Key person insurance

Key person insurance, explained

If your business depends on one person, insure them. A tax-free lump sum to the company if a founder, partner, or critical employee dies or becomes disabled — to keep the lights on, hire a replacement, or fund a buy-sell agreement. Compare quotes from licensed brokers.

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What key person insurance is, in plain English

A key person is anyone whose absence would materially hurt the business — the founder, the lead engineer who built the product, the salesperson responsible for 60 percent of revenue, the clinic's medical director, the architect whose licence the firm trades on. Key person insurance is a policy the business takes out on that individual, so the company receives a tax-free lump sum if they die or, with the right riders, become seriously ill or disabled.

When someone like that suddenly can't work, the business takes a hit on several fronts at once: lost revenue, hiring costs, lender confidence, customer confidence. The payout absorbs those shocks while the company adjusts — buying time to make smart decisions instead of panicked ones.

How a key person policy is structured

The business owns the policy

The corporation is the applicant, the policyholder, and the premium-payer. The insured is the key person — a founder, partner, lead technical hire, or top earner — who signs the application and consents to underwriting.

The business is the beneficiary

On the insured's death (or disability/critical illness, if those riders are added), the benefit is paid to the company, not the individual's family. That's what separates key person cover from personal life insurance.

Term or permanent

Term is the common, affordable choice for pure key person protection over a defined window. Permanent makes sense when the policy doubles as an estate or buy-sell tool meant to last as long as the business does.

Optional living-benefit riders

A critical illness or disability rider extends the payout to cover a key person who survives but can't work — often the more probable scenario than death for someone of working age.

How to value the coverage

There's no single formula — the right amount depends on why the person is hard to replace. These four lenses cover most situations, and a licensed broker can model them against your actual financials:

Multiple of salary

A common rule of thumb is five to ten times the key person's annual compensation — a quick proxy for the cost of operating without them while you recruit and rebuild.

Contribution to revenue or profit

Estimate the revenue or gross profit directly attributable to the person and insure one to two years of it. Best for rainmakers and owner-operators whose absence hits the top line immediately.

Replacement cost

Add up recruiting fees, signing and relocation costs, training time, and the productivity dip during onboarding. For specialised or licensed roles this often lands between $200,000 and $500,000.

Share value (for buy-sell funding)

When the policy funds a buy-sell agreement, size it to the fair market value of the insured owner's shares so the surviving owners can buy out the estate in full.

Funding a buy-sell agreement

The second major use is ownership transitions. Many shareholder agreements include a buy-sell clause that triggers when an owner dies: the surviving owners buy the deceased's shares from the estate. Without insurance, that buyout has to come from cash flow or new debt — exactly when the business can least afford it.

Key person life insurance sized to the share value funds the buyout cleanly. The death benefit is paid to the company tax-free, the estate is fairly compensated, and control stays with the surviving owners. If you're structuring a corporate-owned policy specifically for this, our guide to business life insurance covers the corporate-ownership and buy-sell mechanics in more depth.

Where key person fits with your other coverage

Key person insurance protects the business itself. It sits alongside group benefits, which protect your employees and their families, and personal coverage your owners hold individually. A typical established small business carries some combination of all three: group benefits for the team, key person cover on its critical people, and personal life insurance for each owner's own family. For broader business protection options, start from our small business insurance guide.

FAQ

Key person insurance questions, answered

Key person insurance is a life (and optionally disability or critical illness) policy a business takes out on someone whose loss would materially hurt the company — a founder, partner, lead technical employee, or top salesperson. The business owns the policy, pays the premiums, and receives a tax-free lump sum if that person dies or, with the right riders, becomes seriously ill or disabled. The money cushions the financial shock while the business adjusts.

The simplest test: if this person disappeared tomorrow, would the business meaningfully suffer? The most common candidates are founders, lead technical staff, top salespeople responsible for a large share of revenue, and licensed professionals whose credential the business depends on (medical, legal, engineering). Many small businesses insure two or three people, not just one.

The corporation is the applicant, owner, premium-payer, and beneficiary. The key person is the life insured and must consent to the application and medical underwriting. The benefit is paid to the company on a covered event. This is what distinguishes it from personal life insurance, where an individual owns the policy and names personal beneficiaries.

Common approaches: five to ten times the person's salary; one to two times the revenue or profit they contribute; the all-in cost to replace and onboard them (often $200,000 to $500,000 for specialised roles); or, for buy-sell funding, the fair market value of their shares. A licensed broker can model these against your numbers and recommend an amount.

Valuation usually combines a compensation multiple, the person's measurable contribution to revenue or profit, and the practical cost of replacing them. For buy-sell arrangements, a business valuation sets the share price the policy needs to fund. Because the right number depends on your financials and ownership structure, this is worth working through with a broker and your accountant.

Yes — this is one of its two main uses. Many shareholder agreements include a buy-sell clause that triggers when an owner dies: the surviving owners buy the deceased's shares from the estate. Funding that buyout from cash flow or new debt is painful; a life policy sized to the share value funds it cleanly, and the death benefit is received tax-free by the company.

Generally no. For key person life insurance owned by and benefiting the corporation, premiums are usually not tax-deductible — but the death benefit is received tax-free. Certain collateral-assignment arrangements (where the policy is assigned to a lender) have specific rules. Confirm the treatment for your situation with your accountant.

Term is more common and far more affordable for pure key person protection over a defined period — say, the years until a founder's planned exit or a loan is repaid. Permanent insurance makes sense when the policy doubles as a long-term estate or buy-sell tool that needs to remain in force for the life of the business.

Yes, always. The person being insured signs the application and consents to medical underwriting, and is typically told the coverage amount and its purpose. A business cannot quietly insure someone's life without their knowledge and consent.

Group benefits protect your employees and their families — health, dental, life, and disability they use directly. Key person insurance protects the business itself against the loss of a critical individual. They're complementary: a typical established small business carries group benefits for the team plus key person coverage on its founders or critical staff.

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