Protecting your business revenue through Key Person insurance

5 October 2020

A key person is someone whose sudden absence from management or day to day operations could cause financial loss to your business. This could be a business owner, partner, director, sales person, or even an employee who generates significant profits.

In the event you need to replace one of these people, Key Person insurance can be used to help cover the costs, associated expenses and/or income of that person. Your business can use the funds to:

  • Recruit and train new employees.
  • Replace lost profit.
  • Hold market share and protect your brand.
  • Meet existing contractual commitments.
  • Maintain customer confidence with minimal disruptions.
  • Maintain supplier confidence by continuing to meet financial obligations.

There is no one formula to calculate the value of a key person but you should consider the impact to both your business capital and revenue when calculating the sum insured.

If you are in a partnership or run a small to medium-sized company, you should also consider other key employees such as those with a skill set that gives your business a competitive advantage.

There are two different purposes to consider with Key Person insurance. Each has different taxation consequences dependant on the purpose you select.

1. Capital replacement

A funding mechanism to protect the asset base of the business should one of its owners or key employees unexpectedly depart the business. Calculations may include debt repayment and replacing lost revenue, e.g. the cost of goodwill required to rebuild and maintain client relationships.

2. Revenue replacement

A funding mechanism to protect the business against any loss of revenue or increased costs as a result of losing a key person. This may include multiples of the key person’s remuneration, multiples of gross/net revenue generated by the key person, or costs associated with replacing the key person.

Whichever purpose you choose must be documented through minutes as the continuing purpose of the policy. This will subsequently determine the tax treatment.

Findex has developed a 30 second checklist to assess if you have Key Person or other ownership or debt protection risks. To find out if your business is at risk or for further advice, please contact your adviser or get in touch with the Findex Risk Insurance team.