What is key person insurance?

Key person insurance (sometimes called keyman insurance) is a policy taken out by a business on the life — and often the critical illness — of an individual whose skills, knowledge, relationships or revenue generation are vital to the company. The business owns the policy and pays the premiums, and if the key person dies or becomes seriously ill, the business receives a lump sum to cover lost profits, recruitment, and the cost of keeping the company stable while it recovers.

How do you value a key person?

There is no single formula. Common methods include a multiple of the key person's salary (often two to ten times), their estimated share of gross profit, or the cost of replacing them and the revenue lost while you do. The aim is a figure you can justify to the insurer and that genuinely reflects the financial damage their loss would cause. An adviser will help you arrive at a defensible sum assured.

Are key person insurance premiums tax-deductible?

Sometimes. HMRC's long-standing 'Anderson principles' suggest premiums may be an allowable expense where the cover is purely to protect against loss of profits, is short-term (typically term assurance), and the key person does not have a substantial shareholding. Where those conditions are not met — for example cover taken out to protect a loan, or on a major shareholder — premiums are usually not deductible. Where premiums are deductible, any payout is generally taxable as a trading receipt. Confirm your position with your accountant.

Who counts as a key person?

Anyone whose loss would materially harm the business: a founder or managing director, a top salesperson responsible for major accounts, a technical specialist with rare expertise, or someone whose personal relationships drive revenue. In small companies it is often the owner-managers themselves. The test is simple — if this person were suddenly gone, how badly would profits suffer, and how long would recovery take?

What is the difference between key person and shareholder protection?

Key person insurance protects the business's profits and is owned by and paid to the company. Shareholder protection funds the purchase of a deceased owner's shares and is arranged between the shareholders. They solve different problems — one keeps the business trading through the loss of a vital employee, the other keeps ownership in the right hands — and many businesses need both.

Does key person insurance cover critical illness?

It can. Many key person policies cover both death and critical illness, because a serious diagnosis that takes a key individual out of the business for months can be just as damaging as a death. Adding critical illness raises the premium but broadens the protection to the more statistically likely event.

Key Person Insurance: A Complete Guide for UK Businesses

Most businesses insure their premises, their stock and their liability to others. Far fewer insure the thing that is often most valuable and most exposed: a single person whose departure would seriously dent profits. If your business depends on a founder's vision, a salesperson's relationships, or a specialist's expertise, the sudden loss of that person is a real financial risk — and no buildings-and-contents policy will cover it.

Key person insurance does. This guide explains what it is, how to identify and value a key person, how claims and tax work (including HMRC's Anderson principles), and how it fits alongside other business protection.

What key person insurance is for

Key person insurance is a policy the business owns and pays for on the life, and often the critical illness, of an individual who is vital to its success. If that person dies or becomes seriously ill, the policy pays a lump sum to the company.

That money buys the business something priceless in a crisis: time and stability. It can fund recruiting and training a replacement, cover the profits lost while the gap is filled, reassure lenders and suppliers, and prevent a temporary shock from becoming a permanent decline. The point is not to put a price on a person — it is to give the business the breathing room to survive their loss.

Who is a key person?

A key person is anyone whose absence would materially damage the company's finances. In practice that often means:

a founder or managing director whose vision and decisions drive the business;
a top salesperson who personally holds the major client relationships;
a technical specialist with rare skills or knowledge the business depends on; or
in many small companies, the owner-managers themselves, who wear several hats at once.

The test is straightforward: if this person were gone tomorrow, how much would profit fall, and how long would it take to recover? If the answer is "a lot" and "a long time", they are a key person.

How to value a key person

There is no single right answer, but the common methods are:

A multiple of salary — often two to ten times the key person's remuneration, as a proxy for their value.
Share of gross profit — estimating the proportion of profit attributable to that individual, projected over the time it would take to recover.
Replacement cost — the cost of recruiting, hiring and training a successor, plus the revenue lost in the meantime.

Whichever you use, the goal is a figure that is both realistic and defensible to the insurer. An adviser will help you document the rationale so the sum assured stands up at the point of claim.

The tax position — and the Anderson principles

This is the most misunderstood part of key person cover, so it is worth setting out carefully — and confirming for your own circumstances.

Whether premiums are tax-deductible is usually judged against HMRC's long-standing "Anderson principles", named after a statement made in Parliament. Broadly, premiums may be treated as an allowable business expense where all of the following hold:

the cover exists solely to protect against loss of profits (not, say, to secure a loan);
it is short-term in nature — typically a term assurance policy, not a long, investment-type contract; and
the key person does not have a substantial shareholding in the business.

Where these conditions are met and the premiums are deducted, any payout is generally taxable as a trading receipt — the relief and the tax broadly offset over time. Where the conditions are not met — for example cover protecting a loan, or on a major shareholder — premiums are usually not deductible, and the position differs again. Because the treatment turns on the specifics, confirm it with your accountant before assuming either outcome.

Death cover, critical illness, or both

Key person policies can cover death only, or death and critical illness. Adding critical illness matters because the more likely event during someone's working life is a serious illness that takes them out of the business for months, not a death. Covering both protects against the full range of ways you could lose a key person's contribution, at a higher premium. An adviser will help you weigh the cost against the risk.

Where key person insurance fits

Key person insurance is one piece of a wider business protection picture. It protects profits; shareholder protection insurance protects ownership; relevant life insurance provides tax-efficient death-in-service cover for individuals; and business loan protection covers borrowings. Most established businesses need a combination. Our business protection guide for directors shows how the pieces fit together.

Get advice from a regulated adviser who can value the cover correctly and structure it for the right tax outcome alongside your accountant. Cover Your Family is not FCA regulated and does not give advice — we connect you, free of charge, with a separate, FCA-regulated adviser who provides whole-of-market business protection advice with no obligation. Enquire today to find out what cover is available for your business.