If you have employees who make a significant impact on the success of your organisation, you’ll agree that such people may not be easily replaced, especially if they become critically ill or die. To protect your assets, you should consider keyman insurance (or key person cover).

60% of businesses think they would cease trading in under a year after the death or critical illness of a key person.*

75% of SMEs have some form of business debt, and these businesses are now running high levels of debt, especially due to the government’s Bounce Back Loan and Corporate Business Interruption Loan schemes, which were launched to support businesses through the pandemic. As a result of COVID-19 and the shift in perceptions among business owners, over half of all businesses are now likely to consider protection for many different needs.*

*Legal and General, State of the Nation’s SMEs Report 2021

The loss of a key employee can have catastrophic consequences, particularly for a small business. If the above applies to you, key person insurance is designed to mitigate this risk by shoring up your finances and enabling your business to continue trading through this challenging period.

What is keyman insurance?

Keyman insurance (or key person insurance) is an insurance policy taken out by businesses to protect you against the financial loss that may arise in the event a key person dies or becomes critically ill.

Your business purchases the policy on the life of the key person, pays the premiums and is the named beneficiary. If the key person dies or becomes critically ill, your business will receive a lump sum which can be used to recruit and train a replacement, offset a loss in profit, manage any detriment in supplier credit terms and/or repay any liabilities to the bank.

Who is a key person?

Your business decides. There are no rules on this other than being able to justify the amount of insurance cover. If you believe that the death of an employee would result in a financial loss to your business sufficient to warrant insurance, then that employee is a key person. Typically, the list of potential key people includes: the business owner, directors, employees with specialist skills or knowledge, high performing salespeople, operations executives or simply someone who plays a fundamental role in the success of your business.

Is keyman insurance tax deductible?

This aspect is relatively complex and we know from experience that it’s not widely understood. The HMRC guidance regarding key person policies states:

• If the sole purpose is meeting a loss of trading income that may result from loss of the services of the key person, and not a capital loss or a condition associated with a loan; and

• the policy is a term policy that does not extend beyond the period of the employee’s usefulness,

then generally, the premiums will be tax deductible.

If the premiums are tax deductible, the proceeds will be taxed as income of the business.

Conversely, if the policy does not meet these tests, the premiums will not be tax deductible and the proceeds may be tax free. However, HMRC cannot give future assurances that the proceeds will be tax free just because the premium is not allowable against tax.

It’s therefore very important to take advice in this area and to review any existing cover that you may already have in place, to ensure the structure you have has the potential to provide tax free proceeds.

How much cover should you obtain?

The amount of cover required will depend on an assessment of the financial loss that your business would suffer in the event of the death of the key person. This may be determined, for example, by considering how much profit the key employee creates and the costs of recruiting a suitable replacement. Our Financial Planning experts can advise on the level of cover that is right for your business.