Explained: What is Keyman insurance policy?

If your employer has a significant insurable interest in you, that is, if your loss would cost your employer a great deal since your services are considered invaluable by the firm (eg. you’re the chief executive officer or heading a key department), the company can get you a life insurance policy. This is also known as keyman insurance policy. The employer becomes the proposer and pays monthly premiums for the policy and gets the sum assured in case of the employee’s sudden demise.

As an organisation, you tend to put a lot of time and effort in growing and polishing the talent pool. This is part of your overall investment in the due course of running a company. Therefore, it only makes sense to insure the position of important employees that are invaluable to the company’s growth and everyday success. The primary objective behind this policy is, thus, to protect the company in case of an untimely death of the ‘keyman’ or the key person with insurance proceeds received.

Who can be a keyman? 

The key person insured by the company under Keyman insurance can be anyone with specialized skills and whose loss will certainly cause a financial strain to the company. For example, such people may include the top directors of an organisation, key sales and marketing people, upcoming project managers or anyone with exclusive skills, etc.

The death of any employee can bring about two types of losses to the company.

– Loss due to immediate profit reduction

– Costs for replacing the deceased keyman with a new employee alongside time and effort in training them from square one

Insurance worth of keyman

The insurance worth of a keyman is considered either five times the average net profit of the company for the past three years or two times the average gross profit of the company for the past three years or ten times of the keyman’s annual compensation package. The lowest amongst these is considered for insurance.

Now, if the company has already bought a keyman insurance, the sum assured will be paid to the company in case of the demise of such employees. This amount is considered to be quite high and believed to cover for business downturn and new recruitments. However, if the insured key person survives the term of the insurance, no money is paid to the company.

Benefits of keyman insurance

The keyman insurance is actually a pure term plan that can be purchased by a company to cover the life of an important employee. But, this policy has many other uses as well. The sum assured that an employer can claim with a keyman insurance allows them to recruit and train individuals as per their needs, secure and settle loans, offer salary continuation arrangements to the spouse of the deceased and fund executive compensation plans among other facilities. Here are other advantages of such a policy.

– The policy contributes to the company’s tax planning, i.e., any company buying a keyman insurance for its employees can claim a deduction for the premium paid for such policies as a business expense under Section 37(1) of the Income Tax Act.

– No advance intimation or approval is needed from the Income Tax authorities to claim such deductions of insurance premium payment.

– The company can also raise loans on the policy from LIC.

– Apart from recruiting and training employee replacements, handling debt and liquidation of the company become easier when the business is covered by keyman insurance.

This type of insurance plays a rather important role in family businesses that are mostly dependent upon a few key individuals. It will also help start-ups take on any early financial losses due to the death of the co-founder or other executive members. It can act as the perfect financial shock absorber during an employment crisis.

Watch outs

If the keyman insurance policy, after attaining maturity, is endorsed to the employee, then it is chargeable for taxation under Section 17 of the Income Tax Act. This is because, it is now treated as ‘profit in lieu of salary’ in the hands of the employee. Meanwhile, in case the insured keyman is retiring, the company can surrender the policy for its cash value or assign the policy in favour of the keyman itself.