Who is a key person?
A key person is someone whose death or serious illness would cause the business a measurable financial loss. That is often a director or founder, but it can equally be a senior engineer, the person who holds the main client relationships, or the only member of staff with a particular licence or technical skill.
Job title matters less than consequence. A useful test is to ask what would happen to turnover, profit, lending and recruitment costs in the twelve to twenty-four months after that person was suddenly unavailable.
- Owners or directors whose personal guarantees support business borrowing
- Employees who generate or hold a significant share of revenue
- People with specialist knowledge that would be slow or costly to replace
- Individuals whose absence could unsettle lenders, investors or major customers
Who owns key person cover and who receives the payout?
In a typical arrangement the business is the policyholder, pays the premiums and is the beneficiary. The insured person is the life assured, but neither they nor their family normally receive the proceeds. Money paid to the business can then be used for purposes such as recruiting a replacement, covering lost profit or reducing debt, at the directors’ discretion.
Because the payout goes to the business, key person insurance does not replace personal life cover for the individual’s dependants. Where a director also wants to protect their own family, relevant life insurance or personal life insurance may be considered separately.
Life cover and optional critical illness cover
Key person cover is usually arranged as term life insurance, paying out if the key person dies during the policy term. Some insurers allow specified critical illness cover to be added, which can pay on diagnosis of a condition defined in the policy, provided the definition and any survival period are met.
Critical illness definitions vary between insurers and not every serious diagnosis qualifies. Adding it raises the premium, so it is worth weighing the cost against how likely a long illness is to affect the business compared with a death.
Recruitment costs and lost-profit exposure
Most key person calculations start from two questions: how much profit could the business lose while it recovers, and what would it cost to find and settle a replacement? Lost profit might include delayed projects, cancelled contracts or a gap in sales activity. Replacement costs can include recruitment fees, a higher salary to attract the right person, handover time and training.
Some businesses also consider loans or overdrafts that a lender might ask to be repaid if a key individual died. That is a separate exposure and may be better handled through a loan protection arrangement.
How much key person cover does a business need?
There is no single correct figure and no universal salary multiple. Rules of thumb you may see online are starting points at most. Insurers will want to see that the amount requested is reasonably connected to the financial loss the business would suffer, and may ask for accounts, profit figures or an explanation of the person’s role.
A defensible sum assured is usually built from a documented estimate of lost gross profit over a recovery period, plus realistic replacement costs, and is reviewed as the business grows or the person’s role changes.
Underwriting and exclusions
The insurer will assess the key person’s age, health, medical history, lifestyle and sometimes their pastimes or travel. It will also look at the financial justification for the amount requested. Cover may be offered on standard terms, with a higher premium, with exclusions, or declined.
Policies have exclusions and conditions. Failing to disclose relevant information accurately can lead to a claim being reduced or declined, so applications should be completed carefully and honestly.
Tax treatment depends on purpose
Whether premiums are deductible for corporation tax, and whether a payout is taxed as a trading receipt, depends on the purpose of the policy and the business’s circumstances. Treatment can differ between cover intended to replace lost profit and cover connected to capital items such as a loan.
Tax relief is not automatic. The business’s accountant or tax adviser should confirm the treatment before cover is arranged, and again if the purpose of the policy changes.
