What Is Key Man Insurance for Small Businesses?
What Is Key Man Insurance?
Key man insurance - also known as key person insurance - is a life insurance or critical illness policy taken out by a business on the life of a person whose skills, knowledge, or relationships are critical to the company's success. The business pays the premiums and is the beneficiary of any payout.
The logic is straightforward: if a key person dies or becomes seriously ill and cannot work, the financial impact on the business can be severe. Key man insurance provides a cash lump sum to help the company survive, recruit a replacement, or compensate for lost revenue during the disruption.
Who Qualifies as a Key Person?
- Founders and directors
- Top sales performers who generate a disproportionate share of revenue
- Technical specialists whose expertise cannot be easily replaced
- Anyone whose loss would trigger a clause in a loan or investment agreement
Types of Cover
Key Man Life Insurance
Pays out a lump sum if the key person dies during the policy term. The sum insured is typically calculated as a multiple of the person's salary or as a percentage of the company's annual profits.
Key Man Critical Illness Cover
Pays out if the key person is diagnosed with a specified serious illness (such as cancer, stroke, or heart attack) that prevents them from working. This addresses the reality that serious illness is statistically more likely than death during a person's working life.
Tax Treatment
The tax treatment of key man insurance in the UK is complex and depends on the purpose of the policy and whether premiums are treated as a business expense. HMRC guidance indicates that if the policy is wholly for business protection rather than as a benefit for the individual, premiums may be deductible. Always seek professional tax advice specific to your circumstances.
How Much Cover Do You Need?
- Calculate the cost of recruiting and training a replacement
- Estimate the revenue at risk during the transition period
- Consider any loan covenants or investor requirements
- Factor in the key person's salary as a baseline
