What Is Key Person Insurance?

The Basics

Key person insurance (also called key man insurance) is a life insurance or critical illness policy taken out by a business on the life of an employee or director whose loss would have a significant financial impact on the company. If that person dies or suffers a serious illness during the policy term, the policy pays a lump sum directly to the business.

Unlike a Relevant Life Plan — which is designed to benefit the individual's family — key person insurance is designed to protect the business itself.

Who Is a Key Person?

A key person is anyone whose absence would materially damage the business. This could be:

• A founder or managing director who drives the business
• A sales director responsible for a significant proportion of revenue
• A technical specialist whose knowledge is difficult to replace
• A director who has personally guaranteed business loans
• A key client relationship manager

What Can the Payout Be Used For?

Because the payout goes directly to the business, it can be used however the business needs:

• Covering lost profits while the business recovers
• Funding the recruitment and training of a replacement
• Repaying business loans or overdrafts
• Reassuring clients, suppliers and lenders
• Buying time to restructure or find a buyer

Is Key Person Insurance Tax Deductible?

The tax treatment depends on the purpose of the policy. HMRC applies a three-part test:

• The relationship between the employer and the key person must be that of employer and employee
• The policy must be taken out to meet a loss of profits (not a capital loss)
• The policy must be a short-term arrangement

Where all three conditions are met, the premiums may be treated as an allowable business expense and the payout treated as a trading receipt (subject to corporation tax). Where the policy is intended to cover a capital loss (for example, repaying a loan), the premiums are generally not deductible and the payout is not taxable.

We always recommend seeking independent tax advice alongside your protection advice.

How Much Cover Do You Need?

The level of cover depends on what you are trying to protect. Common approaches include:

• Multiple of profits: Typically five to ten times the key person's contribution to annual profits
• Replacement cost: The estimated cost of recruiting and training a replacement
• Loan value: The outstanding balance of any loans the key person has guaranteed