Business cover
Key person insurance
Key person insurance pays a lump sum to the business if a critical owner or employee dies or can no longer work, so the business has the cash to absorb lost revenue, repay debt, or fund a replacement.
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A person-shaped hole in the balance sheet.
Lose the person who drives the revenue, holds the lending, or carries the relationships, and the gap lands on the business. Key person cover funds it.
Also called key man insurance
It pays the business, not the family
Key person insurance, often called key man insurance, is a life insurance policy owned by and paid to a business to offset the financial impact of losing someone critical to its success. If that person dies or becomes permanently disabled, the policy pays the business a lump sum it can use to cover lost revenue, repay debt, fund recruitment and training of a replacement, or reassure lenders while it recovers. It is distinct from [buy/sell insurance](https://safetynest.com.au/buy-sell-insurance/), which funds the transfer of an owner's share between owners. Key person insurance protects the business itself, not the owners' families.
Who to insure
Who is a key person
A key person is anyone whose loss would materially hurt the business. Often it is an owner, but it can equally be the employee the business runs on. The test is simple: ask what would happen to revenue, key relationships, or funding if that person were gone tomorrow. If the answer is serious disruption, they are worth insuring, and each one is usually covered by a separate policy.
What it responds to
The cover types behind it
- DeathThe key person dies.
- Total & permanent disabilityThey can no longer work.
- Trauma / critical illnessOn diagnosis of a defined condition, in some arrangements.
- Temporary incapacityReplaces a lost contribution for a period, in a less common form.
How it works
How key person cover protects the business
Identify the key person
The owner or employee whose loss would seriously hurt revenue, funding, or operations.
Size the cover
For a revenue purpose, a capital purpose, or both, based on the loss the business would carry.
The business owns it
The business owns the policy and pays the premiums; the person is the insured life.
A trigger event
The key person dies, or can no longer work due to disability or serious illness.
Lump sum to the business
Used to replace lost revenue, repay debt, or recruit and train a replacement.
The decision that shapes everything
Is the cover for a revenue purpose, or a capital purpose?
This single question shapes how the cover is sized, how the proceeds are likely to be treated, and how premiums are likely to be treated for tax. Getting the stated purpose right at application matters, because it is difficult to recharacterise later.
The key decision
Revenue purpose vs capital purpose
This is the single most important choice in key person cover. It shapes how the sum insured is sized, and how premiums and proceeds are likely to be treated for tax.
Revenue protection
Replacing lost income or profit
- What it replaces
- Lost income or profit while the business recovers
- Typical purpose
- Bridging the revenue gap, funding a temporary replacement, steadying cash flow
- How it is usually sized
- A multiple of the key person’s contribution to gross profit or revenue
- General tax treatment
- Premiums may be deductible; proceeds generally treated as assessable income
Capital protection
Covering a capital loss
- What it replaces
- A capital loss, such as repaying debt or replacing a loan guarantee
- Typical purpose
- Clearing business debt, protecting the balance sheet, funding a permanent loss of value
- How it is usually sized
- The specific debt or capital amount the business needs to cover
- General tax treatment
- Premiums generally not deductible; proceeds generally not assessable
Sizing the cover
How cover is sized
There is no single formula. The amount is led by the financial loss the business would actually suffer, and it must be substantiated to the insurer at application rather than re-justified at claim time. Because the sum insured is financially underwritten upfront, the business generally receives the agreed lump sum on a valid claim without proving the loss again.
Three methods
Ways to size the cover
- Revenue or profit methodA multiple of the key person’s contribution to gross profit or revenue.
- Replacement cost methodThe cost to recruit, hire and train a replacement, plus lost productivity.
- Debt or capital methodThe business debt or guaranteed lending their loss would expose.
Tax treatment
The tax outcome follows the purpose
Whether premiums are deductible and whether proceeds are taxed depends on whether the cover is held for a revenue or a capital purpose. This is general information only, not tax advice.
What to watch
Risks and considerations
Most key person shortfalls trace back to a few avoidable mistakes: an unclear purpose that breaks the expected tax outcome, a sum insured left unreviewed as the business grows, or a lapsed policy where nobody owned the premiums. Key person cover protects the business, not the family, so an owner who also needs personal cover holds that separately.
Our rule of thumb
Review key person cover at least once a year, and whenever the business, the person’s role, or the lending materially changes. Most shortfalls come from cover that was set and never revisited.
The person walks out the door and the revenue goes with them. Key person cover keeps the cash in the business.
In a client’s words
What working with us is like
Before switching to Safety Nest, we rarely heard from our previous adviser and didn’t realise how much I was overpaying. The team at Safety Nest took the time to thoroughly review our situation, and I found out we could save thousands of dollars a year. Their personalised approach and regular check-ins gave us peace of mind, knowing our family’s future is now secure and well-managed. (Individual results vary; not a typical or expected outcome.)
Shuie Gestetner
Director, Charidy Australia
FAQs
Frequently asked questions
What is key person insurance?
Key person insurance is a policy owned by and paid to a business to offset the financial loss of someone critical to it, such as an owner or a key employee, if that person dies or can no longer work. The proceeds help the business cover lost revenue, repay debt, or fund a replacement. It is general information only, and how it should be set up depends on your business, so it is worth reviewing with an adviser.
Is key person insurance the same as key man insurance?
Yes. "Key man insurance" is the older term and "key person insurance" is the gender-neutral version now preferred by most publishers. They describe the same cover. Both terms are still widely searched in Australia.
How much does key person insurance cost?
There is no single price. The premium depends on the sum insured, the key person's age and health, the cover types included, such as life, TPD, or trauma, and whether premiums are stepped or level. Age in particular can create a large gap between two otherwise similar policies. Because cost is specific to each person and business, a meaningful figure requires an individual quote, which an adviser can prepare for your situation.
Is key person insurance tax deductible?
It depends on the purpose of the cover. For revenue-purpose cover, premiums may be deductible while proceeds are generally treated as income. For capital-purpose cover, premiums are generally not deductible while proceeds are generally not assessable. The ATO ruling IT 155 is the classic reference for revenue-purpose deductibility. This is general information only, not tax advice, so confirm the treatment for your situation with your accountant.
How much key person cover does a business need?
The amount is led by the financial loss the business would suffer if the key person were lost. Common methods are a multiple of their contribution to profit or revenue, the cost to recruit and train a replacement, or the business debt their loss would expose. The cover amount must be substantiated to the insurer at application. The right figure depends on your business, so it is worth working through with an adviser.
What is the difference between key person and buy/sell insurance?
Key person insurance is owned by and paid to the business to offset the loss of a critical person. Buy/sell insurance funds the transfer of an owner's share between the owners and the departing owner's family when an owner dies or is permanently disabled. One protects the business as a going concern; the other funds a clean change of ownership. Many businesses with co-owners hold both.
Protect the business against the loss of a key person
Put a value on the person, before you have to
A no-obligation chat with a specialist who sizes the cover to the loss your business would carry, sets the revenue or capital purpose deliberately, and works alongside your accountant and solicitor. No separate advice fee for our advice.