Why is keyman insurance critical for growing businesses?
In most startups, SMEs, and even mid-sized companies, a small group of people carries a disproportionate amount of responsibility. It could be a founder who brings in key clients, a sales leader who closes most of the revenue, or a technical expert who holds the product together. If such a person is suddenly unavailable due to death or permanent disability, the business may face:
- Immediate revenue disruption
- Delays in operations or delivery
- High costs of hiring and training a replacement
- Loss of client or investor confidence
A well-structured keyman insurance policy gives the company financial breathing room during this transition. It ensures the business can survive the shock, stabilize operations, and recover without being forced into desperate decisions.
Keyman insurance meaning
Keyman insurance is a life insurance policy taken by a company on the life of a critical employee, founder, or director. The company is both the policyholder and the beneficiary. If the insured key person passes away or becomes permanently disabled, the payout is received by the company and used to:
- Offset loss of profits
- Cover hiring and training costs
- Manage operational and financial disruptions
Who qualifies as a “key person” in a company?
A key person is anyone whose absence would cause serious financial or operational stress to the company. This may include:
- Founders, co-founders, or CEOs
- CTOs or senior technical leaders
- Top sales leaders or rainmakers
- Senior operational or strategy heads
A practical rule: if replacing someone would take months and materially hurt business performance, they are likely a key person.
To learn more about ‘Keyman Insurance Policy’, you can also read this insightful blog.
What is the purpose of a keyman insurance policy?
- Protect business continuity: Give the company time and money to stabilize after a major loss.
- Cover revenue and profit loss: Compensate for the business impact caused by the absence of the key person.
- Fund replacement costs: Pay for recruitment, onboarding, and training.
- Support financial commitments: Help meet loan obligations and reassure investors or partners.
Factors that decide the sum assured for keyman insurance
- Revenue or profit contribution: How much business does this person influence directly or indirectly?
- Time to replace: Will it take 6 months, 12 months, or 24 months to rebuild their impact?
- Stage of the company: Younger companies are usually more dependent on fewer individuals.
- Nature of the role: Sales, leadership, and product roles usually carry higher risk exposure.
- Financial structure: Loans, investor expectations, and growth plans also matter.
Common methods to calculate sum assured
1. Salary multiple method
This is the simplest and most commonly used approach.
Method: Insure for up to 10 times the key person’s annual salary or total compensation (CTC).
Example: If a key employee earns ₹50 lakhs per year, the sum assured could be around ₹4–5 crores.
Best for: Creating a quick baseline estimate.
2. Profit multiple method
This method links coverage directly to the company’s profitability.
Two common approaches:
- 3 times the company’s average gross profit (last 3 years), or
- 5 times the company’s average net profit (last 3–5 years)
Best for: Roles that directly drive revenue, margins, or growth.
3. Economic value or contribution method
This is the most precise and business-aligned approach.
Method: Estimate how much profit or revenue the person contributes, and multiply it by the number of years the business would need to recover.
Example: If a person contributes ₹2 crores in profits annually and recovery would take 2 years, the sum assured could be around ₹4 crores.
Best for: Senior leadership, sales heads, and founders.
Keyman insurance policy under the Income Tax Act
The keyman insurance policy under the Income Tax Act also has important tax implications:
- Premiums paid by the company are generally treated as business expenses, subject to applicable conditions.
- The payout received by the company is treated as business income and taxed accordingly.
- The policy must be owned by the company and taken strictly for business purposes.
How insurers assess the sum assured
- The company’s financial statements
- The role and importance of the key person
- The person’s age, experience, and health profile
- The company’s size, turnover, and dependency on that role
Mistakes to avoid while choosing the sum assured
- Underinsuring critical roles: Choosing a low number just to save premium defeats the purpose.
- Overinsuring without logic: This increases cost without real business justification.
- Using only one method: Salary alone often underestimates real business impact.
- Never reviewing coverage: As the company grows, risk exposure changes too.
- Ignoring business dependencies: Loans, investors, and clients should influence the coverage amount.
Conclusion
Keyman insurance is about buying the right amount of protection. The ideal sum assured should reflect how dependent your business is on that person, how long recovery would take, and what it would cost to stabilize operations. Using a mix of salary multiple, profit multiple, and economic contribution methods gives a far more realistic answer than relying on any one formula. For growing companies, getting this number right can be the difference between surviving a crisis and being permanently set back.
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