What key person insurance means
Key person insurance is a policy a business takes out on the life or health of somebody it cannot easily replace.
The business pays the premium, the business is the beneficiary, and the payout goes to the business rather than to the individual's family. That is the distinguishing feature and it is the source of most of the confusion about it.
The insured person is somebody whose loss would materially damage the business: a founder whose relationships hold the customer base, a technical lead who is the only person who understands the system, a rainmaker who generates most of the revenue.
Insurable interest is what makes the policy valid. The business must genuinely stand to lose financially if the person is lost, which is exactly the case being insured.
The payout is not compensation for grief. It is working capital to survive the disruption: to keep paying staff while revenue falls, to recruit and train a replacement, to repay debt that becomes due, or to buy out the deceased's shareholding.
How it is used
The practical questions are who to insure and for how much.
Who: run the exercise honestly. If this person did not come in on Monday, permanently, what would happen to revenue, to customer relationships, to the ability to deliver, and to lender or investor confidence. The people whose absence produces a serious answer are the key persons.
How much: the sum should reflect the financial consequence rather than the person's salary. Common bases include a multiple of the profit attributable to that person, the cost of recruiting and replacing them combined with the revenue expected to be lost during the transition, or the amount of debt that would fall due or need refinancing.
The policy should be set up correctly. The business is the policyholder and the beneficiary, the premium is paid by the business, and the insured individual consents.
It is often paired with a shareholders agreement provision. Where the key person is also a shareholder, the agreement can provide that on death the surviving shareholders or the company acquire the shares, and the insurance funds that purchase. Without funding, a buyout provision is an obligation nobody can meet.
Key features
- Taken out by the business on a person it depends on
- The business pays the premium and receives the payout
- Requires an insurable interest in the person insured
- Sum insured should reflect financial consequence, not salary
- Frequently paired with share buyout provisions in a shareholders agreement
- Sometimes required by lenders or investors as a condition
How this works in Nigeria
Key person risk is acute in Nigerian small and medium businesses and it is almost never insured.
The typical Nigerian SME is built around one or two people. Customer relationships are personal. Supplier terms depend on who negotiated them. Bank relationships follow the founder. Institutional knowledge is unwritten. The loss of that person is not a setback, it is frequently the end of the business.
Awareness is the obstacle rather than availability. Nigerian insurers offer the cover, and the premium for a healthy person of working age is modest relative to the exposure.
Lenders and investors are the other route by which businesses encounter it. A bank lending to a company that depends on one individual may require key person cover assigned to it as part of the security package, and an investor may require it as a condition in the shareholders agreement.
The shareholder buyout point deserves emphasis. Many Nigerian shareholders agreements provide that on a shareholder's death the survivors may buy their shares. Where nobody has the cash, the provision does nothing, and the deceased's family inherits a stake in a business they cannot influence and cannot sell. Insurance funds the mechanism and makes the clause real.
The practical starting point for a founder is to write down what would actually happen if they were unavailable for six months, and to price cover against that answer.
Key person insurance vs group life vs personal life cover
Three policies covering people connected to a business, paying different beneficiaries.
Key person insurance is taken out by the business on a person it depends on. The business pays and the business receives the payout, using it to survive the disruption.
Group life cover is taken out by an employer for the benefit of employees' families. It is a benefit provided to staff, and within the Nigerian pension framework employers within scope are required to maintain it. The payout goes to the employee's beneficiaries.
Personal life cover is taken out by an individual for their own family. The individual pays, and the family receives the payout.
A founder should think about all three separately: cover for the business against losing them, cover for staff as an employment benefit, and cover for their own family. They answer different questions and one does not substitute for another.
Limits and risks
It compensates the business, not the family, which sometimes causes friction where that was not understood at the outset.
Underwriting can be restrictive. Older individuals and those with health conditions face higher premiums or exclusions, which is precisely the situation where the business most needs the cover.
The sum insured is also a guess. It is easier to model the cost of replacement than the loss of relationships, and businesses tend to under insure.
And it does not fix the underlying dependency. Insurance funds the transition; it does not create the documented processes, shared relationships and second line of management that reduce key person risk in the first place.
Worth knowing
If your shareholders agreement provides that survivors may buy a deceased shareholder's shares, fund it with insurance. Nigerian businesses have that clause and no money behind it, and the family ends up holding a stake nobody can buy in a company they cannot influence.
Questions people ask
What is key person insurance?
A policy taken out by a business on the life or health of somebody it depends on. The business pays the premium and receives the payout, using it to survive the disruption of losing that person.
Who receives the payout?
The business, not the family. That is the defining feature and it distinguishes key person cover from personal life insurance and from group life cover provided as an employee benefit.
Who should be insured?
Anybody whose permanent absence would materially damage revenue, customer relationships, delivery capability or lender confidence. Run the exercise honestly rather than insuring only the founder by default.
How much cover is appropriate?
A sum reflecting the financial consequence rather than the person's salary: the profit attributable to them, the cost of recruiting and replacing them plus revenue lost in transition, or debt that would fall due.
Why do lenders ask for it?
Because a facility to a company dependent on one individual carries that individual's risk. A lender may require cover assigned to it as part of the security package, and investors may require it in the shareholders agreement.
How does it relate to a share buyout clause?
It funds it. Where the agreement provides that survivors may buy a deceased shareholder's shares, insurance provides the money. Without funding the clause is an obligation nobody can meet.