Key man or relevant life cover: what do small businesses need?

As many entrepreneurs know to their cost, the loss of a single individual in a business, or the sudden illness of a director or founder, can cause a business to fail.

Experts urge businesses to consider these risks and to ensure that they are appropriately protected with either key person (or key man) insurance, or the correct type of life cover.

Fail to prepare, prepare to fail

Gareth Buckley, who runs  The Insolvency Company (theinsolvencycompany.co.uk), a family firm that supports businesses in financial difficulties, says his company encounters companies every day that could have remained solvent if they had the right insurance in place.

“A building company faced insolvency after one director’s sudden death,” Buckley says. “Another business struggled when one of its directors underwent unexpected heart surgery and was unable to work for three months. With key person cover, they could have maintained repayments until he recovered.”

Finding the right policy

If you feel your company’s success is dependent on one person or a small group of people, then key person insurance is useful to have. 

Some directors of companies may want to have a policy known as ‘relevant life cover’ which provides money for the individual, rather than the business.

Personal finance expert Leo Smigel, who founded Analyzing Alpha, says that you should examine individual roles and staff contribution value to decide what cover is needed.

“It’s important to consider both internal factors and external ones like market volatility and business-specific circumstances. It’s far from a one-size-fits-all approach,” he says.

While key person insurance pays money to the business if the policy pays out, relevant life cover pays money to the family of the insured. This means they serve two different purposes – one keeps a business running in the event of illness or death of a vital director or staff member, the other effectively offers a death-in-service benefit for directors and staff members of smaller companies.

What about tax?

Both types of policy are tax efficient. Because they are owned by the company, they count as a business expense, and can be offset against corporation tax.

A relevant life policy is usually not treated as a benefit in kind for the employee or director.

It becomes more complicated if you are looking for cover if a member of staff becomes ill and cannot work. In this case you might want to examine critical illness cover or executive income protection cover. 

Executive income protection pays the business if the claim is valid, and the cost of paying the premiums is treated as an allowable business expense. Critical illness cover, or ordinary income protection policies, pay the individual but these cannot be treated as a business expense.

Other considerations

As well as deciding which policy fits best, you will need to consider other aspects including the amount to be insured and the need to declare pre-existing conditions for income protection policies. You may also want some types of policy to be written into trust, to help save on inheritance tax for employees.

Because it is a complex area, speaking to a business insurance broker who specialises in protection will help you to get the right answer. Try BIBA, the British Insurance Brokers’ Association to find someone to help.

Don’t procrastinate

Whatever you do though, don’t ignore the need for this vital cover.

Tim Doman, who now runs digital banking site Top Mobile Banks, and is a former venture capitalist, says that he once backed a tech start-up with a lead engineer whose creativity was “paramount to the company’s success”.

When this key individual suffered a health issue, there was a fall in staff morale, slowing innovation and a “significant dip in revenue”,” he says.

“This experience was a stark reminder of the importance of such insurance – it provides stability in the face of unforeseen events, offers potential tax deductions, and most crucially, ensures the smooth functioning of business operations,” he explains.

Rosie Murray-West

Rosie Murray-West is a freelance journalist covering all aspects of personal finance, as well as business, property and economics. A former correspondent, columnist and deputy editor at The Telegraph, she now writes regularly for publications including the Times, Sunday Times, Observer, Metro, Mail on Sunday, and Moneywise magazine.