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Understanding Key Man Insurance

Does your company employ someone who is absolutely crucial to your business? Someone who is instrumental in the profitability and smooth running of the company? If they were to suddenly pass away, what impact would that have on your business?

Have you heard the term ‘key man insurance’ but you’re not sure exactly what it is?

You may have some questions, such as:

  • What is key man insurance?
  • What is key person insurance?
  • What defines a ‘key employee’?
  • Does my business need key man insurance?
  • How does key man insurance work exactly?
  • How much coverage do I need?

We are here to answer all your questions about key man insurance so that you understand what this type of insurance is and whether or not your business needs a key man life insurance policy.

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What Is Key Man Insurance?

Are you a business owner looking into the various types of insurance that your company needs to set up?

Key man insurance, also known as key person insurance, or key employee insurance, is a specific type of life insurance designed to insure a business against the loss of a key employee.

So what is a ‘key employee’?

A key employee is an individual who is critical to the business, the loss of whom would cause serious financial harm to the business. This person could be an owner, executive, sales person, accountant, or anyone whose skills and knowledge play a key role in the business.

Taking out key person insurance is a way for a business to protect itself in the event that the key employee dies or becomes critically ill.

Key Man Insurance for Business Owners

When a business takes out a key man life insurance policy, the objective is to compensate the business for the loss of a key individual.

Does your company depend on a key individual? All staff are important to a company, but there are some employees who play a crucial role in the smooth running of the company and are integral to the success of the business.

Perhaps this person contributes significantly to the profitability of your business and if they were unable to work, due to death or serious illness, it would have a devastating impact on your business.

The loss of such an individual can be expensive, as losing a key person can cause financial loss to the company. Having appropriate business insurance is one way to compensate for the disruption and cost to your business.

How Does Key Man Insurance Work?

Key person insurance is especially important for companies who would struggle to remain in business if they were to suddenly lose an important member of staff.

Insuring against this loss can help the business weather the storm.

Who owns the policy?

The company takes out and pays for the insurance policy, not the ‘key person’ themselves.

Which individual is insured?

The insurance can cover anyone who is considered an integral employee – someone whose death would have a significant negative impact on the business in question.

How much does it cost?

The premiums will depend on some important factors, such as; the age and health status of the key person, whether they smoke or not, their lifestyle generally and their risk of dying, the amount of coverage required and duration of the coverage.

Are there any tax benefits?

This type of insurance is usually considered a business expense and may be eligible for tax relief.

How does it work?

The business takes out the insurance policy on behalf of the key employee and in the event of the key person dying or becoming critically ill, the insurance company makes a lump sum payment directly to the company. The company can use the funds to hire a replacement or cover any revenue lost due to losing the key person.

Key Man Insurance vs Life Insurance

There are some important distinctions between key person insurance and a personal life insurance policy. Here are some of the main differences between these two types of insurance:

  • Purpose: to compensate a business upon the death of a key employee
  • Beneficiary: the company receives the payment
  • Premiums: the premiums are paid by the company
  • Taxation: premiums are usually considered to be tax-deductible

  • Purpose: to provide funds to the family of an individual after their death
  • Beneficiary: the individual’s beneficiaries (usually family members) receive the funds
  • Premiums: the premiums are paid by the individual who is ensured
  • Taxation: premiums are not usually tax-deductible, although the death benefit to the beneficiary is usually tax free

Key man insurance is designed to protect a business from the devastating effects of the death of an important employee, whereas a typical life insurance policy has the purpose of compensating the beneficiaries of an individual who has passed away.

Getting a Key Man Insurance Quote

If you are considering taking out a key person insurance policy then it’s advisable to shop around to get the best deal for your business. Getting expert, free advice is a good idea, to help guide you through the various complexities of business insurance.

Your insurer will likely require you to show that the loss of your key person would have a detrimental effect on your business.

The cost of the premiums will be based on a calculation factoring in such things as:

Typically, a younger individual has a lower risk of dying, therefore the premiums will reflect that.

Statistically women live longer than men so the premiums may be lower based on that fact.

Having a family history of diseases, a pre-existing health condition, and/or being a smoker can impact the premiums.

Certain industries and job roles carry more risk than others, with a higher chance of death.

Generally, the more coverage required, the higher the premiums will be.

It’s worth noting that different insurance companies have different fees and make their risk assessments in slightly different ways. Comparing insurers will help you get the right amount of coverage at the best price for your business.

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How Can Key Man Insurance Protect Your Business?

If a key employee passes away it can have a profound effect on your business. Having insurance can help mitigate potential damage to your business in a variety of ways. A payout can help with:

Loss of profits

Losing a key employee can impact income and profits. An insurance payment can help cover lost profits during this period.

Costs in recruiting and training a replacement

Recruitment and training can be expensive and may include relocation or ‘welcome’ packages for the replacement employee.

Keeping business operations running

Having a cash payout can help with the immediate impact of losing your key employee and maintain business operations and costs.

Help finance winding down the company

If your business cannot withstand the loss of your key person, you may need to close down the company. Having a lump-sum insurance payment can help with associated costs such as paying creditors and staff. This may be a worst-case situation but being proactive and planning for this circumstance can help you to settle debts and keep the company afloat while you find a suitable buyer for your business.

How To Calculate How Much Coverage You Need

Working out how much coverage your business would need if you were to lose your key employee can be a tricky business. How do you put a price on the value a key individual provides to your company?

One formula that is sometimes used is a multiplier of their salary, including bonuses and any other benefits. For example 10 x their salary and other compensation they normally receive.

The advantage of this approach is that it is simple to calculate, but the disadvantage is that it may not be an accurate representation of the true value they bring to the company.

Another way to figure out how much coverage you need would be to take into account the various costs you would incur if your key individual were to unexpectedly die, such as:

  • Finding and onboarding a replacement
  • The costs of a ‘golden hello’
  • Business expenses and loss of income due to losing your key employee

The amount of insurance you need will depend on what value your key employee represents and what it would cost you if you were to lose your key individual.

How To Identify a Key Employee

So, how do you know who your key employees are?

This will depend greatly on the type of business you have, but generally a key person is someone who makes a significant contribution to your company and whose death would have a serious negative effect on the successful running of your business.

This could be a founder, executive, head of sales, an engineer or software developer, someone who is a creative force or someone who has important contacts in your industry.

A key employee is an individual whose skills and knowledge are critical for the success of your business. Taking out a key man insurance policy can help protect your business if you were to lose the contribution this individual brings to your company.

Summary

Often a business depends heavily on the input from a key employee – their valuable contributions significantly impact the success of the company.

Taking out a key man insurance policy is a proactive way to ensure that in the unfortunate circumstance of them passing away, your business won’t be devastated by their loss.

For more helpful and friendly advice, contact us and we can help you find the insurance cover you need for your business.

FAQ

Premiums are generally considered to be a tax-deductible business expense and as the business is the beneficiary, the insurance payment is usually not subject to income tax. However, consulting with a tax professional is advisable.

The company has a number of options:

  • Continue paying the premiums and make a claim if the insured individual dies
  • Switch the policy to another named individual (subject to underwriting)
  • Change the policy so that the retiring employee owns the policy

This type of insurance is suitable for large and small businesses. Larger companies may be devastated by the loss of a key employee, but equally a small start-up business may be dependent on an individual for it to survive.

No, although the primary cover is for death of the individual, it can also cover terminal illness where the insured has been diagnosed as having less than a year to live. Critical illness, long-term sickness or disability can be added to the insurance policy at an extra cost.

Executive income protection covers an individual who is unable to work due to sickness or injury. Key man insurance protects a business against the death of a key employee.