Common Mistakes to Avoid When Buying a Keyman Insurance Policy

A Keyman Insurance Policy is one of the most crucial tools a business can have to protect itself from the financial impact of losing a key employee. Whether it's a founder, top executive, or a highly skilled specialist, their sudden absence can disrupt operations, affect client relationships, and significantly hurt revenue. While the intention to buy a Keyman Insurance Policy is wise, many business owners make avoidable mistakes during the selection and purchase process, limiting the effectiveness of the coverage. In this article, we highlight the most common pitfalls and how to avoid them.

1. Not Identifying the Right Key Persons

One of the biggest mistakes companies make is failing to clearly identify who their "key" people are. Not every employee needs to be insured under a keyman policy. A key person is someone whose skills, experience, or leadership are vital to the company’s revenue or strategic direction. This can include the CEO, founder, lead developer, or a top sales executive. Misjudging who is critical can result in inadequate coverage or wasted premiums.

2. Underestimating the Coverage Amount

Businesses often underestimate how much coverage is actually needed. The insurance payout should cover more than just short-term revenue loss. It should also factor in recruitment costs, training of new personnel, loss of clients, and delays in projects. Choosing a random figure or opting for the cheapest premium can leave your company financially exposed when the policy is actually needed.

3. Not Reviewing the Policy Regularly

A common mistake is treating keyman insurance as a "set and forget" policy. However, as your business grows or changes, the value and role of key employees might evolve too. An outdated policy may no longer reflect current business realities. It's crucial to review your policy annually or when significant business milestones occur, such as expansion, mergers, or leadership changes.

4. Ignoring Tax Implications

Many businesses overlook the potential tax consequences of a keyman insurance policy. In some jurisdictions, premiums may not be tax-deductible, and the insurance payout could be taxable depending on how the policy is structured. It’s essential to consult with a qualified tax advisor to understand the implications and structure the policy in the most tax-efficient manner.

5. Failing to Disclose Complete Information

Insurance providers base their decisions and premiums on the information provided at the time of application. Failing to disclose complete details about the key person’s health, lifestyle, or role in the business can lead to claim rejections later. Transparency during the underwriting process is critical to ensure the policy delivers when needed.

6. Choosing the Wrong Type of Policy

There are different types of keyman insurance—term life, whole life, and those with added disability benefits. Businesses often select a policy based purely on cost or without understanding the differences. While term insurance is cost-effective and suitable for short-term needs, whole life insurance might be better for long-term protection. Disability coverage can also be added to protect against loss of a key person due to permanent or temporary disability, not just death.

7. Not Aligning the Policy with Business Continuity Plans

Keyman insurance should be part of a larger business continuity or succession plan. If your company doesn’t have a clear strategy for replacing or redistributing the responsibilities of the key person, even the best insurance payout won’t prevent disruption. A well-thought-out plan alongside the policy ensures smoother transitions.

8. Assuming One Size Fits All

Each business is different in size, industry, and structure. Yet, many companies opt for generic policies without tailoring them to their specific needs. It's important to work with a knowledgeable insurance advisor who can customize the policy based on your company’s unique risk profile and key personnel structure.

9. Not Naming the Business as the Beneficiary

Another mistake is not correctly structuring the policy in terms of ownership and beneficiary. In a keyman insurance policy, the business should own the policy, pay the premiums, and be the beneficiary. This ensures that the payout goes directly to the business in the event of a claim, providing much-needed financial support.

10. Delaying the Purchase

Finally, many business owners delay buying keyman insurance, thinking it's something to consider "later." However, accidents and health issues are unpredictable. The earlier you insure your key employees, the lower the premium and the better the protection. Waiting too long could result in higher costs or even ineligibility due to age or health issues.

Final Thoughts

A Keyman Insurance Policy is more than just a safety net—it’s an essential part of risk management and business continuity planning. However, buying the wrong policy or making critical mistakes can undermine its value when your company needs it most. Take the time to evaluate your business needs, understand your options, and work with trusted advisors to avoid these common errors.

Investing wisely in Key Man Insurance not only protects your business financially but also reassures investors, stakeholders, and employees that your company is prepared for any eventuality.