Key Person Life Insurance UK

Protecting your business against the loss of a key employee

Have you ever stopped to consider who is truly indispensable to your business? It might be the founder with the vision, the salesperson who consistently shatters targets, or the technical genius who built your core product. These are your 'key people' – the individuals whose sudden absence due to death or serious illness could destabilise, or even destroy, the business you've worked so hard to build.

Losing a key team member is not just a financial blow; it's an emotional one. The disruption can be immense, affecting morale, client confidence, and the company's strategic direction. While you can't prevent such life-altering events, you can prepare for the financial fallout. This is where Key Person Insurance comes in.

This comprehensive guide will walk you through everything you need to know about Key Person Life Insurance in the UK. We'll explore what it is, who needs it, how it works, and how it fits into a broader strategy for business resilience.

What Exactly is Key Person Insurance?

Key Person Insurance (also known as key man insurance) is a specific type of business life insurance policy. Here’s the crucial distinction: the policy is taken out and paid for by the business, and if a claim is made, the payout goes directly to the business, not the individual's family.

Think of it as a life insurance policy for your company's most valuable assets: its people.

The primary purpose of the payout is to provide a financial cushion, giving the business the breathing room it needs to navigate the turmoil following the loss of a vital employee. It buys the company time – time to recruit a replacement, time to manage debts, and time to reassure stakeholders that the business remains on a stable footing.

A key person is anyone whose death or long-term incapacity from a critical illness would have a significant and direct negative impact on the company's profits or stability.

Identifying the Key People in Your Business

Identifying your key people requires an honest assessment of your operations. The right person isn't always the one with the grandest title. Look for individuals whose skills, knowledge, relationships, or leadership are fundamental to your success.

Here are some questions to help you pinpoint your key personnel:

• Financial Impact: Would their absence cause a direct and measurable dip in sales or profits? (e.g., your star salesperson or a rainmaking partner in a law firm).
• Specialised Skills: Do they possess unique technical skills, intellectual property, or knowledge that would be incredibly difficult and expensive to replace? (e.g., a lead software developer, a research scientist, or a specialist engineer).
• Leadership & Vision: Is this the person who sets the company's strategic direction and inspires the team? (e.g., the CEO, founder, or managing director).
• Client & Supplier Relationships: Is there someone who holds crucial relationships with major clients or suppliers, which might be lost if they were no longer around?
• Debt & Finance: Does the business have significant loans or overdrafts that are personally guaranteed by a director, or where the lender's confidence is tied to that specific individual?

Common Examples of Key People:

It's a common misconception that this is only for large corporations. In fact, Small and Medium-sized Enterprises (SMEs) are often far more vulnerable to the loss of a key person, as they typically have smaller teams where individuals wear multiple hats. For a sole trader or a small partnership, the 'key person' is often the business owner themselves.

How Does Key Person Insurance Work?

The mechanics of a Key Person policy are straightforward, designed to provide certainty in a time of crisis.

1. Identification: The business identifies one or more key individuals.
2. Application: The business applies for a policy on the life of the key person. The key person will need to consent to this and provide information about their health and lifestyle.
3. Ownership & Premiums: The business owns the policy and pays the monthly or annual premiums. These premiums are based on the employee's age, health, smoker status, the level of cover, and the length of the policy term.
4. The Insured Event: If the key person passes away or is diagnosed with a specified critical illness (if this cover is included) during the policy term, the business initiates a claim.
5. The Payout: The insurer pays the agreed-upon tax-free lump sum directly to the business.
6. Business Continuity: The company uses these funds to manage the financial consequences of the loss, ensuring business continuity.

It's important to note that the key person has no rights to the policy. If they leave the company, the business can choose to either cancel the policy or, in some cases, reassign it if there is an insurable interest in a new key person (subject to the insurer's terms).

What Can the Payout Be Used For?

The beauty of a Key Person Insurance payout is its flexibility. The funds are paid to the business to be used as it sees fit to mitigate the impact of the loss. There are no strict rules, but common uses include:

• Recruitment and Training (illustrative): The cost of finding and onboarding a high-calibre replacement can be substantial. This includes headhunter fees, advertising costs, and the salary costs during the training period where the new employee is not yet fully productive. A 2024 report by the Recruitment & Employment Confederation (REC) highlighted that the cost of a bad hire at a mid-manager level with a £45,000 salary could be over £130,000 once training, lost productivity and other factors are included.
• Covering Lost Profits: The payout can replace the profits or revenue that the key person would have generated, protecting the company's bottom line while it gets back on its feet.
• Repaying Business Debt: If the key person had guaranteed a business loan, the payout could be used to clear that debt, preventing the bank from calling it in.
• Reassuring Stakeholders: The cash injection can demonstrate stability to lenders, investors, and important clients, preventing a loss of confidence that could trigger a downward spiral.
• Project Completion: If the key person was integral to a specific project, the funds could be used to hire specialist contractors to see it through to completion.
• Orderly Wind-Down: In a worst-case scenario, if the business is not viable without the key person, the money can be used to close the business down in an orderly manner, paying off debts, settling accounts, and covering redundancy payments without forcing a fire sale of assets.

Types of Key Person Cover

When setting up a policy, you have a crucial choice to make regarding the 'trigger' for the payout.

1. Life Insurance Only

This is the simplest form. The policy pays out a lump sum if the key person dies during the policy term. It provides essential protection but doesn't cover the significant risk of long-term illness.

2. Life and Critical Illness Cover

This is a more comprehensive and often more relevant option. The policy pays out if the key person either dies or is diagnosed with one of a list of specified critical illnesses (such as some types of cancer, heart attack, or stroke).

Why is this so important? The reality is that a key employee is statistically far more likely to suffer a serious illness than to pass away during their working life.

According to Cancer Research UK, 1 in 2 people in the UK will be diagnosed with some form of cancer during their lifetime. While survival rates are thankfully improving, a diagnosis and subsequent treatment can easily lead to an absence of a year or more, creating the same business disruption as a death. The financial impact is often identical, but the risk is significantly higher. (illustrative estimate)

Life Only vs. Life & Critical Illness Cover:

For most businesses, the added premium for critical illness cover is a worthwhile investment for the significantly enhanced protection it provides.

How Much Cover Does Your Business Need?

This is one of the most critical questions in the process. Under-insuring can leave the business exposed, while over-insuring means paying unnecessarily high premiums. Insurers will also require you to justify the level of cover you're applying for through financial underwriting.

There are three common methods for calculating the appropriate sum assured:

1. Multiple of Salary

This is the simplest method. You take the key person's gross salary and multiply it by a certain number, typically between 5 and 10. For example, a key person earning £80,000 might be insured for £400,000 (5x) to £80,000 (10x).

• Pro: Simple and quick to calculate.
• Con: Can be arbitrary. It doesn't accurately reflect the individual's value, which may be far greater than their salary.

2. Contribution to Profits

This is a more accurate and widely accepted method. It aims to quantify the person's direct impact on the company's profitability.

There are two ways to approach this:

• Gross Profit: Calculate the percentage of gross profit the individual is responsible for.
• Net Profit: Calculate the percentage of net profit the individual is responsible for.

Formula Example: (Key Person's Attributable Profit) x (Number of Years to Recover) = Sum Assured

For example, if a sales director is directly responsible for £500,000 of the company's annual net profit, and you estimate it would take 3 years to find and train a replacement to the same level, you might insure them for £1.5 million.

3. Cost of Replacement

This method focuses on the direct costs associated with replacing the individual. This includes recruitment agency fees (often 20-30% of the first year's salary), training costs, the salary of the replacement, and the cost of any temporary staff or contractors needed in the interim. This method is often used for roles with highly specialised skills rather than direct profit generation.

Comparing Calculation Methods:

Ultimately, the right level of cover may be a blend of these methods. Working with an expert adviser, like our team at WeCovr, is invaluable here. We can help you analyse your business financials and present a robust justification to the insurer, ensuring you get the right level of cover approved.

The Tax Implications of Key Person Insurance

The tax treatment of key person policies is a complex area and you should always seek professional advice from your accountant. However, we can outline the general principles laid out by HMRC.

Are the Premiums Tax Deductible?

For the premiums to be considered an allowable business expense (and therefore deductible against corporation tax), they must meet HMRC's 'wholly and exclusively' test. This means the sole purpose of the policy must be for the benefit of the business's trade.

HMRC generally allows premiums to be deducted if the policy is intended to cover a loss of profits resulting from the loss of a key employee.

However, premiums are unlikely to be deductible if:

• The key person is a major shareholder, and the policy looks like it's mainly for the benefit of them or their family rather than the business.
• The policy is linked to securing or paying off a business loan.
• The policy term extends beyond the employee's period of service or usefulness to the company.

Is the Payout Taxable?

There is usually a direct link between the tax treatment of the premiums and the payout.

• If premiums were allowed as a business expense: The payout from the insurer is likely to be treated as trading income and therefore subject to corporation tax.
• If premiums were not allowed as a business expense: The payout is likely to be tax-free.

While a taxable payout might seem less attractive, remember that the business would have been receiving tax relief on the premiums for the entire duration of the policy. Your accountant can help you determine the most advantageous structure for your specific circumstances.

Key Person Insurance vs. Other Business Protection Policies

Key Person Insurance is just one piece of the business protection puzzle. It's often confused with other policies, but they serve very different purposes.

For company directors and business owners, a comprehensive protection strategy might involve several of these policies. For example, a business might have:

• Key Person Insurance on the CTO.
• Shareholder Protection for all three founding directors.
• Executive Income Protection for the senior management team.

This multi-layered approach ensures that the business and its owners are protected against a range of different risks.

The Application Process: What to Expect

Setting up a key person policy is a more involved process than personal life insurance, as it involves both medical and financial underwriting.

1. Initial Consultation & Quotes: The first step is to speak with an expert broker. At WeCovr, we'll discuss your business structure, help you identify your key people, and determine the appropriate level of cover. We can then gather quotes from across the UK's leading insurers to find the most suitable and cost-effective solution.
2. Application Form: This will include details about the business and the key person. The key person will need to complete a detailed health and lifestyle questionnaire. Honesty is paramount here; any non-disclosure could invalidate the policy at the point of a claim.
3. Medical Underwriting: Depending on the key person's age and the amount of cover, insurers may require:
   • A report from their GP.
   • A nurse screening (blood pressure, height, weight, cholesterol, urine sample).
   • A full medical examination with a doctor.
4. Financial Underwriting: You will need to provide financial evidence to the insurer to justify the sum assured. This typically includes:
   • The last 2-3 years of audited company accounts.
   • A letter explaining the rationale for the level of cover and the key person's specific role and contribution to the business.
5. Offer of Terms: Once underwriting is complete, the insurer will issue an offer. This will either be on 'standard terms' (as quoted) or may include a 'loading' (higher premium) or an exclusion if the key person has a pre-existing health condition or a high-risk hobby.
6. Policy in Force: Once you accept the terms and pay the first premium, the policy is active, and your business is protected.

Beyond Insurance: Building a Resilient Business

Key Person Insurance is a powerful financial tool, but it should be part of a wider strategy for business resilience. A payout can't replace lost knowledge or relationships overnight.

Consider implementing these measures alongside your insurance policy:

• Succession Planning: Actively identify and develop potential successors for key roles. This provides a clear path forward and reduces panic if a key person departs unexpectedly.
• Cross-Training and Knowledge Sharing: Encourage team members to share skills and knowledge. This reduces the risk of having 'single points of failure' where crucial information is held by only one person.
• Process Documentation: Create detailed standard operating procedures (SOPs) for all critical business functions. This ensures that tasks can be picked up by others if the primary person is absent.
• Promoting a Healthy Workplace: A proactive approach to employee wellbeing can reduce the risk of long-term absence. This includes promoting a healthy work-life balance, providing mental health support, and encouraging healthy habits.

At WeCovr, we believe in a holistic approach to wellbeing. That’s why, in addition to arranging robust protection policies, we provide our customers with complimentary access to CalorieHero, our AI-powered calorie and nutrition tracking app. By supporting the health of your team, you're not just being a good employer; you're making a sound investment in the future of your business.

Final Thoughts

No business owner likes to think about the worst-case scenario. But the most successful entrepreneurs are those who plan for adversity. The loss of a key person is a significant threat, particularly for smaller, growing businesses where talent is concentrated in a few individuals.

Key Person Insurance is not an expense; it's an investment in continuity, stability, and peace of mind. It transforms an unpredictable and potentially catastrophic risk into a manageable, fixed cost. By providing a crucial injection of cash when it's needed most, it gives your business the ultimate gift: the chance to survive, recover, and thrive.

If you're ready to explore how Key Person Insurance can safeguard the future of your business, our team of expert advisers is here to help. We provide impartial advice, compare plans from all major UK insurers, and guide you through every step of the process to secure the protection your business deserves.

Sources

• Department for Transport (DfT): Road safety and transport statistics.
• DVLA / DVSA: UK vehicle and driving regulatory guidance.
• Association of British Insurers (ABI): Motor insurance market and claims publications.
• Financial Conduct Authority (FCA): Insurance conduct and consumer information guidance.