa
The following companies are those to consider before taking out a key person insurance policy.
Old Mutual
Old Mutual pays a single tax-free amount to the business when a key person such as a director, manager, business partner or employee dies. This payout can be used to minimise financial losses incurred by the loss of the key person. Not only can you cover your key person for death, but also for disability, functional impairment or severe illness.
Benefits include:
- Old Mutual Protect Business Disability Cover: Pays a single amount between R100 000 to R30 million because of an illness or injury, you become permanently disabled and can’t work or are permanently impaired or can’t take care of yourself.
- Old Mutual Protect Business Functional Impairment Cover: Pays a single amount between R100 000 to R30 million if, because of an illness or injury, you become permanently impaired or can’t take care of yourself.
- Old Mutual Protect Business Severe Illness Cover: Pays a portion of the cover amount between R100 000 to R6 million if you suffer a severe illness such as a heart attack, cancer or stroke. If your quality of life is severely impacted by treatment and you can’t care for yourself, the Cancer Enhancer will boost the payout by up to 25% of the cover amount.
FNB
FNB’s key person insurance provides Life Cover up to R100 million with no waiting periods, and Disability Cover up to R50 million can be added as a rider or chosen as a standalone benefit. To qualify, your business must have:
- Valid FNB Business account
- Life assured persons must be:
i) Older than 18 years
ii) Employed by your business
iii) Younger than 70 years to qualify for the life cover
iv) Younger than 60 years to qualify for the disability cover
Momentum
Business life insurance from Momentum Business Assurance helps protect your business against the financial impact of the owner’s death or disability, ensuring business continuity and financial stability. Coverage options include:
- Contingent liability cover: Any business liabilities (outstanding debt) is settled in full.
- Loan account protection: Business loans are fully repaid.
- Key person cover: Covers the cost of losing a valuable employee.
- Business interruption cover: Protects the business in case of any disruptions so operations can continue.
- Buy and sell arrangement: If the business owner dies, remaining owners can buy their shares.
- Momentum trust: If you want to create a will for yourself and your business.
When selecting a provider for your key person insurance policy, ensure you know what you want to be protected against, how the business will benefit and what it will cost you to take out the cover.
