Understanding key person insurance

With many firms reliant on the skills and subject matter expertise of one or a handful of employees, replacing key individuals in the wake of a death or terminal illness can be difficult. Key person insurance is designed to cover the costs of replacing essential employees, acting as something of a lifeline to companies at decisive moments. However, with business protection and key person insurance still a relatively underutilised type of coverage, it is important to understand the finer details of the insurance.

What is Key person insurance and how does it work?

Key person insurance is a form of business protection, aimed at protecting a company from financial distress caused by the death of a key employee.

The policy is designed to cover a company in the case that a specific employee, such as a chairman, director, or founder of an organisation, passes away or suffers a critical or terminal illness. Key person insurance offers companies a way of providing stakeholders with confidence that the firm can operate as usual despite the loss of an essential employee.

Payouts for key person insurance are calculated based on the direct influence a key employee has in creating profits for a company. Calculations take into account the key person’s salary, how long it will take to identify a replacement, the impact the loss will have on net profits, and the time it will take the company to recover.

How is it different to life insurance?

While life assurance policies benefits the families of an employee, key person insurance pays out claims directly to the company.

Along with how key person insurance payment calculations differ from life assurance, which commonly pays out a lump sum based on multiples of an employee’s salary, the policy offers different payment methods. Businesses can either be paid a lump sum, or receive regular payments equal to the same amount.

What is the difference between critical illness coverage and life coverage?

There are two levels of cover that companies can consider, Life only (with terminal illness included) or also including Critical Illness (can be incepted as a standalone policy).

Life cover would pay on the first event of either death or diagnosis of a terminal illness. The diagnosis would need to be within 12 months of the termination date of the policy.

Critical illness cover would pay on the first occurrence of either death, diagnosis of a terminal illness or a stated critical illness as defined in the insurer’s terms and conditions. All insurers would note that the individual would need to meet a stated survival period post diagnosis to submit a claim for critical illness. This is typically 10 days.

Benefits are fully medically underwritten and are subject to confirmation by the underwriter before cover can be confirmed. The amounts of underwriting will depend on several factors including amount to be covered, level of benefit, age of the individual and medical history. Typically underwriting can take 8 to 12 weeks but can take longer depending on the repose time of the medical professionals.

Final terms will be based on the information received and the underwriter reserves the right to impose premium loadings or exclusion based on that information.

What can Lockton do for your key person insurance policy?

Lockton’s role in securing a key person policy will focus primarily on negotiating the right terms for your company.

Whether it’s for a startup which is reliant on one individual, or a company in the midst of a merger or acquisition, Lockton will work to find the best coverage to suit your needs.

We will also ensure that your company has considered all the financial risks attached to losing a key employee, beyond the impact to revenue. This could include the recovery time the company may need, and any loans or other liabilities that may need to be addressed in the wake of an employee becoming ill or passing away.

We use this information to identify the insurer with the best policy for your immediate and future needs.

To discuss how key person insurance works and whether it is the right coverage for your company, please contact:

Antony Thompson, Technical Lead, Employee Benefits

E: antony.thompson@lockton.com

T: +44 020 7933 2878