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3 min read | Published 09/07/2024
Many small businesses rely on the skills and capabilities of certain team members. But what happens if they die or become seriously ill? Key person insurance can help your operation stay afloat even if business-critical individuals are no longer around to lend a hand.
Key person insurance pays out when a business suffers financially due to the death or illness of an individual critical to its everyday operation. Here’s what you need to know about key person insurance.
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Key person insurance is also known as key worker or key man insurance. It protects businesses in the event that an essential individual to the operation dies or contracts a terminal illness.
If you're willing to pay more, you can also add critical illness cover to a key person insurance policy. This additional cover enables you to claim if doctors diagnose the individual with a serious disease – normally, one specified within the policy.
When buying key person insurance, you have to show why your business would lose out financially if the individual concerned could no longer work. You also need the key person’s consent to take out a business insurance policy covering his or her life.
Companies buy key person insurance to help them survive the loss of a fundamental member of the team.
Most policies pay out if the person covered dies or develops a terminal illness that doctors expect to end their life within 12 months.
But if your policy includes critical illness cover, it can also compensate you if the individual concerned contracts an illness on a pre-agreed list.
The payout from a key person policy can help you manage a range of financial consequences, such as:
Loss of profits due to the key person’s absence
Recruiting and/or training a replacement for the key person
Termination of business contracts and relationships dependent on the key person
Having to repay loans held in the key person’s name
A key person is anyone who is integral to the day-to-day running of your company. This could be because of their skill set or perhaps because they allow the business to benefit from vital lending arrangements. In some cases, it could simply be that their presence makes your company more appealing to your customers.
Examples of people who could be key to the survival of a small business include:
A founder
A director
A figurehead
An employee with specialist skills or experience
Key person insurance can help if your company’s success depends on the skills, experience or business relationships of a particular individual linked to your firm. If you started the business, this may be you.
It comes into its own in instances where you know it would be hard to find a replacement with the same qualities.
Buying this cover is not just an investment in the future of your business, though. It can also help to reassure partners or investors that you can survive without a particular individual.
Other types of business insurance that can help to build confidence in your company include:
When you buy key person insurance, you have to decide how much cover you need. There are various ways to calculate this, depending on how the company would lose out without the individual in question.
If, for example, you want key person insurance to cover a loan or lending arrangement, you can simply match your cover to the amount borrowed.
But if your main concern is losing that person’s skills, the right amount of cover is probably around 8 to 10 times their annual salary.
Insurers provide quotes based on different payouts – say £250,000 to £1 million – to help you decide.
The premiums are tax deductible, but you have to pay tax on any payouts received.
You can learn more about how much business insurance cover you need with our short guide.
Buying key person insurance can be a smart move if you know your business would struggle without one or more key team members.
Small start-up businesses, for example, often depend heavily on their founders. So key person insurance could prove invaluable should one die suddenly.
Larger companies, meanwhile, often suffer if a key decision maker is no longer there to steer the ship.
It’s a different story if you’re a sole trader. This is because there’s no legal distinction between you as an individual and you as a business. As a result, you can’t take out key person insurance as a company to protect your business if you pass away or develop a terminal condition. However, you could buy income protection insurance to protect you and your family if you can’t work due to illness or accident. You can also get life insurance, which could help your loved ones in the event of your death.
Alex joined in 2019, bringing his expertise to a range of roles working in both the Analytics and Commercial teams. More recently he has stepped across to focus on Product, where he’s been focusing on scaling up the teams’ SME offering.
