- Key person insurance pays the company a lump sum if a key person dies or, on some policies, is critically ill.
- It exists to cover lost profit, the cost of recruiting a replacement, and any loan the person guarantees.
- Cover is usually sized as a multiple of salary, a share of gross profit, or the size of guaranteed borrowing.
- Premiums can be a deductible business expense (the Anderson principle), but the rules are specific, so check with your accountant.
- It is different from a relevant life policy (which protects the family) and shareholder protection (which buys back shares).
Estimate the cover
What key person insurance is
Most small companies have one or two people the business genuinely cannot run without. Key person insurance (sometimes called keyman insurance) protects the company against the financial hit of losing one of them to death or serious illness.
The company owns the policy, pays the premiums, and is the beneficiary. The payout lands in the company's bank account, where it can replace lost profit while the business recovers, fund the recruitment and training of a replacement, or repay a loan the person had guaranteed.
How the cover is sized
There is no single formula, but three approaches are common, and lenders and insurers recognise all of them:
- Multiple of salary. A straightforward proxy, often 5 to 10 times the person's remuneration.
- Share of gross profit. Estimate the proportion of gross profit attributable to the person, then multiply by the years it would take to recover.
- Loan cover. If the person personally guarantees a bank loan or director's loan, the outstanding balance sets a floor for cover.
The estimator above uses the salary-multiple method as a starting point. In practice you would sanity-check it against the other two.
The tax treatment
The tax position turns on what is known as the Anderson principle, named after a 1920s case. Premiums are generally deductible for Corporation Tax where the cover is on an employee (not a substantial shareholder), is for loss of profit only, and is short-term and annually renewable.
Where premiums are deductible, the payout is usually treated as a taxable trading receipt. Where the premiums are not deductible (for example cover on a major shareholder, or cover linked to a loan), the payout is more likely to be tax-free. The two sides tend to mirror each other, and the detail matters, so this is one to confirm with your accountant before you set the policy up.
Versus relevant life and shareholder protection
Three company-linked policies are easy to confuse:
- Key person insurance pays the company for the loss of a key individual.
- Relevant life cover pays the individual's family, like a death-in-service benefit. See our guide to the relevant life policy.
- Shareholder protection gives the surviving owners the funds to buy back a deceased shareholder's stake, keeping control of the company.
Many owner-managed companies end up with a combination. Modelling what each one would actually pay out, and what it costs, alongside your wider position is exactly what Take Home is for.