Key Man Insurance: Meaning, Benefits and Taxability

The foundation of any organisation is a team of employees, as the employees manage day-to-day operations and make the company functionable. They share their talent with the company to let the business generate considerable revenue, so it makes perfect sense to ensure the key employees are responsible for major tasks. Here comes the role of a keyman insurance policy, an insurance mechanism meant to protect key employees against terminal illness or any harm. In this blog, we will learn in-depth about this policy.

Understanding Keyman Insurance Policy

Keyman insurance policy aims at creating a financial shield for companies in case the company loses a significant employee entrusted with major responsibilities in any accident. Let’s understand the meaning of a key employee now.

Key man insurance meaning

A key employee is an employee or a team member of the organisation who may have to handle daily operations, onboard clients or market the company. In short, a key employee has certain skills or experience, which make them handle vital responsibilities for the company.

Reason for insuring a key employee

• A key employee has major responsibilities that are meant for leveraging and managing the company
• The business may encounter disruption without the key employee
• Key decisions may be delayed as a key employee may act as a decision-maker
• The business may get into a disrupted situation with unnecessary delays without a key employee
• All of these reasons make the insurance of a key employee a vital step for any business.

What is Key Man Insurance?

Let’s get to the keyman insurance policy now for a detailed understanding. A keyman insurance cover is a specific type of insurance policy purchased by a company to cover any losses that arise in case the key employee dies or becomes incapable of performing their entrusted tasks. In case of the absence of a key employee in an organisation, such as the operations manager, or chief marketing officer, there can be a strong disruption in the business workflow. The business may derive heavy losses due to this, and may even have to seek talented personnel as a replacement to the key man. To protect against such financial losses, a company buys a keyman insurance policy. A keyman policy covers all such losses and makes the company financially independent during the loss of a vital employee. There are some unique characteristics of the keyman insurance scheme to note, here are:

• The policy does not support any form of add-ons
• Only the business can be appointed as the nominee
• Acts as a backup plan for any contingency in business
• The policy matures whenever the person retires or is dissolved of their responsibilities with the organisation

What are the losses covered under Key Man Insurance?

All the major losses covered under key person insurance have been compiled into this list as below:

• Coverage for death - The insurance offers a total bulk payment to the company in the case of the death of a key employee.
• Coverage for trauma - Traumatic events can limit or even cause temporary pauses to the work of a key employee. A key man coverage provides benefit to the company in case of such traumatic events which affects the vital employee.
• Coverage for terminal illness - Terminal illnesses are covered too, such as Parkinson’s disease, or an advanced stage of cancer.
• Coverage for permanent disability - In case an employee becomes permanently disabled after encountering an accident, this insurance policy acts as a financial backup for the company.

Key Benefits of Key Man Insurance Policy

Keyman policy comes with a bundle of benefits for the organisation, these can be noted here.

• Creation of a contingent fund - Keyman insurance offers a higher financial incentive to the company, which ensures smooth operation even in the case of death or disability of the employee. Companies don’t need to set a fund aside, a keyman scheme is sufficient enough to create a backup for such losses.
• Higher valuation on acquisition - Company valuation increases to a large extent in the case of a keyman policy. In case a company having this policy gets acquired, the buyer company will see it as an advantage as the company has a financial backup when the key employee passes away or becomes disabled.
• Tax exemption on the premium - The insurance premium of a key man scheme is exempted from paying taxes under Section 37(1) of the Income Tax Act. The premium paid is treated as a business expense, so tax exemption can be easily claimed according to clauses of Section 37(1) of the Income Tax Act.
• Facilitates recruitment of a replacement talent - When a key employee passes away, the company has to look for a replacement soon. This replacement comes at a higher cost and may take months to search for a suitable replacement in terms of talent and sense of responsibility. Having a key man policy provides considerable financial advantage to hire and train a new replacement.
• Assures the investors - This insurance policy has the benefit of assuring investors that it is beneficial to invest in the company, as the company has insured itself for key people. Investors remain assured of an interruption-free functioning of the company because of keyman protection coverage.

Exploring Key Man Insurance Policy Taxability

The taxability on this needs to be explained here concerning two vital cases:

1. Tax exemption on death benefits claim
2. Tax exemption on premium paid Let’s discuss both of these cases in detail.

Case 1: Death benefits tax exemption

The claim amount of a keyman insurance policy cannot be claimed for tax exemption under Section 10 (10D) of the Income Tax Act. Although claims on most types of insurance policies are exempted from tax paying, key man policy is not. There was an interesting court case which ruled out the case of tax exemption from the insurance claim amount. Here is an example from a real case study. In 2011, the Delhi High Court dismissed the case of tax exemption on maturity value of the policy proceedings of a key man protection policy. The Court argued in the favour that the claim proceedings are the same as regular insurance once the insurance is transferred to an employee, which cannot claim any form of tax exemption. From the financial year of 2013-14, the key person insurance policy cannot be claimed tax exemption and is liable to tax payment on claim proceedings under the amended Income Tax Act.

Case 2: Insurance premium tax exemption

Tax exemption can be claimed on payment of insurance premium in a keyman insurance. Because premium is treated as a business expense, businesses can claim tax exemption under Section 37(1) of the Income Tax Act.

Conclusion

The entire concept of keyman insurance policy is to assist a company financially in the unforeseen case of key employee death or disability. The advantage of this policy is to develop a financial backup which the company can use in case the key employee cannot function anymore. Keyman coverage helps a company to become independent and financially stable in any contingency, so it is a significant insurance policy to have.