Key person insurance calculator

Key person insurance is a policy a business takes out on someone it relies on, such as a director or key employee. HMRC describes it as a policy an employer takes out in its own favour against loss of profits caused by the death, critical illness, sickness, accident or injury of an employee, director or other key person. The business owns the policy and a valid claim is paid to the business.

Royal London’s guide says there are no specific rules for valuing a key person, but insurable interest must be shown. This calculator works out four ways that insurers’ own guides describe, side by side:

• Multiple of remuneration: up to 10 times the key person’s yearly remuneration for life cover. With the starting figures that’s 10 × £60,000 = £600,000.
• Share of net profit: up to 5 times the part of the business’s net profit that the key person brings in: 5 × £250,000 × 30% = £375,000.
• Share of gross profit: up to 2 times their part of the gross profit: 2 × £600,000 × 30% = £360,000.
• Replacement and lost profit: what it would cost to recruit and train a replacement, plus their part of the gross profit for the months until the replacement is up to speed: £20,000 + £600,000 × 30% × 12 ÷ 12 = £200,000.

The result is the range from the lowest to the highest of the four: £200,000 to £600,000 with the starting figures. The methods are alternatives, not amounts to add up. Scottish Widows, for example, sets key person cover at a maximum based on either the key person’s remuneration or the loss of profits attributable to them.

Use averages for the profit figures. Legal & General’s guide routinely uses an average of the last two years’ profit, and Scottish Widows averages net profit over the last 2–3 years. Royal London says that where a business has more than one key person, the profit may need to be split between them according to their contribution. Legal & General works out a key person’s share as their salary divided by the business’s total payroll in one of its formulas; the calculator lets you enter the share yourself. The months field stops at five years, the longest recovery period in that formula.

The multiples of remuneration are for life cover. Insurers allow less for critical illness cover: Legal & General considers a lower figure, and Royal London’s guide goes up to 5 times gross salary.

All figures are before tax. The calculator doesn’t allow for inflation or growth, although Royal London says higher multiples may be justified for a rapidly expanding business. Nor does it include a business loan: Royal London says an outstanding loan needs to be covered, divided between the key people as appropriate.

Key person insurance is business protection, which isn’t arranged through our quote forms. The quote form on this site is for personal life insurance, such as cover for your own family alongside any business policy. Legal & General tells businesses to speak to an adviser about how key person protection could work for them.

Legal & General says a key person’s death could cost a business through lost profits or having to recruit or train a replacement, and that the amount of cover should take account of both. Its multiple of earnings is meant to cover the cost of finding a suitable person, training them and paying them while they develop in the role.

Zurich says finding the right person may take time and involve advertising and recruitment agency fees, and that key person cover can help with those and with training costs. Where the profit a key person is accountable for is known, it suggests cover that directly replaces that profit, “say for a year or two”, perhaps with some contingency. Royal London’s adviser guide says the key person’s contribution to profit should ideally be covered for at least a year.

The last method in the calculator follows that approach: the recruitment and training costs you enter, plus the key person’s share of gross profit for the months until a replacement is fully up to speed. Royal London may ask for the same figures when it underwrites: why the person is important to the business, their contribution to net or gross profit, and what it would cost to replace them.

HMRC’s Business Income Manual says the premiums are allowable as a business expense only if the sole purpose of the insurance is the trade purpose of meeting a loss of trading income from losing the key person’s services, not a capital loss. A life policy must also be term insurance that pays only if the person dies within the term, with no other benefits, and the term shouldn’t go beyond the employee’s usefulness to the company.

Where both conditions are met, the premiums are deductible and money paid out under the policy is income of the employer’s trade, so it’s taxed as a trading receipt. As a general rule, where a policy doesn’t meet both conditions, the premiums can’t be deducted and the payout isn’t taxed as trading income, although HMRC says it can give no assurance that a future receipt will be left out of trading income. Premiums on whole life or endowment policies, or on critical illness or accident policies with an investment content, are capital expenditure and aren’t deductible.

Whether the sole purpose test is met is a question of fact, decided by what the directors or owners were trying to achieve. HMRC lists signs of a non-trade purpose, such as a policy that covers directors who are major shareholders but not other employees. Our guide to key person insurance explains the tax rules in more detail. An accountant can confirm how they apply to a particular business.