Key man insurance is a coverage that will protect company in the case of an untimely death or disability of a top salesperson, executive or business owner. Key persons are those within a business who are vital to the business’s profitability and continued financial success. There may be more than one key person within any business.
Who is a Keyman?
The ‘keyman’ here would be any person employed by a company having a special skill set or substantial responsibilities and who contributes significantly to the profits of that organisation.
Who can be a Keyman?
Anybody with specialized skills, whose loss can cause a financial strain to the company are eligible for Keyman Insurance. For example, they could be
1. Directors of a Company
2. Key Sales Person
3. Key Project Managers
4. People with Specific Skills etc.
Why to buy Keyman Insurance Policy?
In case of an unfortunate eventuality to the ‘keyman’, two types of losses can arise for the company –
(a) Loss arising from profit reduction for the company and
(b) Costs for the company in replacing the keyman.
Eligibility for keyman insurance
The ‘Keyman Insurance’ (KMI) is allowed to the employee, if he satisfies the following condition –
1. The ‘keyman’ should hold less than 51% shares of company.
2. The total number of shares of the company held by the keyman and his family should be less than 70%
3. The keyman should be literate.
Benefits to the Company
1. Premiums paid under keyman insurance may be fully allowed as Business Expenses under Section 37(1) of the Income Tax Act, 1961, subject to satisfaction of the assessing authority.
2. Interest on loans taken against a keyman insurance policy may also be allowed as business expenses.
3. Premiums paid by the company on the life of a keyman would not be treated as perquisites in the hands of such a keyman when the company’s request is accepted by the assessing authority.
4. Keyman Insurance policy is a positive measure to improve the retention of the key man in the company.
How to decide the Insurance Worth of a Keyman?
The Sum Assured under key man insurance can be decided by using the following methods –
A. The max S.A. for key man insurance is restricted to 10 times of the keyman’s compensation package (total salary + annual bonuses of a regular nature and paid a fixed percentage of salary + various other perquisites such as furnished houses, utility bills, car and commission out of net profit) The notional value of perquisites is taken as 30% of the gross annual salary.
B. Method of gross profit 3 times of the average gross profit (profit before depreciation) of three years.
C. Method of net profit 5 times the average net profit (profit after allowing depreciation & taxation) of last 3 years. On the basis of above mentioned methods we can decide the max. Sum assured (S.A.) for key man insurance.
Key man insurance to employee of partnership firms
1. Max allowable KMI cover to partnership firms – 3 times of average gross profit of 3 year. Or 5 times of average net profit of 3 year, whichever is lower.
2. The max. Amount of cover will be distributed among the key partners.
3. Key Man Insurance can be given on the lives of more than one partner.
Advantages of keyman insurance to the company
1. In case of death of a keyman the company gets money to cope up with the loss
2. Any company buying keyman insurance for its employee can claim a deduction for the premium paid for the policy as a business expense under Section 37(1) of the Income Tax Act.
3. No advance intimation/approval is necessary from the Income Tax authorities to claim deduction of insurance premium payment.
4. The fact that the employee/director’s life is insured for a large sum that will be paid by insurance company to his family if he dies, it is bound to ensure loyalty and avoids employee turnover.
5. For the executives earning high salaries, this policy can be given as a hike in salary and save on the tax outgo.
6. It helps the company in its tax planning.
7. The directors can also safeguard their immediate family from getting affected by the vagaries of the industry and the various business cycles that company has to face.
8. Insulate the risk of financial loss against loss of a Keyman.
9. Interest on loans taken against a keyman insurance policy may also be allowed as business expenses.
10. Premiums paid by the company on the life of a keyman would not be treated as perquisites in the hands of such a keyman when the company’s request is accepted by the assessing authority.
11. Keyman Insurance policy is a positive measure to improve the retention of the keyman in the company.
Disadvantages of Keyman insurance
1. The amount on claim or maturity under a keyman insurance policy is not exempt under Section 10 (10D) of the Income Tax Act if the company is paying the premiums. However, in case the policy has been assigned to the keyman and the keyman is paying the premiums, then the claim/maturity proceeds are exempt under Section 10 (10D).
2. Company is liable to pay FBT on this expense. This is treated as Employees Welfare & FBT is to be paid at 30% of 20% of value of fringe benefit i.e. 6% of value of FB