Businesses use both key man and shareholder protection insurance to protect them against losses resulting from a significant person abruptly dying. However, they are not the same thing. Key man insurance is a payment made to the company when a critical individual passes away, whereas shareholder protection is a payout that allows existing shareholders to buy shares of another shareholder.
To better understand the difference between key man and shareholder protection, let’s take a look at both in more detail.
What is key man insurance?
Key man insurance – also sometimes called “key person insurance” – is a type of insurance that covers losses resulting from the death or incapacity of a person who is critical for generating profits at your firm. The key person can be the business owner, an executive or an individual employee. For instance, you might take out key man insurance on a sales director or marketing manager if they are responsible for a significant proportion of company revenue.
When taking out key man insurance, you’ll need to provide the insurer with a lot of information. They will then use this to tailor a policy depending on your circumstances and the needs of your business.
In the event that the key person dies or is no longer able to work, you can opt for either a cash lump sum or smaller regular payments to assist with the continued running of the business. You can then use this money to keep the business afloat, hire new staff (perhaps at a higher rate) or close the company without going bankrupt.
Key man insurance often offers significant tax advantages. Because you purchase it through the company, you can designate insurance premiums as an expense. This way, you can reduce your taxable income while protecting your firm at the same time.
What is shareholder protection?
Shareholder protection is a policy that pays out money if a shareholder passes away because of a critical illness covered by the terms. Usually, the goal is to ensure that their shares can pass to existing shareholders so that they can maintain control of the company.
You can set up a shareholder protection policy if there are two or more shareholders in the business. Options include own-life plans in a business trust or company share purchases.
Own-life plans are where each company shareholder takes out protection through their life insurance which is then written into a business trust. When a shareholder dies, the insurance company uses money from the trust to help existing shareholders acquire their leftover shares.
Company share purchase occurs when businesses take out policies on the lives of all shareholders. Instead of going into a trust, the insurance payout is paid directly to the business, allowing it to buy out the shares of the deceased person and then cancel them, increasing the percentage shares of remaining shareholders.
What are the key differences between key man and shareholder protection?
While they might sound similar, there are some key differences between key man and shareholder protection. Here is a summary:
1. Key man insurance payouts go to the company, while shareholder protection goes to shareholders.
2. Key man insurance protects against profitability loss if a critical person passes away. Shareholder protection pays out if a shareholder passes away, whether they are critical to operations or not.
3. Key man insurance does not adjust equity ownership at the company, whereas shareholder protection does.
Should companies take out both shareholder protection and key man insurance?
Whether you take out both shareholder protection and key man insurance depends entirely on your circumstances. If you are the only shareholder in the business, then shareholder insurance isn’t necessary. However, if you would like the company to remain under the directorship of current owners, then it is something you should consider.
Likewise, if your company depends on one or two people for its success, then you should consider taking out key man insurance. However, if all your staff and managers are highly replaceable, then there is often no need.
Speak to an insurance expert today
Working out whether you need either of these policies can be a complicated process, particularly if you are new to the concepts. Fortunately, at WIS, we’re here to help you find the right cover for your business.