Key person insurance

When considering financial planning, we often think about ourselves and our families. We protect against an untimely event that may adversely affect our families. But why then, do we not do the same for our businesses? It seems important then to consider insurance that might help decrease these risks. 

How much would your business suffer if a key member of staff were to unexpectedly pass away? It is not a pleasant thought, but the sudden loss, or extended absence could significantly affect your company’s success.

The success of small and medium sized businesses are usually dependent on a few people who play a fundamental role within the business. Some however, offer little consideration  to what might happen if such an individual was lost to the business, either through death or a critical illness, and how their business can be protected in such an event.

What is key person insurance?

It is a type of insurance policy taken out on someone who is key to the success of the business. The policy is intended to replace the income that the insured would have brought to the company had their death or illness not occurred. The same policy can also be used to cover recruitment and salary costs for a replacement.

What is the role of the key person and who might they be? 

A key person can be anyone employed by the business that, should they be unable to carry out their duties suddenly for an extended period, the business would suffer. 

A key person could be:

  • A director in the business, who customers are loyal to
  • A leading sales person or someone with important contacts
  • A leading negotiator or specialist,
  • Someone running the business on a day-to-day basis
  • Anyone controlling a special project or managing an important project 
  • A person whose record ensures favourable treatment from lending institutions. 

What is the purpose of key person insurance and how does it work?

Key person insurance is like a safety net for companies. It is a way to safeguard your business against the death, terminal or critical illness of a key person in your organisation

The company purchases an insurance policy for specific employees, specifying the level of cover required and the length of term. In the event of the key person’s death or critical illness, the company would receive a payout from the policy. This lump sum payout could significantly help the business to recover as outlined in the reasons below.

Reasons to consider key person insurance

There are a number of reasons to consider this type of insurance, it can:  

  • Help you maintain the level of income that was usually generated by the individual and enable you to cover business expenses. 
  • Cover lost profit, lost business opportunities and breakdown of relationships as a result of the key person no longer being available.
  • Enable the business to continue to function for an extended period where the key person is unable to work, but has not died.
  • Help fund any recruitment fees and the training required for a replacement hire, over the time it takes for the replacement to be ‘up and running’.
  • Provide more favourable terms with lenders since this demonstrates a continued ability to meet commitments.
  • Maintain cash flow for short-term financing needs.
  • Protect existing shareholders and partnerships if the family was due to inherit shares in the business. The liquidity the insurance pay-out provides will allow the remaining shareholders or partners to possibly buy the shares from the family.

How to calculate key person insurance 

The key person insurance your business needs depends on factors like the nature and size of your business and the specific role the key person plays. It is unique to your company’s circumstances.

There are two main approaches to calculating key person insurance; multiple of salary or proportion of profits.

For multiple of salary, the key person’s salary is multiplied by an agreed factor, normally five times but sometimes can be up to ten times.

For proportion of profits, the calculation for the amount of cover needed is more complex as it considers the key person’s salary, annual profit and the time it would take to replace them.

Is key person insurance tax deductible?

For the company taking out key person insurance, the premiums paid can be treated as a business expense, eligible for deduction from profits.

However, the crucial condition is maintaining a formal employer-to-employee relationship with the insured individual. We would always recommend liaising with your accountant on these matters too. 

Types of policy 

What is level term assurance?

‘Level term assurance’, provides a fixed level of financial protection for a certain period of time. It is one of the simplest and most common forms of protection available. It pays a  lump sum on death or critical illness. E.g. An employee could be covered for £200,000 over 5 years. If they pass away or are diagnosed with a critical illness within the 5 years, the £200,000 will be paid to the business.
The cost of premiums depends on variables, such as age, health, amount covered and length of term. 

What is critical illness cover?

Critical illness cover insures a person if they are diagnosed with a disease such as cancer, multiple sclerosis or Parkinson’s, or if they suffer a heart attack or stroke. Providers have their own lists so it is important to check when comparing. Given that an individual is more likely to suffer an illness than suddenly dying, it makes sense to insure both the life and the health of a key person. 

How can we help?

We have access to the whole of the market to help you find the most suitable policies to meet your specific company’s needs. We provide bespoke services to each of our clients’ specific requirements and we help business owners of varying sizes across many industries find solutions to help protect their business’ financial future. 

For help with your business planning and insurance needs, get in touch and arrange a free initial consultation with an adviser who will be able to give you more guidance.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not regulate tax advice.