What is Key Person Insurance?

Key person insurance (also called key man insurance or key woman insurance) is a life insurance or critical illness policy taken out by a business on the life of a person whose death or incapacity would cause significant financial harm to the company. The business pays the premiums, and the business receives the payout.

It is not a legal requirement, but it is an important risk management tool for businesses that depend heavily on specific individuals — whether founders, directors, top salespeople, or technical experts.

How Key Person Insurance Works

The basic structure is straightforward:

1. The business identifies one or more individuals whose loss would seriously impact operations or finances
2. The business takes out a policy on that person’s life (and often critical illness too)
3. The business pays the premiums as a regular expense
4. If the key person dies or is diagnosed with a critical illness, the insurer pays a lump sum to the business
5. The business uses the payout to cover financial losses, recruit a replacement, repay debts, or reassure stakeholders

The key person does not need to be a director or shareholder — anyone whose absence would materially damage the business can be insured.

What Does Key Person Insurance Cover?

Life Cover

Pays out if the key person dies during the policy term. This is the core element of most key person policies.

Critical Illness Cover

Pays out if the key person is diagnosed with a specified serious illness, such as cancer, heart attack, stroke, or multiple sclerosis. The list of covered conditions varies by insurer but typically includes 30 to 50 conditions.

Some Policies Also Offer

• Total permanent disability cover
• Terminal illness cover (usually included within life cover, paying out early if the person is diagnosed with a terminal condition)

What It Does Not Cover

• The key person leaving voluntarily — Resignation or retirement is not an insured event
• Short-term illness or injury — Temporary absence is usually covered by income protection or business interruption insurance, not key person insurance
• The individual directly — The policy belongs to the business, not the person insured

How Much Cover Do You Need?

Determining the right level of cover requires estimating the financial impact of losing the key person. Common approaches include:

Multiple of Profit

Calculate the key person’s contribution to profit and insure for a multiple of that amount (typically 2 to 5 times their annual contribution). This covers the time needed to recruit and train a replacement.

Multiple of Salary

Insure for a multiple of the key person’s salary (typically 5 to 10 times), reflecting the cost of replacing them and compensating for lost productivity during the transition.

Revenue-Based

If the key person directly generates revenue (e.g. a top salesperson), estimate the revenue at risk and insure accordingly.

Loan or Investor Protection

If a bank or investor requires key person cover as a condition of funding, the cover amount is often set at the value of the loan or investment. This is common in business loan agreements and venture capital deals.

How Much Does It Cost?

Premiums depend on:

For a healthy 35-year-old non-smoker, a £500,000 life-only policy over 10 years might cost around £15 to £30 per month. Adding critical illness cover could double or triple that cost.

Premiums are generally affordable relative to the risk being covered, making key person insurance one of the more cost-effective forms of business protection.

Tax Treatment

The tax treatment of key person insurance depends on its purpose:

To Replace Lost Profits

If the policy is designed to compensate for loss of profits resulting from the key person’s death or illness:

• Premiums are an allowable business expense for Corporation Tax or income tax
• The payout is treated as taxable trading income
• The net benefit is the payout minus the tax on it

To Repay a Loan

If the policy is specifically to repay a business loan in the event of the key person’s death:

• Premiums are generally not tax-deductible
• The payout is not taxable (it is treated as a capital receipt)

The distinction depends on the purpose of the policy, so it is worth discussing with your accountant. Proper accounting treatment ensures you handle premiums and any payout correctly for tax.

Who Should Consider Key Person Insurance?

Key person insurance is particularly relevant for:

• Small businesses and startups — Where one or two people are critical to the entire operation
• Businesses with a dominant founder — Where the founder’s relationships, expertise, or reputation drive revenue
• Companies with key technical staff — Where specialised knowledge would be hard to replace
• Businesses with bank loans — Lenders often require key person cover as a condition of the business loan
• Investor-backed companies — Angel investors and venture capital firms frequently require key person cover
• Partnerships — Where the loss of one partner could destabilise the entire firm

How to Set Up Key Person Insurance

1. Identify your key people — Who would the business struggle without? Consider not just directors but also salespeople, technical leads, and relationship managers
2. Calculate the cover needed — Use one of the methods above to determine the appropriate sum assured
3. Choose the right policy — Decide whether you need life only, critical illness, or both
4. Get the key person’s consent — The individual must agree to be insured and undergo any required medical checks
5. Apply through a broker or directly — A specialist insurance broker can compare policies and advise on the right structure
6. Review regularly — As your business grows and people’s roles change, update your cover accordingly

Key Person Insurance on the Balance Sheet

If premiums are tax-deductible (loss of profits purpose), they appear as an operating expense in the profit and loss account.

If premiums are not tax-deductible (loan protection purpose), the treatment depends on the policy type:

• Term policies (with no investment element) — Premiums are expensed but not tax-deductible
• Whole of life or investment-linked policies — May create an asset on the balance sheet if the policy has a surrender value

Related Insurance and Protection

Key person insurance is one element of a broader business protection strategy:

• Shareholder protection insurance — Funds a buy-sell agreement if a shareholder dies, ensuring remaining shareholders can purchase the deceased’s shares
• Partnership protection insurance — Similar to shareholder protection but for partnerships
• Employers’ liability insurance — Covers employee injury or illness claims
• Professional indemnity insurance — Covers professional negligence
• Public liability insurance — Covers third-party injury or damage
• Workplace pension — A legal requirement for employers with eligible staff

A limited company structure provides some protection through limited liability, but key person insurance addresses risks that corporate structure alone cannot mitigate.