What is key person insurance?
Key person insurance is a policy a business takes out on the life — and sometimes the critical illness — of an individual whose loss would cause the business serious financial damage. The business owns the policy, pays the premiums, and receives the payout.
Why it exists. Most small businesses depend on a small number of people far more than their accounts suggest. If one of them dies or becomes seriously ill, the damage is not sentimental — it is measurable: lost sales, a halted project, lost client relationships, a breached loan covenant, the cost of recruiting and training a replacement, and lost confidence among customers, staff and lenders.
Who counts as a key person. Not necessarily the most senior. Typically the owner or founder; a rainmaker who holds the client relationships; a technical specialist whose knowledge is not documented elsewhere; anyone personally named in a major contract; or anyone whose departure would trigger a loan repayment clause.
How the amount is set. There is no formula, but common approaches include a multiple of the person's contribution to gross profit, the cost of recruiting and bringing a replacement up to speed, the value of any loans that would fall due, and the profit expected to be lost over a recovery period. Insurers will ask you to justify the figure.
What it is distinct from:
Shareholder protection, which funds surviving shareholders to buy the deceased's shares, usually with a cross-option agreement — a different problem and a different policy.
Relevant life cover, a death-in-service benefit paid to the employee's family.
Personal life insurance, which pays the individual's own estate.
Businesses frequently need more than one of these and confuse them.
The tax position is not automatic. Broadly, premiums may be deductible and the payout taxable where the policy meets certain conditions — commonly summarised by reference to the Anderson principles — and the treatment differs where the person is a substantial shareholder or the policy covers a capital purpose such as a loan. This is genuinely complex and worth accountancy advice rather than assumption.
General information, not financial or tax advice.