What Is Key Person Insurance and Why It Matters for UK Businesses
Discover how key person insurance protects UK businesses from financial loss if a vital employee dies or becomes ill. Learn what it covers, who qualifies, and tax deductibility.
In the dynamic world of small business, success often hinges on a few pivotal individuals whose skills, relationships, and leadership drive growth. But what happens if one of these key people is suddenly unable to work due to illness or death? That’s where key person insurance—also known as key person insurance—comes in.
This article explores what key person insurance is, what it covers, who qualifies as a key person, its benefits for small businesses, and how it’s treated for tax purposes in the UK.
What Is Key Person Insurance?
Key person insurance is a business-owned life or critical illness policy that protects a company against financial loss if a vital employee or director dies or becomes seriously ill. Unlike personal life insurance, the business is both the policyholder and the beneficiary. The payout helps the company manage disruption, replace lost income, and fund recruitment or training of a successor.
What Does Key Person Insurance Cover?
Most UK key person insurance policies offer:
- Life cover: Pays out if the insured key person dies during the policy term.
- Terminal illness cover: Included in most life policies, paying out if the person is diagnosed with a terminal illness.
- Critical illness cover (optional): Pays out if the key person is diagnosed with a specified serious illness such as cancer, stroke, or heart attack.
Policies are typically term-based (e.g., 5–10 years) and do not have a cash-in value. If premiums stop, the cover ceases.
Who Can Be a Key Person?
A key person is anyone whose absence would significantly impact the business’s operations or profitability. In small businesses, this is often the owner, but it could also be:
- Managing director
- Operations manager
- Lead salesperson or sales manager
- IT manager or technical lead
- Employees with specialist knowledge or client relationships
The defining factor is whether the business would struggle to operate or maintain revenue without them.
Benefits of Key Person Insurance for Small Businesses
Key person insurance offers several strategic advantages:
- Business Continuity
A payout can help cover lost revenue, maintain cash flow, and reassure stakeholders during a period of uncertainty.
- Recruitment and Training Costs
Replacing a key person often requires specialist recruitment, onboarding, and training—expenses that can be offset by the insurance payout.
- Debt Protection
If a key person’s absence jeopardises loan repayments, the payout can be used to settle debts or renegotiate terms.
- Investor Confidence
Having key person insurance in place signals risk management maturity, which can reassure investors, lenders, and partners.
- Shareholder Protection
In some cases, key person insurance can be structured to support share buybacks or succession planning, though this affects tax treatment (see below).
Is Key Person Insurance Tax Deductible?
Key person insurance premiums may be tax-deductible if the policy is solely intended to protect trading profits—not capital interests. HMRC applies the Anderson Principles to determine deductibility:
- Deductible: If the policy protects against loss of trading income due to the death or illness of a key employee or director.
- Not deductible: If the policy is used to repay loans, fund share buybacks, or protect capital value.
For life insurance policies to qualify:
- They must be term-based (not whole-of-life or investment-linked).
- The insured must be an employee or director.
- The policy must not extend beyond the person’s expected usefulness to the company.
The rules are fairly complex, so it makes sense to get some professional advice first to ensure compliance with HMRC rules.
Final Thoughts
Key person insurance is a vital safeguard for small businesses that rely heavily on a few individuals. It offers financial protection, operational resilience, and peace of mind. But to unlock its full benefits—especially tax relief—it must be structured with care.
If your business depends on one or two key people, now is the time to assess your risk exposure. Why not give us a call today, to explore whether key person insurance is right for you and how to structure it tax-efficiently.