Key person insurance

Every small business has someone it cannot easily do without. Sometimes it is an owner. Often it is not — the sales manager who personally holds most of the client relationships, the engineer who is the only one who understands the product, or the practice principal whose registration is the reason the business can trade at all.

Key person insurance is written on that person’s life, and usually on their trauma and disability as well. The business owns it, pays for it and receives the proceeds. If the person dies or cannot work, the business gets a lump sum to absorb the shock — the profit shortfall while revenue dips, recruitment and the salary premium a replacement will demand, and keeping the bank comfortable.

Be clear about who this cover is for, because it is regularly misunderstood. It does not pay the insured person’s family and it does not replace their income. It protects the business from the hole they leave behind. A key employee insured by their employer still needs their own life, trauma, income protection and TPD cover.

The uncomfortable question is whether your business has a key person or just people you would rather not lose. If the revenue keeps arriving because the relationships sit with the firm, and the technical work can be done by someone hired within a few weeks, you probably do not need this cover.

There is no single formula. In practice advisers work from two approaches, often calculating both and taking a view between them.

Approach one — the contribution to gross profit

Estimate what share of gross profit the person generates, then insure a multiple of that annual figure. The multiple reflects how long recovery would take: a firm with sticky contract revenue may need two years, while one where every dollar arrives through one person’s relationships needs more.

It answers the question the money has to answer: how much profit disappears, and for how long. Its weakness is that the share attributable to one person is a judgement. Write down the reasoning at the time, because the insurer will ask for it and so will your accountant.

Approach two — the cost and time to replace

Add up what it would cost to put someone else in the seat: recruitment and search fees, the salary premium needed to attract a replacement quickly, relocation, training and licensing, and the period of reduced output while they learn the business. Multiply by an honest estimate of how many months that takes in the current labour market for that role.

This suits technical and licensed roles, where the loss is about capability that takes time to rebuild. It produces a smaller number than the profit method for a rainmaker and a larger one for a specialist who is hard to find.

1. 1List the people whose absence would change next quarter’s revenue, not just next quarter’s workload.
2. 2For each, calculate both the profit-based number and the replacement-cost number.
3. 3Separate out any debt that exists only because of that person, and treat it as a distinct arrangement.
4. 4Decide which events you are insuring. Illness and injury take people out of businesses more often than death.
5. 5Have the accountant confirm ownership and tax structure for each component, in writing, before the application.

These are the details that decide whether the cover does what you expected. Read them before you compare on price.

• Whether you are insuring death only. A serious illness or permanent disability creates the same commercial hole and is more likely.
• Whether the sum insured will survive financial underwriting. Insurers want financial statements and a written rationale.
• Whether the policy is owned by the right entity. Ownership drives who receives the money and how it is taxed.
• Whether the insured person understands and consents. They must sign the application and be underwritten.
• What happens if the key person leaves. Some businesses transfer the policy to them on exit; others cancel it. Decide beforehand.
• Whether a bank facility already requires cover on a named person, and whether your policy satisfies that or duplicates it.

Every New Zealand insurer writes key person cover to its own wording, and the words are where the money is. Two policies that look identical on price can pay very differently when it matters. Closing that gap is the entire job of an adviser.

• Financial underwriting requirements differ between insurers — an adviser knows what each will want before you go to the trouble.
• Where the key person has a health history, an adviser can find which insurer takes that risk on the best terms rather than accepting the first loading offered.
• Trauma and TPD definitions vary widely, and for a key person policy those definitions matter more than the life cover wording does.
• An adviser can structure the revenue component and the debt component so their ownership matches the tax treatment your accountant recommends.

There are three ways to buy life cover in New Zealand, and they are not equivalent. You can buy direct from one insurer, which means you see one product range and one underwriting appetite. You can buy through your bank, which usually means a single insurer’s product sold under the bank’s brand, often with narrower definitions. Or you can go through an adviser, who quotes several insurers at once and is required to put your interests first.

The premium you pay is the same either way. Insurers build adviser commission into their pricing whether or not an adviser is involved, so going direct does not get you a discount — it just removes the person whose job is to argue your corner at application and at claim time.

• An adviser can see which insurer is currently taking your health history on standard terms, and which one will load or exclude it.
• An adviser can structure cover across two insurers if that produces a better outcome than putting everything with one.
• An adviser handles the underwriting back-and-forth, and is the person who chases the claim when a family is least able to.
• An adviser has to document why the recommendation suits you, which is a written record you can hold them to.

We are a referral service, not an insurer. We do not quote premiums and we do not sell policies. What we do is put you in front of one licensed New Zealand adviser who can compare the market properly.

1. 1

   You tell us what you are looking at

   The form takes about a minute. Nobody asks for your medical history on a web form — that conversation happens with the adviser, properly, and only once you have decided to proceed.

2. 2

   An adviser calls you

   A licensed New Zealand adviser talks through your situation: who depends on you, what you owe, what you already have in place, and what you are actually worried about.

3. 3

   They compare the market

   The adviser quotes across the major insurers, checks which of them will take your health history on the best terms, and puts the options side by side in writing.

4. 4

   You decide, in your own time

   There is no obligation and no cost to you. If the answer is that you already have enough cover, a good adviser will tell you that.