Key person insurance, explained

Key person insurance (sometimes called key man insurance) is cover a business buys on the life, and sometimes the health, of someone it relies on to make money. If that person dies or, depending on the policy, is diagnosed with a critical illness, the insurer pays the business. The money can help cover lost profits while the business adjusts, or the cost of recruiting a replacement.

The business owns the policy and receives the payout. That is what separates it from relevant life cover, where the employer pays but the money goes to the employee's family. It also has a specific tax treatment, set out in HMRC's Business Income Manual, which depends on exactly how and why the policy was set up.

How key person insurance works

The business chooses the person to insure, the amount of cover, the term and what triggers a payment. The main options are:

• Life cover, paying on death within the term.
• Critical illness cover, paying on diagnosis of a listed condition. If the policy is sold as critical illness cover by an ABI member, it must cover cancer, heart attack and stroke to the ABI's minimum definitions. See our critical illness guide.

The cover is priced on the insured person's own health and circumstances, just as personal cover is.

Who counts as a key person

HMRC's guidance does not define a key person by job title. In practice it is anyone whose loss would cause a real drop in trading income: a director who brings in the work, a technical specialist, or someone who holds the main customer relationships. HMRC's tax test, below, turns on that link to trading income, so it helps to be able to explain it.

HMRC's tax rules

When premiums are deductible

HMRC's guidance (BIM45525) says key person premiums are allowable as a trading expense if:

1. The sole purpose of the insurance is the trade purpose of meeting a loss of trading income that may result from losing the key person's services, and not a capital loss.
2. For life insurance, the policy is term insurance, covering only the risk of death within the term, with no other benefits, and the term does not extend beyond the period of the person's usefulness to the business.

HMRC says premiums on whole of life or endowment policies, or on critical illness or accident policies with an investment content, are capital expenditure and not deductible.

How payouts are taxed

Where both conditions are met and premiums are deducted, HMRC says sums received under the policy are income of the trade. In other words, if you get tax relief on the way in, the payout is taxed on the way out.

Where a policy does not meet the conditions, premiums are generally not deductible and receipts are generally not taxed as trading income. But HMRC adds that no assurance can be given that a future receipt will be excluded from trading income just because the premiums were not allowed.

HMRC's warning signs

HMRC's guidance (BIM45530) says whether the sole purpose test is met is a question of fact, based on what the directors were trying to achieve. It lists signs that a policy may serve a personal rather than a trade purpose, including:

• policies covering only directors who are major shareholders, and not other employees who matter to the business
• benefits that go beyond what would be expected from normal sick pay or employee benefit arrangements
• cover that appears to protect a director's personal share value rather than the trade

Where a group of people is covered and only some policies have a non-trade purpose, HMRC says a reasonable apportionment may be made.

What changes the cost

The insured person's age, health, smoking status and occupation affect the premium, as with any protection policy. So do the amount of cover, the term, and whether critical illness is included.

How claims work and why they get refused

The business makes the claim, supported by medical evidence about the insured person. A claim succeeds if the event meets the policy definition, for example the ABI's definitions for critical illness. A claim can be refused if the condition does not meet the wording, or if answers on the application were inaccurate. The Consumer Insurance (Disclosure and Representations) Act 2012 protects individuals buying insurance wholly or mainly for purposes unrelated to their trade or business, so a policy bought by a business for business reasons falls outside it. Ask the insurer what disclosure duty applies to the business.

What to check in your policy

• Policy owner and beneficiary: the business, not the individual or their family.
• Type of cover: term life, critical illness, or both, and whether there is any investment element.
• Term: whether it ends within the person's expected useful period to the business.
• Sum insured: how it was calculated and whether it still reflects the person's contribution to profits.
• Critical illness definitions, if included, and whether the policy states it meets the ABI Guide to Minimum Standards.
• Tax treatment agreed with your accountant: whether premiums are being deducted, and therefore whether a payout will be taxed.
• Records of purpose: board minutes or notes explaining why the cover was taken.
• What happens if the person leaves: whether the policy can be cancelled or reassigned.
• Premium type: fixed or reviewable.

When to talk to a regulated adviser

A regulated financial adviser can recommend the type and amount of cover, and an accountant can confirm the tax treatment before the policy starts, which is easier than unpicking it later. If the business also needs to plan for an owner's shares, see our guide to business protection. InsuredRight does not recommend products, but our free policy check can help you find the clauses above in an existing policy.

Common questions

Who counts as a key person?

HMRC's guidance does not define a key person by job title. A key person is anyone whose death or serious illness would cause the business a significant loss of profit, for example a director who wins most of the work, a specialist with skills that are hard to replace, or someone who holds key client relationships. The business needs to be able to explain the link between that person and its trading income.

Is key person insurance tax-deductible?

HMRC's guidance says premiums are allowable if the sole purpose is the trade purpose of meeting a loss of trading income from losing the key person's services, not a capital loss. For life cover, the policy must be term insurance with no other benefits, and should not run beyond the person's usefulness to the business. Whole life, endowment or investment-linked policies are treated as capital and not deductible.

Is a key person insurance payout taxable?

HMRC's guidance says that where premiums are allowed as a deduction, sums received under the policy are income of the trade, so they are taxed. Where premiums are not allowed, receipts are generally not taxed as trading income, but HMRC says it cannot give assurance that a future receipt will be excluded. Your accountant can confirm the likely treatment before you rely on it.

Is key person insurance the same as shareholder protection?

No. Key person cover pays the business to make up for lost profits. Shareholder protection provides money for the remaining owners, or the company, to buy a deceased or seriously ill owner's shares. A business may need both, as they solve different problems. HMRC also warns that a policy covering only directors who are major shareholders may be for a non-trade purpose.

How much key person cover does a business need?

HMRC's guidance does not set a formula. The amount should reflect the realistic loss to the business, such as lost profit and the cost of recruiting and training a replacement. Ask the insurer how it will assess the sum insured, and keep a record of how you worked the figure out, as it also helps show the trade purpose.

Sources

1. HMRC BIM45525: specific deductions, insurance, employees and other key persons checked 2 Oct 2026
2. HMRC BIM45530: specific deductions, insurance, key persons, non-trade purposes checked 2 Oct 2026
3. ABI Guide to Minimum Standards for Critical Illness Cover (16 September 2022, updated April 2023) checked 2 Oct 2026
4. Consumer Insurance (Disclosure and Representations) Act 2012, section 1 (definitions) checked 2 Oct 2026

This guide is general information about how insurance works in the UK. It isn't advice and doesn't take your circumstances into account. Policies differ: your own policy documents are what count.