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What Is Key Man Insurance?

Written by, Marija Petkova

Updated September, 19, 2022

Key insurance can be an important part of a cover for businesses whose success depends on the expertise and knowledge of a few core employees (or owners). 

 But, what is key man insurance, what does it cover, and how does it work?

Read to find out.

What Is Key Man Insurance?

Key man insurance is a form of life insurance that the business carries on its core employee(s) to cover for the financial losses that it might suffer in case of the key person’s death, terminal illness, or disability.

It is valuable for businesses whose revenue is dependent on a person’s performance, expertise, or personal network. 

Who Is a Key Person?

A key person is an individual who is extremely difficult and expensive to replace and whose loss would resonate throughout the entire business. 

This can be the owner of the business, someone who is highly specialized in their role, or a person that is responsible for bringing a large share of sales. 

How Does Key Man Insurance Work?

Under a key man life insurance policy, the company owns (buys) the insurance policy, pays the premium, and is the beneficiary. 

If that person dies or suffers an illness that prevents them from working, the company can make a claim and use the money from the insurance to cover any expenses that may arise from their absence.

Key person insurance comes in two forms:

  • Life insurance – The insurance company will pay a lump sum to the business if the key person dies or is diagnosed with a terminal illness (usually with less than 12 months to live). 
  • Life insurance & critical illness cover – The insurer will pay the business if the key person dies or suffers a serious illness such as a heart attack, stroke, or cancer.

What Does Key Man Insurance Cover?

Businesses can use the proceeds from the insurance and use it to:

  • Cover operating expenses.
  • Find a replacement hire.
  • Training the replacement hire.
  • Offset lost income.
  • Buy a former owner’s interest in the company.

If the person in charge decides that it’s better to close the business, the company can also use the process to distribute money to investors, pay off debts, or pay severance to employees. 

What Level of Key Man Insurance Do I Need?

To determine how much insurance the company will need, you’ll need to consider the impact of the person’s loss on the business. 

While there are no rules on how you can put a price on a key person to a business, the insurance company will use calculations based on various metrics to ensure they aren’t overinsuring. 

Here’s how they usually work that out, according to Moneysupermarket.com:

  1. If the person produces revenue: Average Gross Profit X 2 X their contribution.
  1. If the person doesn’t produce revenue (Chief Technical Officer, Head of HR, or Finance Director):  Average Net Profit X 5 X their contribution.
  1. The person’s loss results in a big replacement cost: Annual Earnings x 10.

They’ll also consider the gender, age, and physical health of the insured.

Is Key Man Insurance Tax Deductible?

Key man life insurance tax treatment is a complicated matter that mainly depends on what and who will benefit from the insurance policy payout. 

Whether a company can treat the premiums as deductible expenses depends on whether it can pass the ‘wholly and exclusively’ test.

If the payout from the policy is ‘wholly and exclusively for the purposes of the company’s trade’ i.e. solely for the benefits of the business, then the premiums are typically tax deductible. 

In other words, if the company intends to use the payout to fill in the hole in its income that the death of the key individual would cause, then the insurance is an allowable expense.

When a policy benefits a shareholder or is taken out to protect a business loan rather than the business as a whole, it fails the ‘wholly and exclusively’ test, in which case the premiums would be a taxable expense.

How Much Does Key Man Insurance Cost?

The cost of a key man insurance policy depends on the level of coverage (the size of the benefit and policy length) and other factors, including:

  • The age of the insured
  • Smoker status
  • General health status (including pre-existing medical conditions)
  • Hobbies

Here’s an example of how much you can expect to pay if the insured is a healthy non-smoker with an office-based job and a cover of  £150,000 for 10 years:

Life Insurance Only
AgeMonthly premiums 
35 years£7
45 years£13
55 years£27
Life Insurance & Critical Injury Cover
35 years£33
45 years£72
55 years£158

Bottom Line

Key man insurance is a policy that covers a business for a person whose death or absence can leave a financial dent in the company’s revenue. 

The company buys the policy, pays for the premiums, and is the beneficiary should something happen to the key person that prevents them from working. The cost of the policy largely depends on the key person’s general health, as well as the size of the benefit and the length of the policy.

                           

Frequently Asked Questions And Their Answers

Who benefits from key man insurance?

The beneficiary in key man insurance is usually the company. 

What does the key person cover?

Key person insurance covers any expenses that might arise as a result of the absence or death of the key employee. 

How is key man cover calculated?

Insurance companies based their calculations on the type and percentage of the key person’s contribution to the company, in addition to other factors like general health.

Is key man insurance expensive?

Key man insurance can be expensive, depending on the type of insurance policy you choose, the general health of the key person, and the policy size.

What is key man insurance?

Key man insurance is a type of life insurance that offers a financial cushion to businesses in case of the death or illness of a person that is responsible for a large share of revenue or the success of the company. 

My name is Marija, and I'm a financial writer at DontDisappointMe. Although finance might not be everyone's cup of tea, my 10+ years of working in one of the biggest banks in my country, and my interest in extensive research on everything finance/investment-related, have made me somewhat of an expert in the field (if I do say so myself). No longer having the passion to work in a corporate setting, I decided that I couldn't let all of this knowledge go to waste so I started writing. And, here I am! Today I try to share my knowledge with my audience in the hopes of making this topic as simple and interesting as possible. In my leisure time, I like spending time with my family and travelling to new locations.