Protecting your practice - key person insurance explained

Could your medical practice continue to operate if one of its key people were to suddenly pass away, or is diagnosed with a terminal illness or becomes unable to fulfil their role for a period due to a medical condition? Would the other practice owners or partners cope financially? These are the kinds of uncertainties key person insurance can protect your practice from.

It's not the most enjoyable aspect of practice planning but an essential and often overlooked factor for practice owners or managers to consider.  In this article, Nathan Brophy from Avant Life Insurance, provides a wrap up on what you need to know about this type of insurance.

How does key person insurance work?

If a medical practice takes out key person insurance, they would take out one or more of the following life insurance covers: 

• life cover
• total and permanent disability (TPD) insurance
• trauma cover
• income protection  

The practice owns the policies and pays the premiums, and if something happens to the key person(s), its financial position is protected and may be eligible to receive compensation. This is different from similar types of policies that may be owned personally or through a person’s superannuation fund.

When the practice makes a claim, the entity will receive the insurance benefit, normally paid in a lump sum (some insurers will offer monthly benefits). The benefit can be used for revenue and/or capital purposes, to ensure the practice can continue to operate and cover associated costs from losing the key person.

Another additional cover to think about is business succession insurance. This type of cover protects the practice if ownership changes due to unforeseen events such as the owner's death or incapacitation, and usually forms part of funding buy/sell arrangements     in shareholder's agreements.

Who is a key person?

Key persons are essential to the day-to-day operations, revenue generation, and overall functioning of your practice. They can include business owners, founders, key executives, employed practitioners, or anyone whose absence or loss would have a substantial financial impact on the company.

Depending on the size and nature of your medical practice, you may have more than one key person. For example, if you run a rural GP practice and employ three GPs, all three could be classified as key persons because their knowledge, skills, and experience are crucial to the success of your practice.

What can you use key person insurance for?

How much cover will you need?

To help you to decide how much cover you need to take out, consider the following factors:

• How much remuneration does the key person(s) receive?
• What is the key person’s contribution to the profitability of your practice?
• How much will it cost to recruit and train a replacement(s)?
• Are there any practice debts, including any outstanding loans for which the key person may be a guarantor?
• Are you looking to cover more than one person?
• Are there any tax consequences that need to be factored in the calculation?

Ultimately, how much cover you decide to take out will depend on the circumstances of your practice and the nature of each key person’s contributions. A qualified financial adviser can recommend the right strategies to help you understand the complex nature of key person insurance.

Summary

Key person insurance is not a life insurance product, but a strategy that uses life insurance products for a specific business purpose. When used appropriately, key person arrangements can protect your medical practice from the financial consequences of unexpected events. This usually involves taking out policies that insure the lives of the key person(s), where the practice pays the premiums and receives the benefit from a claim. 

A key person(s) in your medical practice is someone who contributes to the daily operations and financial success of your practice. These could be a business owner, founder, key executive or employed practitioner whose absence would have a substantial financial impact on your practice.

This type of insurance can provide your practice financial protection in several different ways, including mitigating revenue loss from the death, sickness, or invalidity of the key person, covering replacement costs, servicing debts, addressing goodwill write-downs, providing liquidity, and maintaining supplier relationships.

When deciding how much cover you need, there are multiple factors, including tax implications, to consider. However, it comes down to the nature of your practice and the financial contribution your key person(s) makes.  

If you are thinking about taking out key person insurance, book an appointment with Avant Life Insurance for advice tailored to your personal circumstances.