By Tushar Chatterjee
Today’s businesses are thriving on specialised talents. Hundreds of startups are coming up every month and some of these are becoming unicorns in a short span of time. In most of these enterprises, the invaluable contributions of a few are actually keeping the business profitable. They are the key persons of these firms.
What will happen if such key persons die prematurely, before the date of retirement or before the end of contract period? It will be extremely difficult to find a suitable replacement. Sometimes, it may take weeks and even months to get an equally talented person to step into the shoes of the departed key person. A lot of expenses may have to be incurred to properly train a future ‘Key Man’.
Insuring lives of key persons
Does the insurance industry have any solution to manage such risks? Yes, Key Man Insurance (KMI) is the answer. As the name suggests, KMI policy insures the life or lives of the key persons of a company. The premiums are paid by the employer and the beneficiary is also the employer, money being available only if the Key Man dies while being in such a key position that his absence can result in significant financial loss of the company. Insurers will indemnify the losses through appropriate term insurance policies.
How much insurance cover should be taken on the life of Key Man (or Woman)? The simple answer is, the amount of insurance should be the likely loss of profits as a result of the death of the Key Man. The underwriter carefully examines the qualifications, experience and the compensation package of the Key Man. He also examines the financial statements of the company. All these documents enable the insurer to arrive at a prudent underwriting decision.
KMI is a high-risk plan since the sum assured involved is very high. While it is extremely difficult to quantify the likely loss of profits which may happen following the death of the Key Man, the thumb rule is to allow a maximum sum assured of 10 times the annual compensation package of the Key Man. If the annual package is Rs 50 lakh, it is quite reasonable to look for a risk cover of Rs 5 crore. Another method is to grant a maximum sum assured which equals five times the average of the last three years’ net profits.
Which formula will be applicable also depends on the nature of the concerned company. There are separate criteria for partnership companies and public limited companies. Another consideration of issuing KMI is to check whether the shareholding of the Key Man is less than 75%. In case it exceeds 75%, the KMI will not be available.
The writer is an insurance industry analyst.