Most small UK businesses look fine on paper. Revenue is growing, customers are coming back, the team is stable. But quietly, the entire operation runs through one or two people — often the founder, sometimes a key salesperson, occasionally a technical lead whose head holds half the system.
If that person stopped showing up tomorrow, what would actually happen? For most businesses, the honest answer is: a lot of bad things at once. Key person insurance is the cover designed for exactly that scenario.
What key person insurance actually does
Key person insurance is a life and/or critical illness policy taken out by a business on the life of a critical employee or director. The business pays the premiums, owns the policy, and is the beneficiary. If the insured person dies or — depending on the cover — is diagnosed with a serious illness, the policy pays a lump sum directly to the business.
Crucially, the payout is to the company, not to the individual or their family (that’s what personal life cover does). The point is to give the company financial breathing room to:
- Cover lost profit while the loss is absorbed.
- Fund the cost and time of finding, hiring and onboarding a replacement.
- Repay business loans or director loans that depended on the individual.
- Reassure lenders, suppliers and customers that the business remains stable.
- Buy out the deceased’s interest where appropriate (often handled by separate shareholder protection — see below).
Who counts as a “key person”?
The label is descriptive, not formal. A key person is anyone whose absence would have a material financial impact on the business. In small UK businesses that typically includes:
- The founder or managing director. Particularly in owner-managed businesses where most relationships, decisions and IP sit with one person.
- Sales-driving individuals. A senior salesperson whose pipeline accounts for a disproportionate share of revenue.
- Technical specialists. A developer, engineer or operator with hard-to-replicate skills.
- Operational leaders. A finance director, COO or general manager who keeps the company running day to day.
For many small companies, two or three people fit this definition. Cover can be put in place for each.
How the sum assured is typically worked out
There’s no formula that universally applies. The most common starting points are some combination of:
Multiple of profit. Often a multiple (e.g. 2–5x) of the gross profit the key person is responsible for generating. The multiple reflects how long it would realistically take the business to replace the contribution.
Multiple of salary. A simpler approach, sometimes 5–10x the key person’s total remuneration. Easier to calculate, but can understate the impact for high-leverage individuals.
Cost of replacement. Direct costs of recruiting, training and ramping up a replacement, plus the operational gap during the interim.
Loan and overdraft coverage. If the business has borrowings backed by the key person’s involvement, the sum assured can be sized to clear them.
In practice, advisers often build the figure from a blend of these — and the right number for any business depends on its own financial profile.
Term and structure
Key person policies are usually written as term assurance over a defined period — five, ten, fifteen years — aligned to a strategic horizon (a loan term, a growth plan, an expected exit timeline). The policy can be renewed or restructured later.
Cover commonly includes the option to attach critical illness cover, which pays out on diagnosis of a specified serious condition rather than only on death. This matters because, in many real cases, the key person doesn’t die — they have a major heart attack, a serious cancer diagnosis, or a stroke that takes them out of the business for an extended period. Death-only cover doesn’t respond in that scenario.
Tax treatment
Tax treatment of key person policies in the UK is nuanced and depends on the specific facts of each case. The general principle that often applies — sometimes called the “Anderson principles” — is that premiums may be allowable as a deductible business expense, and the payout may be received tax-free, when the policy meets a particular set of conditions: term-only cover, the sole purpose is to meet loss of trading income, the life assured is an employee (not a major shareholder), and so on.
Where those conditions aren’t fully met (for example, the key person is a 50% shareholder), the position can shift — premiums may not be deductible, and the payout may be taxable. Every case needs to be reviewed with both an adviser and the company’s accountant. Don’t take it as automatic.
Where this sits next to shareholder protection and relevant life
Key person insurance is one piece of a wider business protection picture.
Shareholder protection pays the surviving shareholders to buy the deceased’s shares from their estate, keeping control of the business in the right hands.
Relevant life cover provides death-in-service-style cover for an individual director, structured tax-efficiently as a company-paid benefit.
Income protection for the individual director protects their personal income if they’re medically unable to work.
The right blend depends on the company structure, the shareholder arrangements, and the individuals involved. They’re complementary, not interchangeable.
Where this fits in a wider plan
For most small UK businesses, the gap between the cover that the company van has and the cover that the company’s most important person has is jarring once you look at it. Key person insurance closes that gap.
When my authorisation is in place, this is one of the first conversations I’ll be having with business-owner clients — alongside shareholder protection and director-level personal cover. Join the waitlist to be first in line.