Key-man Insurance

A Category III AIF often depends heavily on one or two people — most of all, the investment manager making the calls. What happens to investors if that person suddenly cannot work?

Key-man Insurance answers that. The fund takes out a policy on a key executive, and the policy compensates the fund for financial losses if that person dies, becomes incapacitated, is kidnapped, or is disabled. The point is not personal compensation for the executive — it is protecting the fund and its investors from the disruption of losing the person who was making the investment decisions.

Key-man Insurance sits alongside two other insurance types the workbook covers in the same section:

• Professional Indemnity Insurance, also called E&O (Errors and Omissions) Insurance, protects the fund from costs arising when an investor suffers a substantial loss because of an error or omission in the services the fund provided.
• D&O (Directors and Officers) Liability Insurance protects individual directors, partners and executives from personal losses if they are sued for actions taken while serving the fund — though it does not cover claims arising from fraud.

Key-man Insurance is different again: it protects against the loss of a specific person's services, covering death, incapacity, kidnap or disability. The workbook ties its value to giving investors comfort that the fund can achieve an orderly dissolution or transition — including appointing a new investment manager as part of succession planning — rather than being forced into an abrupt, disorderly wind-down.

Cost. The premium is typically around 1-2% of the fund's total Assets Under Management, and it is indirectly borne by the fund's investors. The cover can extend to all entities connected to the fund, including the trust, the fund scheme, the investment manager, the sponsor and the settlor.

Sundarbans Special Situations Fund, a Category III AIF with Rs 300 crore of AUM, relies almost entirely on one experienced portfolio manager for its investment calls.

The fund takes Key-man Insurance on that manager, at a premium of 1.5% of AUM:

Annual premium = 1.5% x Rs 300 crore = Rs 4.5 crore

If the manager is suddenly incapacitated by a medical event mid-way through the fund's tenure, the policy pays out to compensate the fund for the resulting disruption — for instance, the cost and delay of transitioning to a new manager — rather than leaving investors to absorb that loss with no cushion. The Rs 4.5 crore annual cost is, in turn, indirectly borne by the fund's investors as part of its overall expenses.

Chapter 10, section 10.5 (Importance of Insurance for a Category III AIF), sets out Key-man Insurance alongside Professional Indemnity/E&O Insurance and D&O Liability Insurance, and gives the 1-2% of AUM cost range. One of the chapter's sample questions asks directly which insurance type covers death, incapacity, kidnap or disability of a key executive — the answer is Key-man Insurance.

• Series X-B's keyman insurance is a different subject. That page is the life insurance policy a company buys on an executive, and what it tests is the tax treatment — the company pays and benefits, and the proceeds are NOT exempt. This page is a Category III AIF's operational cover on its investment manager. Answer from the paper you are sitting.
• Key-man Insurance covers death, incapacity, kidnap or disability of a key executive — the workbook's own sample question tests this exact list against the other insurance types as distractors.
• D&O Insurance does not cover fraud claims against directors and officers — a distinct limitation from Key-man Insurance, which is not fraud-related at all.
• The 1-2% cost is of total AUM, not of the key person's salary or of the fund's profits, and it is indirectly borne by investors.
• Do not confuse Key-man Insurance with a Business Continuity Plan — the BCP is the operational plan for continuing the fund's work; Key-man Insurance is the financial compensation if a key person is lost.