Most small and medium-sized businesses in the UK depend heavily on a small number of individuals. If one of those people were to die or become critically ill, the financial impact on the business could be severe, covering lost revenue, disrupted operations, the cost of finding a replacement, or in the worst cases, business failure. Key person insurance is designed to protect against exactly this risk.
What Is Key Person Insurance?
Key person insurance is a life insurance or combined life and critical illness policy taken out by a business on the life of an individual whose death or serious illness would have a significant financial impact on the company.
Unlike personal life insurance, the business is both the policyholder and the beneficiary. If the key person dies or suffers a qualifying critical illness claim, the payout goes to the business, not to the individual's family.
Who Counts as a Key Person?
There is no single definition of a key person, but the test is straightforward: whose loss would materially damage the business's ability to trade or generate profit? Common examples include:
- Founders and managing directors whose relationships, reputation, or decision-making are central to the business
- Top sales performers who generate a disproportionate share of revenue
- Technical specialists with skills that would be difficult or expensive to replace
- Directors personally guaranteeing business loans
How the Payout Is Used
A key person insurance payout gives the business time and financial resources to respond to an unexpected loss. Typical uses include:
- Covering lost profits during the period of disruption
- Funding the recruitment and training of a replacement
- Repaying business loans or overdrafts that were personally guaranteed by the key person
- Maintaining confidence among customers, suppliers, and lenders during a difficult period
How to Calculate the Sum Assured
There is no single formula, but common approaches include:
- A multiple of the key person's salary or total remuneration, typically five to ten times
- An estimate of the key person's contribution to annual profit, multiplied by the number of years it would take to replace that contribution
- The outstanding balance of any business loans or personal guarantees linked to the key person
In practice, many businesses use a combination of these approaches and review the sum assured regularly as the business grows.
Tax Treatment
The tax treatment of key person insurance is fact-specific and depends on the nature and purpose of the policy. HMRC's general position is set out in the Business Income Manual at BIM45525. Premiums are not deductible as a business expense if the policy has an endowment or investment element, or if it is primarily intended to meet a capital rather than revenue loss. The payout to the business may also be subject to corporation tax.
Because the tax treatment is not straightforward, businesses considering key person insurance should seek advice from both a regulated financial adviser and an accountant.
Frequently Asked Questions
Who owns a key person insurance policy?
The business owns the policy, pays the premiums, and receives the payout. This is what distinguishes it from relevant life insurance, where the policy is for the personal benefit of the employee and their family.
Is key person insurance tax deductible?
Not always. HMRC's approach depends on the purpose and structure of the policy. Premiums are more likely to be deductible if the policy is a pure term policy taken out to protect against a trading loss. If in doubt, speak to an accountant alongside a financial adviser.
What happens to the policy if the key person leaves the company?
The business can choose to cancel the policy, transfer it to the key person so they take over premium payments, or arrange a replacement policy on the new key person. The approach depends on the policy terms and the circumstances of the departure.
Can key person cover include critical illness?
Yes. Many key person policies include a critical illness component that pays out if the key person is diagnosed with a specified serious condition, such as cancer, heart attack, or stroke. This means the business receives a payout even if the key person survives, which is particularly valuable given that many critical illness claimants do survive and recover.
Sources
- HMRC: Business Income Manual BIM45525
- GOV.UK: Corporation Tax guidance
- Association of British Insurers: abi.org.uk
About the Author
Tanweer Hussain is the editor at TopQuote.co.uk. He oversees the editorial accuracy of all published content, with a particular focus on the factual detail relevant to UK protection insurance. TopQuote is authorised and regulated by the Financial Conduct Authority.
This article is intended for general information purposes only and does not constitute financial advice. Your individual circumstances will affect which options may be available to you. TopQuote.co.uk is a comparison and information service, not a financial adviser. Always seek independent financial advice from a regulated adviser before making any financial decisions.