Key Person Insurance: The Complete Business Guide

Every business depends on certain individuals whose skills, relationships, or specialist knowledge are disproportionately valuable. The sudden loss of such a person — through death or critical illness — can threaten the very survival of the enterprise. Key person insurance is the mechanism businesses use to transfer that risk to an insurer.

This guide explains what key person insurance is, how to calculate the right level of cover, how HMRC treats the premiums and the claim proceeds, and how the product differs from shareholder protection.

What Is Key Person Insurance?

Key person insurance (also called keyman insurance) is a life assurance or critical illness policy owned by the business on the life of an individual whose death or incapacitation would cause significant financial harm to the business.

The structure has three parties:

• The policyholder: the business (company, partnership, or sole trader)
• The life assured: the key person (typically a director, founder, top salesperson, or technical specialist)
• The beneficiary: the business itself, which receives the claim proceeds

The business pays the premiums from its own funds. The key person does not pay anything and does not personally receive any benefit. The payout on death or diagnosis goes to the business account.

The key person must typically consent to being insured and will need to complete a health questionnaire as part of the underwriting process.

Why Businesses Buy Key Person Cover

The financial consequences of losing a key individual are wider than most directors realise until they stress-test the scenario:

Revenue risk: A key salesperson or client relationship holder may take clients with them on death or incapacitation. Revenue can fall sharply and quickly.

Recruitment costs: Replacing a senior executive costs money — search fees, interim cover, time — and can take six to twelve months. During that period, the business is operating below capacity.

Loan covenant breaches: Banks routinely include covenants requiring the business to maintain life cover on key directors as a condition of lending. The death of a key director without insurance can trigger a covenant breach, forcing repayment of the loan at the worst possible time.

Working capital risk: Projects stall, contracts may be renegotiated, suppliers may require payment upfront — the business needs cash to absorb the disruption.

Loss of intellectual property and relationships: In professional service firms, the key person may hold client relationships, technical know-how, or regulatory approvals that take years to replicate.

The insurance provides the business with a cash injection at the precise moment when cash is most needed.

Calculating the Sum Assured

There is no single correct method. Businesses use one of three approaches, or a combination:

The Debt-Based Approach

Set the sum assured equal to the business loans personally guaranteed by the key person. If the managing director has personally guaranteed £500,000 of bank debt, £500,000 of cover addresses that specific liability.

This is often the minimum — it answers the immediate creditor risk but does not address lost revenue or replacement costs.

The Profit-Based Approach

Estimate the proportion of business profit attributable to the key person, then multiply by a recovery period of two to five years. A director responsible for 40% of a £1 million annual profit might generate a key person value of £400,000 per year — multiplied by three years' recovery period, the sum assured would be £1.2 million.

This approach is subjective and requires documenting the assumptions, but it gives a more realistic picture of the financial exposure than debt alone.

The Salary Multiple Approach

A simpler calculation: multiply the key person's total remuneration (salary plus bonus) by a factor of five to ten. A director earning £150,000 per year would generate a sum assured of £750,000 to £1.5 million.

The salary multiple approach is quick and widely used for initial quotations, but it should be cross-checked against the profit-based approach for senior executives where the profit contribution significantly exceeds the salary.

Most insurers will accept any of these methods, and some will ask you to document the basis when applying for large sums assured.

The HMRC Tax Treatment of Premiums

This is an area where mistakes are common and expensive. The tax treatment depends on the type of cover and the policy's characteristics. HMRC guidance (BIM45525 and related) sets out the position:

Critical Illness Cover Premiums

CI premiums are generally deductible against corporation tax provided all of the following conditions are met:

1. The policy is not an endowment policy (i.e., it has no investment or savings element).
2. The policy is for the benefit of the business — not for the employee or their estate.
3. The purpose of the cover is to protect trading income (replacing lost profit) rather than to provide capital.

CI cover protects income — the loss of a key person disrupts trading. HMRC accepts this as a trading expense.

Life Assurance Premiums

Life assurance premiums for key person cover are generally not deductible against corporation tax. HMRC's position is that life assurance on a key person protects the business's capital (it replaces the capital value of the individual to the business), not its trading income. Capital expenditure is not deductible.

This is a meaningful distinction in practice: a combined life and CI policy requires the premium to be apportioned, with the CI element deductible and the life element non-deductible.

When in Doubt, Seek a Ruling

The analysis is not always clear-cut, particularly for combined policies or where the policy purpose straddles income and capital protection. HMRC offers a non-statutory clearance mechanism. For large sums, a specific ruling is worth the effort.

Tax Treatment of the Claim Proceeds

The claim proceeds mirror the premium treatment:

• If premiums were deductible (CI cover meeting the conditions above): the claim proceeds are treated as a taxable trading receipt. The business pays corporation tax on the payout.
• If premiums were non-deductible (life assurance or CI cover that did not qualify): the claim proceeds are received tax-free by the business.

The after-tax position must be factored into the sum assured calculation. If CI cover proceeds will be taxed at the 25% corporation tax rate, the gross sum assured needs to be sufficiently large to leave an adequate net amount after tax.

Key Person vs Shareholder Protection

These two products are often confused because the same individual may need both, but they serve different purposes:

	Key Person Insurance	Shareholder Protection
Purpose	Business continuity	Share purchase on death
Policyholder	Business	Typically each shareholder individually
Beneficiary on claim	Business	Surviving shareholders (via trust)
Proceeds used for	Absorbing financial loss	Buying the deceased's shares from the estate
Legal mechanism	No formal agreement required	Cross-option (buy-sell) agreement
IHT position	Not relevant (business receives funds)	Estate's shares typically qualify for BPR

A key person may also be a shareholder. In that case, the business almost certainly needs both:

• Key person cover to absorb the revenue, recruitment, and working capital costs
• Shareholder protection to fund the purchase of the shares from the deceased's estate

Writing a single policy and trying to use it for both purposes creates complications — the proceeds may need to be split, and the trust structure for shareholder protection conflicts with the business-as-beneficiary structure for key person cover. Two separate policies, each fit for purpose, are usually the cleaner solution.

Practical Considerations

Consent: The key person must consent in writing to being insured. Most insurers require a signature on the application.

Ownership changes: If the business is sold or restructured, the policy may need to be assigned or surrendered. Plan for this at the outset.

Annual review: Business profits, loan balances, and key person contributions change over time. Review the sum assured annually to ensure it remains appropriate.

Medical underwriting: Insurers will ask about the key person's health history. For older individuals or those with pre-existing conditions, premiums may be loaded or certain conditions excluded. Use a specialist broker if the key person has complex health disclosures.

Multiple key people: A business may have several key people — the founder, the finance director, the lead engineer. Each may warrant a separate policy. There is no legal limit on the number of key person policies a business can hold.

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Key person insurance is a complex area where the tax treatment is genuinely case-specific. The information in this guide reflects HMRC's general position as at 2026, but rules can change and individual circumstances vary. Seek advice from a qualified financial adviser and your accountant before effecting a policy. The value of the financial protection provided depends on the sum assured and the terms of the policy — businesses should ensure coverage is reviewed regularly to reflect current exposures.

How Global Investments can help

Global Investments works with business owners and directors across the international markets we work in to structure business protection programmes that genuinely reflect the financial exposure — not just a round number. Our advisers can quantify the key person value for your business, obtain competitive terms from specialist insurers, navigate the HMRC premium deductibility question with your accountant, and ensure your key person and shareholder protection policies work together as a coherent plan. Contact us to arrange a business protection review.