Key person insurance is taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business. A key person can be anyone directly associated with the business whose loss can cause financial strain to the business.
The insurance payout is a lump sum and is used to offset the costs (such as recruiting a successor) and the losses (such as a reduced ability to trade), which the business is likely to suffer in the event of the loss of a key person.
There are three types of risks that can be covered by key person insurance:
- the death of a key person (life insurance)
- their total and permanent disablement (TPD insurance)
- them suffering a trauma such as heart attack, stroke, cancer, and paraplegia (trauma insurance).
Key person insurance is often owned by the business, as the business is generally the entity that will require the proceeds of the policy if something were to happen to the key person.