Key Person Cover Insures A Balance Sheet, Not A Family

Key person cover is life or illness insurance bought by a business on an individual whose loss would damage it. The company owns the policy and receives the benefit.

The insurable interest sits with the company

Insurance requires that the buyer would suffer a financial loss from the insured event. A business demonstrates that through the individual's contribution to profit or to its ability to trade.

Typical subjects are founders, senior technical staff, key salespeople or anyone whose relationships or knowledge cannot be replaced quickly.

Without a demonstrable financial connection the arrangement is not insurable, which is why the underwriting file asks about the business rather than only about the person.

How the sum insured is justified

Underwriters generally expect the sum to be reasoned from accounts. Common approaches use a multiple of the individual's contribution to gross profit, or a multiple of their remuneration.

An alternative approach values the cost of replacement: recruitment, training, lost contracts and the period of reduced output while a successor becomes effective.

Financial underwriting exists to keep the sum proportionate. A figure far above any defensible calculation invites questions about the purpose of the contract.

Shareholder and partnership protection is a different mechanism

Where the concern is ownership rather than operations, cover is arranged so surviving owners can buy the departing owner's share from their estate.

This depends on an agreement between the owners setting out what happens on death or serious illness, alongside the policies that fund it.

Without that agreement the policy provides money but no obligation to trade shares, and the outcome is negotiation at the worst possible moment.

Loan protection sits alongside both

Lenders often require cover on individuals whose loss would jeopardise repayment, particularly where a loan was advanced on the strength of one person's involvement.

Such policies are usually written on a decreasing basis to follow the outstanding balance, and may be assigned to the lender directly.

The arrangement resembles personal mortgage protection but sits inside the business, which changes both ownership and the treatment of the proceeds.

Structure carries consequences

Who owns the policy, who pays the premium and who receives the benefit determine how the arrangement is treated for accounting and tax purposes.

Those treatments differ by jurisdiction and change with legislation, and they are the reason these arrangements are set up with professional advice rather than from a template.

Insurable interest rules, financial underwriting limits, agreement requirements and statutory treatment vary by insurer and jurisdiction. The policy wording and the governing agreements determine the outcome.