Mistakes to Avoid When Taking Out Key Person Insurance

Key Person Insurance is a very useful type of cover for many businesses. It can help protect a company if an important team member becomes very ill or passes away. This cover gives businesses the money needed to stay stable during a difficult time.

But it is easy to make mistakes when setting up this kind of insurance. These errors can cost a business money and may even leave it without the cover it thought it had. Understanding what can go wrong helps you to plan better and avoid future problems.

This article will help you learn what to avoid when taking out Key Person Insurance. We will look at the common mistakes and how to make better choices for your business. Whether your business is new or well-established, these tips can help you protect it more effectively.

Choosing the Wrong Person to Insure

One of the most important steps is deciding who the key person is. If you choose the wrong person, the insurance may not help your business when needed. This decision should be made with care and based on a clear understanding of the person’s role.

Not Understanding Who is Truly Key

Some people may seem important, but they are not truly key to the success of the business. A key person is someone whose loss would cause serious harm to the company. This could be a founder, a top salesperson, or someone with special knowledge or skills.

Think about who brings in the most income, who clients trust the most, or who knows things that no one else does. Make your choice based on facts, not just job titles. A key person is often someone behind the scenes whose contribution is hard to replace.

Insuring Too Many People

It might seem like a good idea to cover lots of staff, but this can waste money. You may end up paying for cover that your business does not really need. Focus on the people who are truly key. This keeps costs lower and ensures the right people are protected.

If too many people are listed, it could also make it harder to manage the policy or explain the cover to others in the company. Insuring the wrong people can also dilute the value of the policy, making it less useful when it is needed most.

Leaving Out a True Key Person

Sometimes, companies forget to cover someone who is truly vital. This often happens in growing businesses, where roles change quickly. Make sure you review your team and ask if anyone new has become key to how the business runs.

Missing someone important could leave the business at risk if that person becomes seriously ill or dies. A fresh review of roles and impact can help identify hidden risks and ensure the right people are included.

Choosing Based on Emotions or Pressure

In smaller teams, choosing who to insure can be personal. But it should not be based on friendship, family ties, or pressure from others. Always base your choice on the needs of the business. Speak to a financial adviser if needed to make the right call.

Sometimes, a long-serving staff member may seem like the obvious choice, but if their current role no longer has a strong impact on profit or key functions, they may not be the right person to insure.

Underestimating How Much Cover You Really Need

Another common mistake is choosing too little cover. Businesses often guess a number without thinking about what the company would truly need to keep going. The value of the key person needs to be measured carefully to ensure the cover amount reflects the real financial risk.

The payout should be enough to cover lost profits, find a replacement, and give the business time to recover. If the figure is too small, it may not protect the company at all. Underestimating the cost of disruption can lead to serious cash flow issues and even job losses.

Work with a professional to calculate how much money your business could lose if the key person is gone. Think about how long it might take to find a new person and train them. You should also consider loans or other debts that could be at risk.

Make sure the amount of cover matches the level of loss the business would face. This helps you avoid a shortfall when the money is most needed. Do not forget to include hidden costs like loss of client trust, delays in projects, or penalties in contracts.

Setting Up the Policy Incorrectly

Even if you choose the right person and the right cover, it can all go wrong if the policy is not set up properly. Small mistakes in the paperwork or structure can cause big problems later on. It is important to check every detail before signing the agreement.

For example, if the policy is not in the name of the business, the payout might go to the wrong place. This could create tax problems or delays. The policy should clearly state who the insurer pays, and why. Always read the terms to ensure they match your intentions.

Some companies forget to link the policy to a specific goal, such as replacing lost income or paying off a loan. Without this, the payout may not be used in the right way, or could even be taxed as a benefit. Your accountant can help with choosing the right setup for your needs.

It is also important to check who pays the policy premiums. If an employee pays instead of the business, this might lead to tax issues or confusion about who owns the policy. Keeping payment records clear and correct helps avoid any future problems.

It is best to get advice from an insurance expert or accountant when setting up Key Person Insurance. They can make sure all the details are correct and that the policy meets your business goals. Proper setup means the policy will work exactly as needed if a claim has to be made.

Not Reviewing or Communicating the Policy Effectively

Once the policy is in place, many companies forget about it. But a Key Person Insurance policy is only useful if it stays up to date and everyone knows about it. A forgotten policy can cause delays or even make it hard to claim at all.

Not Reviewing the Policy Regularly

People change roles, businesses grow, and new staff join. A policy that made sense three years ago might not fit the business today. You should review the policy every year or when there are big changes in the team. Changes in income, staff structure, or services offered should all trigger a review.

Ask yourself if the insured person is still the key person. Check if the level of cover still matches the size and income of the business. Making updates ensures the policy remains helpful and not a wasted cost. A quick review now can save your business from big losses later.

Not Telling Key Staff About the Policy

In some companies, only the directors know about the policy. But if something happens, the people left behind may not know it exists or how to use it. Everyone in a management role should know where to find the policy and what steps to take in an emergency.

Make sure at least a few trusted team members know the details of the policy. This includes who is insured, how much is covered, and how to claim. This helps avoid delays or confusion if the worst happens. It can also give staff peace of mind knowing the business has a safety net in place.

Not Informing Your Adviser or Accountant

It is also smart to let your accountant or financial adviser know about the policy. They can make sure it is handled correctly in your books and offer support when making a claim. Their guidance can also help you make better use of the funds if a payout is made.

If the policy is kept secret or forgotten, the money may not be used in the best way, or it might even cause tax problems later. Keeping advisers informed means you can be sure the policy serves its purpose without creating new issues.