Keyman insurance is an insurance taken by a business firm on the life an employee (Keyman) whose services contributed substantially to the success of the business of the firm.

Key Man Insurance

The object of Keyman insurance is to indemnify a business firm from the loss of earnings resulting from the death of a valuable employee.

Loss of earning may occur because immediate replacement of the Keyman may not be possible and it may take a longer time to train another person to perform his functions. Further loss may occur if the Keyman insurance can be estimated to be the monetary values of the likely to the profits of the likely to the profits of the concern due to the death of the Keyman.

WHO IS KEYMAN ?

“Keyman is a person whose services contribute substantially to the success of the business Generally he is a person with special technical knowledge who can only be replaced at a considerable cost of training.

The basic purpose of the company taking this insurance is to protect itself against premature death of a person whose services to the firm have significant and unique effect on the profitability of the firm operations.

It implies therefore that in the period immediately following his death, there will be a vaccum in the company in the company with the result that the company with the result that the company incurs financial losses or even at times becomes unable to fulfill the commitments made by it.

The insurance money in such circumstances come in handy. If this reason for indemnifying against loss is absent or if the sum assured is excessive in relation to the object, the moral hazard is high.

Keyman Insurance can be taken by business firm on the life of its employee/s and no benefit of any sort accrues to the concerned employee/s .

While the primary object of this insurance is to protect the company against premature death of valuable employee, the company secures also some tax advantages.

The keyman is an employee or a director, whose services are perceived to have a significant effect on the profitability of the business. The premium is paid by the employer.”

Thus Keyman Insurance cannot be given in the following cases-

1. Keyman has share holding of more than 51% in the firm.
2. His Family has a share holding of more than 70% in the firm (Family” of Keyman includes Keyperson, spouse, minor children.)
3. The Company is incurring is losses consistently.
4. The Keyman is illiterate.

The Keyman is generally identified by his qualifications, experience, responsibilities, remuneration and his contribution to his contribution to the growth of the company.

The following factors would generally be taken into account while deciding the quantum.

1. The qualification of the Keyman.
2. Experience vis-a-vis exposure in different capacities.
3. His services in the company and previous record.
4. Whether he is the only Keyman in the particular area or otherwise.

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 People
3. Key Project Managers
4. People with Specific Skills

Keyman Insurance Proceeds will cover:

>The loss of sales attracted by his/her ability and personality.
>The loss due to his/her day to day specialized skills.
>The cost of Recruiting and Training a suitable replacement.
>The cost of delay or cancellation of any project upon which he/she is working.
> The loss of opportunities for future expansion.
>The loss of stable Management and good labor Relations.
>The Reduction of Credit Standing of the company due to:
>>The loss of sales attracted by his/her ability and personality.
>>The loss due to his/her day to day specialized skills.
>>The cost of Recruiting and Training a suitable replacement.
>>The cost of delay or cancellation of any project upon which he/she is working.

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. If the policy, after attaining surrender value, is endorsed to the employee, then the surrender value/maturity value is chargeable to tax under Section 17 of the Income Tax Act. This is because it is treated as `profit in lieu of salary’ in the hands of the employee.

Treatment of Payments – for the Company

> All claims – maturity, surrender or death benefit received by the company are taxable.

> In case of the keyman retiring, the company may surrender the policy for its cash value, or assign the policy absolutely in favour of the keyman.

> In case of an assignment, the surrender value of the policy at the time of assignment may be treated as perquisite in the hands of the employee, and taxed accordingly by the assessing authority.

Insurance Worth of a Keyman :

> The insurance worth of a keyman is the lower of:
>> 5 times the average net profit of the company for the past 3 years
>> 2 times the average gross profit of the company for the past 3 years
>> 10 times of the keyman’s annual compensation package.

How the amount of Insurance is arrived at?

A) Directors of Public limited company, Private limited Company with at least 10 employees and Partners of Partnership firm

> Multiple of Keyman’s Compensation Package: The Insurance will be limited to 10 times of Keyman’s compensation package including perks. (The notional value of the perks can be taken as 30% of the gross annual salary).

> Gross profit method: The Insurance will be limited to 2-times of average Gross profit for last 3-years (before depreciation and taxation).

> Net profit method: The Insurance will be limited to 5-times of average net profit for last 3-years (after depreciation and taxation).
The Maximum insurance allowed will be restricted to least of the amounts arrived at by above three methods and distributed among all the key persons proposed for. There is no restriction on turnover of partnership firm.

B) Private limited Company with less than 10 shareholders/employees

Maximum keyman insurance allowed will be restricted to 3 times of average net profit of last 3 years.

C) Companies where 3 years P/L accounts are not available:

> Companies having 2 years P/L account:
Maximum keyman insurance allowed will be restricted to 2 times of average net profit of last 2 years.

> Companies having 1 year’s P/L account:
Maximum keyman insurance allowed will be restricted to equal to net profit of one year.

D) Keyman Insurance to Employees of Public limited/ Private limited/Partnership/ Proprietary firms:

Keyman insurance to employees of above firms will be restricted to 10 times the salary for the latest financial year as reflected in Form No.16. The firm should be profit making one and the profits for the last three years should justify the cover being allowed. (3 times of average gross profits or 5 times of average net profits, whichever is lower).

E) Key Man Insurance on the Basis of Loan Liability:

Key man insurance is also considered on the basis of loan liability of the company. If the company has taken a loan from a bank/financial institution, KMI to the extent of 2/3 of the loan can be considered on the life of its Directors, since the repayment of loan is dependant upon the profitability of the company, which to a great extent depends on the Directors. For example, if a company with 3 Directors has raised a loan of Rs. 1.00 crore, S.A. of Rs. 22 lac under KMI can be considered on the life of each Director, in general.

Advantage of keyman insurance for corporate Sector?
 
> The company is protected against the financial loss in the event of Keyman’s death.
> The company is able to create an asset for itself in the form of Sum assured and guaranteed/loyalty additions.
> It gives a substantial relief to the company in Income Tax.
> It protects the interest of other employees, shareholders and customers.
> It keeps the company’s position stabilized in the market.
> It generates confidence, sense of security and loyalty in the minds of Keyman.
> It can be given as security to Bankers even though policy is not allowed to be > assigned.
> It is a guarantee to the creditors.

The following requirements, apart from usual requirements, must be submitted:

> Copy of Project Report / viability report submitted with application for loan and agreement regarding the terms and condition of loan.

> Letter regarding sanction of loan. Proof of loan having been availed of Further,
Term of the policy shall not exceed the repayment term for the Loan.

> The company should be capable of paying the premium. However, quantum of S.A. will not be restricted to 3 times / 5 times of profit as described earlier.

> Credentials of the company should justify acceptance of the KMI.

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