Find out what key person insurance is, what it includes and whether your business can benefit from it.
Keyman insurance protects key employees in your business, to help your business operate as normal if something was to happen to them. We’ve looked at how you can calculate how much cover you need for each employee and whether there are any tax benefits in it for your business.
What's in this guide?
- What is keyman insurance?
- How do you define someone has a key person?
- What does keyman insurance cover?
- How does keyman insurance work?
- Who needs it?
- Is keyman insurance tax deductible?
- How much keyman insurance do you need?
- How much does keyman insurance cost?
- Key man life insurance pros and cons
- Bottom line
- Compare life insurance providers
- Frequently asked questions
What is keyman insurance?
Recent research by Legal & General shows that 52% of businesses think they would cease trading in under a year if a key person in the company dies or becomes seriously ill.
Keyman insurance (also known as key person insurance or key person protection) can protect your business against this eventuality, by covering any potential lost profits, loan repayments or the cost of recruiting a replacement staff member or director if they are crucial to the operation of the business.
How do you define someone has a key person?
A key person is someone who plays a vital role in the financial success of a company.
It can be a founder, the person in charge of setting the business strategy, or a top salesperson who brings a significant amount of profit into the business. It can even be your tech expert who has knowledge no-one else in the company does and that is crucial to the correct operation of the business.
What does keyman insurance cover?
Keyman insurance covers the people named in the policy and pays out if any of them die.
Some policies also include critical illness cover, and so pay out in case the person covered becomes critically ill or long term disabled and cannot perform their duties. Note that life insurance policies rarely pay out more than once, so, if you get a payout for critical illness, you’re unlikely to get another payout should the staff member later die.
If you take out a business loan, the lender may require you to take out keyman cover to protect it. The cover reassures the lender that the loan will be repaid even if the person, or people, most vital to the success of the company are unable to continue in their role.
Some policies also allow you to add an option to cover the costs of replacing the key employee (like part of the replacement employee’s salary), and protect any loss in profits while you search for a replacement.
How does keyman insurance work?
Keyman insurance works in a similar way to regular life insurance, with premiums calculated according to the insured person’s age, health and lifestyle (such as whether they smoke or drink).
The difference is that it’s the business the person works for that pays the premium, not the individual insured, and the business also acts as the beneficiary of the policy (meaning it will receive the payout after a successful claim).
Who needs it?
Many different types of businesses can benefit from key person insurance, but small businesses may be more vulnerable to the affects of losing a key staff member. This type of insurance is often overlooked by small businesses, despite the fact they are more likely to have one or two significantly important people who the business relies on to succeed.
Key people inside a business might include:
- The founder. Can be one or more people, this is the team or the person who created the business from the ground up.
- Office manager. This person is usually crucial in the day-to-day running of the business operations.
- Technology expert. If you rely on a website or app to generate profit for your business, without your developer your business could lose its main route to profitability.
- Top salesperson. Even if you have multiple sales people, if there’s one person the business relies on in particular to bring in business and keep clients happy, this person is key to the profits of the business.
Is keyman insurance tax deductible?
This is often asked by businesses, but the answer relies on principles outlined by chancellor Sir John Anderson in 1944 – more than 70 years ago.
The simple answer is that, if the sole relationship between the business and the key person insured under the policy is that of employer and employee, then the staff member should be able to deduct keyman insurance premiums. That said, each case will be different, so seek the advice of an accountant, the HMRC or an independent tax advisor if you’re not sure.
For shareholders, the premiums can only be claimed as an expense if the person covered doesn’t have a significant holding in the company (usually less than 5%, but this can be open to interpretation). Additionally, the policy must be a term life policy (meaning it only covers the employee while they are working for the business), not a whole-of-life policy. Lastly, the policy must be used to cover lost profits only, and not any additional elements, like a business loan.
The tax treatment of any payout is also unclear. Generally, if you received tax relief on the premiums, then the payout will be taxed. This is because it will be used to boost your profits, which will push up your corporation tax liability. If you did not receive tax relief on the premiums, then the likelihood is the payout will be treated as capital and not business profits and so won’t be taxable. Check with the HMRC if you’re unsure how your business is affected.
How much keyman insurance do you need?
This will depend on the person you are covering and their contribution to the company’s profits.
The general recommendation for ensuring that your business has the minimum amount of protection is, once you’ve identified the net or gross profits that the person is directly responsible for, insure them for twice the amount of gross profit they bring, or five times the amount of net profit.
You can use our handy tables below to help you calculate the amount of cover you need:
|Percentage of Gross profit||Gross profits of £20k||Gross profits of £75k||Gross profits of £150k||Gross profits of £300k||Gross profits of £1m|
|Responsible for 10%||£4000||£15,000||£30,000||£60,000||£200,000|
|Responsible for 20%||£8000||£30,000||£60,000||£120,000||£400,000|
|Responsible for 30%||£12,000||£45,000||£90,000||£180,000||£600,000|
|Responsible for 40%||£16,000||£60,000||£120,000||£240,000||£800,000|
|Responsible for 50%||£20,000||£75,000||£150,000||£300,000||£1m|
|Responsible for 60%||£24,000||£90,000||£180,000||£360,000||£1.2m|
|Responsible for 70%||£28,000||£105,000||£210,000||£420,000||£1.4m|
|Responsible for 80%||£32,000||£120,000||£240,000||£480,000||£1.6m|
|Responsible for 90%||£36,000||£135,000||£270,000||£540,000||£1.8m|
|Responsible for 100%||£40,000||£150,000||£300,000||£600,000||£2m|
|Percentage of Net profit||Net profits of £20k||Net profits of £75k||Net profits of £150k||Net profits of £300k||Net profits of £1m|
|Responsible for 10%||£10,000||£37,500||£75,000||£150,000||£500,000|
|Responsible for 20%||£20,000||£75,000||£150,000||£300,000||£1m|
|Responsible for 30%||£30,000||£112,500||£225,000||£450,000||£1.5m|
|Responsible for 40%||£40,000||£150,000||£300,000||£600,000||£2m|
|Responsible for 50%||£50,000||£187,500||£375,000||£750,000||£2.5m|
|Responsible for 60%||£60,000||£225,000||£450,000||£900,000||£3m|
|Responsible for 70%||£70,000||£262,500||£525,000||£1.05m||£3.5m|
|Responsible for 80%||£80,000||£300,000||£600,000||£1.2||£4m|
How much does keyman insurance cost?
The cost of insurance is always an individual thing, and depends on many personal factors. In the case of key person insurance, this will relate to who you’re covering and for what amount.
Elements relating to the person that might affect the cost of cover include their age, location, existing medical conditions, family medical history and lifestyle factors (such as whether they smoke, how much they drink and whether they engage in any dangerous hobbies).
Their role will also have an effect on the cost of cover. If their job includes any serious risk, this will make cover more expensive. Their salary can also make a difference to premiums, as can the amount of profit they bring to the business (as this will affect the amount you cover them for).
Different providers offer different rates for insurance, so make sure you shop around and compare policies to get the right deal for you.
Key man life insurance pros and cons
- Can help your business stay afloat in an unexpected situation
- You can cover any key employee – from the founder to the office manager or tech person
- Can help with the costs of recruiting a replacement for the lost staff member
- Makes for an extra monthly expense
- Not always tax deductible
If you run a small business, you may think that keyman insurance is an unnecessary expense in what is undoubtedly already a tight budget.
However, consider how your business will manage if you, one of the other founders, or another employee crucial to the day-to-day operation and profitability of the business was to die suddenly or become incapacitated. If you’re not sure whether the company can survive this situation, protecting it with key person insurance cover can be a good idea.
Think carefully who you want to insure and calculate how much cover you need, based on our tables above.
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