There may be a large number of employees in a company, but only a handful are truly essential.

Who exactly is a keyman? If a person suddenly leaves the business:

• Would the business be disrupted because the keyman was responsible for the company’s operations?
• Would creditors lose faith in the company’s ability to pay its debts and call-in loans or refuse to issue credit?
• Would customers delay or withhold business, or even worse, leave for competitors?
• Would suppliers reduce credit terms and working capital is reduced?
• Would competitors come in to take market share, causing overall profits to fall?

If the answer is yes to any of the above questions, the person is likely a keyman.

Keyman insurance protects a company’s most important asset: its key people. Such an insurance policy provides financial compensation if a keyman becomes unable to work.

When the business purchases keyman insurance on the keyman’s life, the business is both the policy owner and the beneficiary of the policy. The insured person does not receive any benefits from the policy.

Keyman insurance is usually written as either a term policy or a permanent policy. A term policy is the more affordable of the two. It applies for a specific period of time and coverage ends when the term expires or the insured person dies, whichever happens first.

Permanent keyman life insurance such as whole life insurance stays in effect for the life of the insured individual. It has other benefits:

• It can later be transferred to the insured, say at the worker’s retirement, if the firm no longer needs the coverage.
• It can be used as collateral for a loan. In fact, when the business borrows money from the bank, it is normal for the bank to require that keyman insurance be in place before financing for the business is provided.

Premiums incurred on a keyman insurance policy is deductible if all of the following conditions are met:

1. The purpose of the policy is to insure the business against loss of profits arising from the death or disability of the keyman. It cannot be for the loss of capital.
2. The sum insured is directly related to the extent of the annual profits directly attributable to the services of the keyman.
3. The insurance policy remains the property of the business. It cannot belong to the keyman. The proceeds of the policy also cannot be used to benefit the keyman’s family.
4. The insurance policy does not provide for a cash surrender or investment value. The company should not be earning a return from the policy.
5. The loss of the keyman does not affect the business’ entire profit-making structure.

Where the premiums paid on a “keyman” insurance policy qualify for deduction, any recovery made under the policy will constitute a trading receipt and be subject to tax.

• compensating the company for lost profits;
• providing recruitment and training expenses for the successor;
• assuring existing customers and key stakeholders like creditors and suppliers that the company can withstand the keyman’s departure;
• payment of loans that may be called in on the keyman’s death; and
• protection of the personal assets of the keyman.