Key Person Insurance Valuation: How to Calculate the Right Sum Insured

Key person insurance is one of the most widely acknowledged but poorly calibrated forms of business protection. Most business owners know they should have it; far fewer have thought rigorously about how much is appropriate — or whether the sum insured on an existing policy reflects the genuine financial exposure to the business.

Getting the valuation right matters for two reasons: an under-insured key person policy leaves the business financially exposed if a claim arises, while an over-insured policy wastes premium and may raise questions from HMRC about whether the sum insured is commercially justifiable. This guide explains the main approaches to calculating an appropriate sum insured and the practical considerations around key person insurance design.

What is Key Person Insurance For?

The fundamental purpose of key person insurance is to compensate the business for the financial loss it suffers as a result of the death or incapacitation of a critical individual. This financial loss may manifest as:

• Loss of revenue or profit that the key person generated or enabled
• The cost of recruiting, hiring, and training a replacement
• The cost of servicing or retaining client relationships that depended on the key person
• Loan or debt obligations that the key person personally guaranteed, where a lender may now seek repayment
• Disruption costs — projects delayed, contracts renegotiated, operational continuity costs

The key person is typically a founder, a principal revenue generator, a technical specialist with rare expertise, or a senior executive whose loss would cause material disruption. The HMRC test (discussed below) provides a useful framework for identifying who genuinely qualifies.

HMRC's Test: Who Qualifies as a Key Person?

HMRC's guidance (Business Income Manual BIM45525 and related guidance on business protection, applying the long-standing "Anderson" principles) provides a working definition of a key person as an individual whose loss would cause:

1. Significant disruption to the business operations, and/or
2. A material loss of profit

The emphasis on materiality is important. Most businesses would suffer some disruption from any employee's departure, but key person insurance is reserved for those whose loss would cause business-level financial damage — not merely inconvenience. In practice, this typically means:

• Founders and owner-managers of small businesses where the business depends on their personal involvement
• Senior revenue generators (a rainmaking partner in a law firm, a senior broker generating 40% of office revenue)
• Technical specialists holding unique knowledge or certifications that cannot quickly be replaced
• Client relationship holders where clients are linked personally to the individual, not the business

For large businesses with significant management depth, insurance underwriters and HMRC alike are more sceptical about the key person argument — the argument is strongest for businesses where the identified individual's removal would create a genuine cliff-edge risk.

Valuation Methodology 1: Multiple of Salary

The simplest and most commonly used methodology is a multiple of the key person's total remuneration package — salary, bonuses, employer pension contributions, and benefits in kind.

Typical market multiples:

Age of Key Person	Typical Multiple Range
Under 35	15–25×
35–45	10–20×
45–55	5–15×
Over 55	3–10×

The multiple reflects the combination of the recruitment and replacement cost (typically 1–2× salary for senior roles), the revenue impact period (time until replacement is productive), and the business disruption allowance.

Example: A 42-year-old managing director earning £250,000 in total package might attract a multiple of 10–15×, giving a sum insured of £2.5–3.75 million.

Limitations of the salary multiple approach: it does not directly reflect the individual's profit contribution, which may be far higher (or occasionally lower) than their cost. A highly efficient founder who earns £150,000 but generates £2 million of profit per year would be significantly under-insured using a salary multiple; a well-paid functional director who earns £200,000 but is easily replaceable might be over-insured.

Valuation Methodology 2: Profit Contribution Multiple

The profit contribution method is more analytically rigorous and more closely linked to the actual financial exposure the business faces.

The calculation requires estimating what proportion of the business's EBITDA or net profit is attributable to — or at risk from the loss of — the key person. This is then multiplied by a factor representing the number of years the business would be affected.

Formula: (Attributable EBITDA) × (Replacement Period in Years)

Example: A software business with EBITDA of £2 million per year has a CTO who is responsible for the proprietary technology platform. Without them, client retention is at risk, new product development would halt, and the business estimates it would take two to three years to replace their contribution fully. The attributable EBITDA is estimated at 30% of total EBITDA, or £600,000 per year. A three-year replacement period gives a sum insured indication of £1.8 million.

This approach produces a more defensible and accurate sum insured, but requires honest assessment of what proportion of profit is genuinely at risk — which can be difficult to determine and is inherently subjective.

Valuation Methodology 3: Revenue at Risk

The revenue at risk method focuses on the revenue that would be lost or at risk following the key person's death or incapacity.

Formula: (Gross Revenue at Risk) × (Margin) × (Risk Period)

Revenue at risk is typically the proportion of annual turnover that could be expected to leave or be disrupted. For a key client relationship holder, the relevant figure might be the revenue from their specific client base. For a founding entrepreneur, it might be a proportion of total business revenue.

This method is most useful where the key person's connection to specific clients or contracts is the primary concern — for example, a financial adviser whose book would be at risk, a property developer whose lender relationships depend on their reputation, or a principal in a professional services firm whose clients have personal loyalty to that individual.

Debt-Based Valuation: Personal Guarantees

Where the key person has provided personal guarantees for business borrowings, the guaranteed debt represents a specific and quantifiable exposure. If the key person dies or becomes critically ill, the lender may call in the guarantee — requiring immediate repayment of what may be several million pounds of business debt.

Key person insurance can be structured to cover the value of personal guarantees outstanding at the time of claim. This is a straightforward sum insured calculation — the total guaranteed debt (or the business's share of it) — and can be periodically reviewed as debt levels change.

For business owners with significant bank debt or commercial mortgage borrowings supported by personal guarantees, this element of key person cover is often the most immediately pressing.

HMRC and Tax Treatment of Premiums

The tax deductibility of key person insurance premiums is governed by HMRC's guidance at BIM45525 (the "Anderson" rules) and associated manuals. The key tests are:

1. The insurance is for the loss of profit (not to repay capital or to create an asset for the company): premiums are potentially deductible
2. The policy is term insurance only (no investment value, no surrender value): premiums are potentially deductible
3. The benefit is payable to the employer (not to the employee's estate or family): premiums are potentially deductible

Where all three conditions are met — a pure profit indemnity policy with no element of personal benefit to the employee — HMRC's guidance indicates that premiums are a deductible trading expense for the employer. The death benefit received would then be treated as a trading receipt for the business (taxable on receipt).

Where the policy has an element that would benefit the employee personally on death — for example, a policy that would repay a debt that would otherwise fall on the employee's estate — the deductibility position is less clear, and specific advice should be sought.

Critical illness versions of key person cover present additional complexity. Where the policy pays on critical illness of the key person, the benefit may represent compensation for lost profits (deductible) or may have an element of personal benefit (if the business could use the proceeds to fund the individual's return to health, for example). HMRC guidance on CIC key person cover is less settled than for pure life.

Structuring the Policy: Ownership and Beneficiary

The company (or partnership/LLP) is the policyholder, premium payer, and beneficiary. The benefit is paid to the business, not to the individual's estate.

This structure distinguishes key person insurance from life insurance in trust (where the benefit goes to the family). If the purpose is to protect the business, the business should receive the proceeds; if the purpose is to protect the individual's family, a relevant life plan or personal life policy in trust is more appropriate.

For companies with multiple shareholders, key person insurance on a shared employee or director should address who in the company actually receives the benefit and how it will be applied.

How Frequently Should the Sum Insured Be Reviewed?

Key person insurance should be reviewed:

• Annually — to ensure the sum insured remains aligned with current profit, salary, and debt levels
• When debt levels change — if a new commercial mortgage is taken or an existing one is repaid, the debt-based element should be recalculated
• When the key person's role changes — a promotion, a new client win, or a new technical responsibility may materially change the financial exposure
• When the business is sold or restructured — key person insurance may need to be cancelled, transferred, or re-structured on a business change

Many policies are set and forgotten — and the sum insured that was adequate three years ago may be wholly inadequate today. A periodic review with a specialist adviser is worthwhile.

Key person insurance is a commercial insurance product. The tax treatment of premiums and benefits is complex and subject to HMRC guidance and interpretation that may change. The information in this guide is for general educational purposes and does not constitute tax or financial advice. A qualified financial adviser and tax specialist should be consulted before taking out or reviewing key person insurance.

How Global Investments Can Help

Key person insurance sits at the heart of business protection — and getting the sum insured right requires a thoughtful, structured approach that goes beyond simple rules of thumb. Our advisers work with business owners, managing directors, and technical specialists to apply the appropriate valuation methodology for their specific business, ensure the tax position is properly understood, and structure the cover to reflect genuine financial exposure.

If your business has key individuals whose loss would cause material disruption — and you are not confident that existing cover accurately reflects that risk — a structured review is the right starting point. Contact us to discuss your business protection needs.