Every business has people it cannot afford to lose. The founder who holds the client relationships. The technical director who built the product. The sales leader who generates 60% of revenue. If one of these people died tomorrow or was diagnosed with a critical illness, most SMEs would face an existential crisis — not because the business model failed, but because a single point of human dependency was never protected.
Key person insurance — sometimes called keyman insurance or key man insurance — is a life and critical illness policy taken out by the business on a person whose loss would cause significant financial damage. The business pays the premiums. The business receives the payout. It is designed to buy the company time and resources to survive the loss of its most important person.
What Key Person Insurance Covers
A key person policy typically covers two events: death and critical illness. If the insured person dies or is diagnosed with a specified critical illness (such as cancer, heart attack, or stroke), the policy pays a lump sum to the business. The business can use this money however it needs to — there are no restrictions on how the payout is spent.
Common uses of a key person payout include:
- Recruiting a replacement — senior hires take time and cost money. Headhunter fees, relocation costs, and the higher salary needed to attract talent at short notice can easily reach six figures.
- Covering lost revenue — if the key person was responsible for client relationships or sales, revenue may drop significantly while the business adjusts. The payout provides a cash buffer.
- Repaying debts — many business loans include personal guarantees from the key person. Their death or illness may trigger repayment demands from lenders.
- Reassuring stakeholders — suppliers, clients, and investors need confidence that the business can survive. A funded continuity plan provides that confidence.
- Funding a buyout — if the key person was also a shareholder, the payout can fund the purchase of their shares from their estate.
How Much Cover Do You Need
There is no single formula, but three common methods are used to calculate the right level of cover:
Multiple of revenue contribution. If the key person is directly responsible for generating revenue — through sales, client management, or business development — cover is typically set at two to five times their annual revenue contribution. This provides enough time and resource to rebuild those revenue streams.
Multiple of salary. A simpler approach: cover the cost of replacing the person. This typically means five to ten times their annual salary, reflecting recruitment costs, training time, and the productivity gap during the transition.
Impact on profits. Calculate the impact on profits over two to three years if the key person were lost. This approach works well when the key person’s contribution is to profitability rather than direct revenue — for example, a technical founder whose expertise reduces costs or drives efficiency.
For most UK SMEs, key person cover ranges from £250,000 to £2 million. The premiums are modest relative to the cover — typically a few hundred to a few thousand pounds per year, depending on the insured person’s age, health, and the level of cover.
Tax Treatment
The tax treatment of key person insurance depends on the purpose of the policy:
Revenue purpose — if the policy is designed to cover lost profits or revenue, the premiums are a deductible business expense and the payout is taxable as trading income. This is the most common arrangement and is usually the most tax-efficient overall.
Capital purpose — if the policy is designed to repay a loan, fund a share purchase, or protect the capital value of the business, the premiums are not tax-deductible and the payout is not taxable. This is less common but may be appropriate in specific circumstances.
HMRC’s guidance (BIM45525) sets out the conditions for deductibility. The key test is whether the insurance is taken out wholly and exclusively for the purposes of the trade. Most key person policies that protect revenue and profits will qualify.
Key Person Insurance vs Shareholder Protection
Key person insurance and shareholder protection insurance are related but different. Key person insurance pays the business. Shareholder protection insurance pays the surviving shareholders (or the deceased’s estate) to fund the purchase of shares.
If the key person is also a shareholder, you may need both. Key person insurance covers the business impact of their loss. Shareholder protection — typically arranged alongside a cross-option agreement — ensures the shares are bought and sold at an agreed price, preventing the deceased’s family from becoming unwilling shareholders and the surviving shareholders from losing control.
Who Needs It
The businesses most exposed to key person risk include:
- Owner-managed businesses where the founder is the business — the face, the client relationships, the strategic direction
- Professional services firms where revenue depends on individual expertise and client trust
- Tech companies where the product depends on a small technical team
- Businesses with outstanding loans that depend on the key person’s personal guarantee
- Any business where one or two people generate a disproportionate share of revenue or profit
The Cost of Not Having It
Without key person insurance, the death or critical illness of a key individual can trigger a cascade of failures. Revenue drops. Clients leave. Lenders call in loans. Staff lose confidence and start looking for other jobs. Suppliers tighten credit terms. The business enters a downward spiral at exactly the moment when the remaining team is grieving and least equipped to respond.
A key person policy does not prevent the loss. It buys time. And in business, time is often the difference between survival and closure.
Key person insurance is one element of a broader business protection strategy. Contact Legacy Wills to discuss how it fits alongside shareholder protection, succession planning, and your personal estate plan.