What is key man insurance — and does your business need it?

1. What is key man insurance?

Key man insurance (also called key person insurance or key person cover) is a life insurance or critical illness policy taken out by a business on the life of a key individual within it. If that person dies or suffers a serious illness during the policy term, the policy pays a lump sum directly to the business.

Unlike personal life insurance — which pays out to a family — key man insurance pays out to the company. The business uses the money to manage the financial impact of losing that person: covering lost revenue, funding recruitment, repaying business loans, or simply keeping the lights on while the business stabilises.

2. How does it work?

The mechanics are straightforward. The business takes out a policy on a named individual, pays the premiums, and is the named beneficiary. If the insured event occurs — typically death or a specified critical illness — the insurer pays the agreed lump sum to the business.

The sum insured is calculated based on the financial impact that person's loss would have. Common approaches include:

• A multiple of salary — typically 5–10x the key person's annual salary
• Contribution to profit — an estimate of how much of the business's profit is attributable to that person
• Loan cover — the value of any business loans that person has personally guaranteed
• Replacement cost — what it would cost to recruit, hire, and train a replacement

There's no fixed formula — your broker will help you work out a sum that genuinely reflects the risk.

3. Who needs key man insurance?

Any business that would suffer significantly if a specific individual was no longer able to work should consider it. In practice, this tends to mean:

Owner-managed businesses

If the business exists because of the owner's relationships, reputation, or skills, the business and the person are effectively the same thing. The loss of that person could mean the business ceases to operate entirely. Key man cover provides the capital to wind down in an orderly way, repay debts, or fund a successor.

Businesses with key salespeople

If one salesperson is responsible for 40% of your revenue, losing them is a serious financial event. Key man insurance gives you the runway to replace them and absorb the revenue shortfall while you do.

Businesses with specialist knowledge holders

Engineers, developers, consultants, clinicians — sometimes a business's entire value sits in one person's expertise. If that person is gone, the business may be unable to fulfil contracts or serve clients. Cover gives you the resources to respond.

Businesses with bank loans or investor obligations

Many business loans are personally guaranteed by a director. If that director dies, the loan may become immediately repayable. Key man cover can be structured specifically to cover that liability.

4. What does key man insurance cover?

Key man policies typically come in two forms — or a combination of both:

Life cover only

Pays out on death during the policy term. This is the most common and most straightforward form of key man insurance. It is also generally the cheapest.

Life and critical illness cover

Also pays out if the key person is diagnosed with a specified critical illness — typically including cancer, heart attack, stroke, and a range of other serious conditions. Given that critical illness is statistically more likely than death for working-age adults, this addition is often worth the extra premium.

It is worth noting that key man insurance does not cover income protection — that is a separate product. If you want cover for a key person who is unable to work due to long-term illness or injury (but has not been diagnosed with a critical illness), you would need a separate income protection policy.

5. How much does key man insurance cost?

Premiums vary significantly based on:

• The age and health of the insured person
• Whether the policy includes critical illness cover
• The sum insured
• The policy term
• Whether the person smokes

As a rough guide, a healthy non-smoking 40-year-old covered for £500,000 on a life-only basis might pay in the region of £50–£100 per month. Adding critical illness cover will increase the premium, typically by 2–4 times the life-only cost.

These are indicative figures only — actual premiums depend on underwriting and the specific insurer. A whole-of-market broker will be able to search all available options and find the most competitive terms for your specific situation.

6. Tax treatment of key man insurance

The tax treatment of key man insurance depends on the purpose of the policy. HMRC applies a three-part test:

• The relationship between the employer and the insured is that of employer and employee (or director)
• The policy is taken out to meet a loss of trading income (not capital)
• The policy is annual or capable of being cancelled annually

Where all three conditions are met, the premiums are generally deductible as a business expense, and any pay-out is treated as a trading receipt (i.e. subject to corporation tax). Where the policy is intended to cover capital losses — such as repaying a loan — different rules apply and the premiums may not be deductible.

Tax treatment is complex and depends on your specific circumstances. We always recommend speaking to your accountant alongside your insurance broker when setting up key man cover.

7. How to get key man insurance

The process is straightforward:

1. Identify your key people — who, if they were gone, would seriously damage the business?
2. Decide what to cover — life only, or life and critical illness?
3. Calculate the sum insured — your broker will help with this
4. Apply through a broker — a whole-of-market broker will compare all available insurers and find the best terms
5. The insured person completes medical questions — straightforward for most healthy adults
6. Cover starts — usually within a few days of application

CompanyPMI arranges key man insurance for UK businesses of all sizes. As whole-of-market brokers, we search every major insurer to find the right cover at the right price — and our service is completely free to your business.