Key person insurance answers a question no liability policy touches: what happens to the business if the person it depends on dies or becomes critically ill. In a small company that is often a founder, a lead technician or the one person who holds the client relationships, and the loss is not a legal liability at all. It is revenue, continuity and sometimes the loan the bank lent against that person being there.
What the policy is, and who it pays
The business takes out and owns a life, or life and critical illness, policy on the individual, pays the premiums and is the beneficiary. On a claim the money goes to the COMPANY rather than to the family, which is what separates it from personal life cover. It is used to fund recruitment, to cover lost profit while the business recovers, or to repay a loan a lender required cover for.
Sizing it without guessing
Three approaches are common and none is exact: a multiple of the person's contribution to gross profit, the cost of replacing them including recruitment and the time to competence, or simply the amount of debt the cover has to clear. Lenders often name the figure, because the requirement arrived with the loan. Writing down which basis you used, and revisiting it when the business changes shape, matters more than the precision of the number.
The tax position is not automatic
HMRC's own manuals set out the conditions usually applied to premiums being deductible: the relationship is employer and employee, the policy is short term and against loss of profits rather than a capital asset, and the sole purpose is trade protection. Where those hold, premiums may be deductible and proceeds taxable as trading receipts; where they do not, the treatment differs. It is a question for your accountant, with the manual as the reference rather than a broker's summary.
What it is not
It is not shareholder protection, which funds the purchase of a departing shareholder's shares and is usually written with a cross option agreement. It is not relevant life cover, which is a death in service benefit for the individual's family. All three are sold by the same brokers and answer different questions, and the commonest mistake is buying one and believing you have another.
Questions people ask about key person insurance
What is key person insurance?
A policy the business owns on the life, or the life and critical illness, of a person it depends on. The business pays the premiums and receives the proceeds, which are used to cover lost profit, recruitment or a loan the cover was required for.
Who receives the payout?
The company, not the family. That is the defining difference from personal life cover, and it is why the policy is taken out and owned by the business.
Are key person insurance premiums tax deductible?
Sometimes. HMRC's Business Income Manual sets out the conditions usually applied, including that the policy is against loss of profits rather than a capital asset and that the sole purpose is trade protection. Ask your accountant against your own facts.
Is it the same as shareholder protection?
No. Shareholder protection funds the purchase of a departing shareholder's shares, usually alongside a cross option agreement. Key person cover replaces profit and funds recruitment. A business may need both and they are separate policies.