At its core, a keyman insurance policy pays out if the insured person dies during the term of the policy. Most businesses also add critical illness cover, which pays out if the key person is diagnosed with a specified serious illness, and some policies can include cover for long-term incapacity so the business can pay for temporary staff while that person is off work.
The payout goes to the business, and it can be used wherever it’s needed most. Typical uses include:
- Replacing profit lost while the business adjusts
- Recruiting and training a replacement, including headhunter fees for senior or specialist roles
- Repaying business loans or overdrafts that relied on the key person
- Covering salaries and overheads during a difficult period
- Reassuring lenders, suppliers and customers that the business is financially secure
Because the policy is owned by the business, the individual being insured doesn’t benefit from it personally. If you want to provide life cover for directors or employees and their families, relevant life insurance or group life cover is usually the better route, and we can advise on those too.
Who counts as a key person?
A key person is anyone whose absence would seriously disrupt your business. This is often a director or owner, but it can equally be a top-performing salesperson, a project manager running your biggest contracts or an employee with a niche skill that the business can’t easily replace.
If you’re not sure who qualifies, these questions are a useful starting point:
- Are any loans or overdrafts dependent on this person?
- Would losing them put current projects or expansion plans at risk?
- Would customers take their business elsewhere?
- Would suppliers tighten their credit terms?
- Would the business struggle without their management or technical knowledge?
If the answer to any of these is yes, that person is likely a key person.
Do you need keyman insurance?
Most businesses that rely on one or two people for a large share of their revenue, relationships or expertise should at least consider keyman insurance. Smaller and newer businesses are often the most exposed, because a single person tends to carry more of the load and there’s less cash in reserve to absorb a sudden loss.
You may also find that a lender asks for keyman cover as a condition of a business loan, since the payout gives them confidence that the debt can still be repaid if the key person dies.
To see what can happen when a business doesn’t have cover in place, read our case study on Alan Jones, the managing director of a private limited company whose business faced an uncertain future without keyman insurance.
How much keyman cover do you need?
There’s no single formula for calculating keyman cover, but two rules of thumb give most businesses a good starting point. The first is to multiply the key person’s annual salary by five, so a director earning £100,000 would be insured for around £500,000. The second is to look at the profit that person generates and cover the business for the loss of that profit over the time it would take to replace them.
From there, an adviser will refine the figure by looking at the details of your business, including:
- Outstanding debts – If the business has borrowed to fund equipment, premises or growth, the cover should be enough to clear those debts so they don’t fall on your remaining partners or the key person’s family.
- The cost of replacing them – Recruitment fees, a higher salary to attract the right candidate and the cost of training all add up, especially for senior or specialist roles.
- Client relationships – If clients stay with you because of one person, you need to allow for revenue that might walk out the door when they go.
- Whether the business would continue – A sole trader might only need enough to clear debts and close the business properly, while a larger company will want enough to keep trading through the transition.
- Affordability – If you can’t cover everyone you’d like to, start with the people who generate the most revenue or whose loss would cause the most disruption, and build from there.
How much does keyman insurance cost?
The cost of keyman insurance depends mainly on the amount of cover, the length of the policy and whether critical illness cover is included. The key person’s age, health and lifestyle also matter, so an older person who smokes or has pre-existing health conditions will usually cost more to insure than a younger, healthy non-smoker.
You must give the insurer accurate information when you apply. If details are wrong, for example, if someone is declared as a non-smoker when they smoke, the insurer may refuse to pay out when you need to claim.
Premiums also vary between providers, which is where an independent adviser earns their keep. We’ll compare the market and negotiate on your behalf, so contact us for a quote based on your business.
Is keyman insurance tax deductible?
Keyman insurance premiums can be allowable as a business expense for corporation tax, but only when the policy meets certain conditions. HMRC generally expects the policy to exist purely to replace lost profits, to be a short-term term assurance policy (usually five years or less) with no surrender value that can’t be converted into another type of policy, and for the key person to be an employee rather than a significant shareholder.
If the premiums are treated as deductible, any payout is usually taxed as a trading receipt. Many businesses increase the sum assured slightly to allow for that tax. If the premiums aren’t deductible, the payout is normally tax-free. HMRC looks at each case on its own facts, so we’ll work through the position with you and your accountant when we set up the policy. For more detail, read our guide to how HMRC deals with keyman insurance.
What happens if a key person leaves?
People move jobs far more often than they used to, so it’s worth knowing your options before you take out a policy. If a key person leaves, you can usually either stop paying the premiums and let the policy lapse, or transfer it to the individual so they can keep the cover.
Transferring a policy can have tax consequences for both the business and the employee, so speak to us before making any changes.
How to set up keyman insurance with Rigby Financial
Setting up keyman insurance through us is straightforward, and we’ll handle most of the work.
- Identify your key people – We’ll talk through how your business makes money and where it’s most exposed, so you’re covering the right people.
- Choose the type of cover – You can protect against death only, or add critical illness cover for broader protection.
Set the amount and length of cover – We’ll help you arrive at a sum assured and term that reflects each person’s value to the business and what you can afford.
- Compare the market – As independent financial advisers, we search policies from across the UK market to find the right cover at a competitive price.
- Apply and review – We’ll help you complete the application accurately, then review the cover as your business changes, whether that’s a new hire, a new loan or a key person leaving.
Call the team at Rigby Financial on 01744 886077 to discuss your company and how we can support you in your pursuit of keyman insurance.
