Does the continued success of your business rely on the talent or knowledge of a key individual?
Many businesses are built around one person’s unique ability, personality, or specialist skills, whether it’s the business owner, managing director, brilliant engineer, or designer.
In this guide to key person insurance, we will explore how you can protect the financial security of your business if a key individual is no longer there.
- What is key person insurance?
- Why is key person insurance important?
- Who is a key person?
- What does key person insurance cover?
- How much key person insurance do I need?
- How much does key person insurance cost?
- How does keyman insurance differ from life insurance or death in service insurance?
- Who pays for key person insurance?
- Is key person insurance tax-deductible in the UK?
Also known as ‘keyman insurance’ or ‘keywoman insurance’, key person insurance is a form of life insurance which protects against the potential losses a business could incur if a key person were to die or be unable to work because of a serious illness.
In the event of a claim, the proceeds are paid directly to the business, helping them to protect profits or reduce debts so they can continue to trade.
The death or prolonged absence through illness of a key person in a company can leave a serious gap in leadership, experience, or knowledge.
With a critical member of the team absent, businesses can suffer from a loss of confidence from stakeholders, falling profits, and increased workload for the remaining members of staff.
It’s no exaggeration to say that some businesses would struggle to survive in the short-term without key person insurance to provide a cash injection to help compensate for the loss of their skill, knowledge, and experience.
The money can be used to replace lost revenue, pay debts, or help find and hire a replacement.
A key person is crucial to the business’s day-to-day running and whose absence would cause serious problems.
In most small businesses, the key person is the owner, but it could also be anyone whose skills, knowledge, and experience affect revenue.
The important thing is to consider whether the business could continue if that person died or became seriously ill and how much it would cost to replace them.
Examples of a key person include:
- Business owner
- Managing director
- Operations manager
- IT manager
- Sales managers and leading salespeople
- Employees with specialist skills or knowledge
Your business can take out key person insurance for anyone who is crucial to the successful running of your organisation, with cover including:
- the death of the individual;
- terminal illness;
- optional critical illness;
The cover is taken out for a specified term, such as five or ten years, depending on how long you need the cover to run.
There is usually no ‘cash-in’ value to the policy, so if you stop paying the premiums, the cover will cease.
It’s important to consider the potential impact of the key person’s loss, how it would affect your business’s revenue and profits, and what it would cost to replace them.
There are three considerations businesses typically use to calculate the level of cover they require.
Cost of replacement
Some job roles are harder to recruit than others, and you may need to use specialist recruitment agencies and pay additional costs for relocation to attract the right person. You can consider how much this would cost the business and set the cover accordingly.
Formula based on wages
Another commonly used formula would be to calculate up to ten times the key individual’s earnings for the life cover, with a lower figure used for critical illness cover (for example, up to five times their earnings).
Impact on gross or net profits
Another common method is to look at the key person’s contribution to either gross or net profits and how long it would take you to recover that contribution.
For example, a key salesperson might be responsible for 25% of your company’s overall sales, so you will need to factor in the short-term impact while also allowing a period of time for recovery following the person’s loss to the business.
The cost of key person insurance depends on a number of variables, including the level of cover required, the nature of the business, and which ‘key people’ are to be insured.
Premiums are calculated for each individual policy, and other factors that can influence costs are:
- the key person’s role in the business;
- the number of years the cover is to run;
- the age/s of the key person or people;
- whether the key person has a pre-existing health condition;
- whether the key person is or has been a smoker.
Application forms will include questions about the key person’s medical history and, depending on the level of cover required, financial information about the company and its turnover of staff.
Key person insurance has some similarities with both life insurance and death in service insurance, but there are some important differences.
Unlike life insurance, which is designed for private individuals, key person insurance is designed for companies. Therefore, in the event of the death of the key person insured, the lump sum payment is paid to the company, not the individual’s spouse or family.
Death in service insurance is an employee benefit taken out by an employer to pay out a lump sum to an employee’s family on their death. It is usually based on a multiple of their annual salary.
Key person cover is paid for by the employer because it benefits the business rather than the employee or their family.
When you take out insurance to cover a non-shareholding employee, premiums are typically tax-deductible business expenses eligible for corporation tax relief.
This is because any payout from the policy will be solely for the benefit of the business.
However, if you take out a policy on a key person who is a shareholder in the business, HMRC may not allow any tax relief on premiums.
Alan Boswell Group offers a full range of business protection policies, including key person cover. We can ensure you get the right kind of policy at the right level. We also offer shareholder protection insurance among other options.
When the company is reeling from the loss of a director, owner, leading employee or manager, key person insurance is essential for keeping the company afloat in difficult times. Give us a call on 01603 967967 to find out how we can help your business to survive the loss of an irreplaceable member of the team.
Tax benefits depend on your individual circumstances and the laws concerning these can change.