Every business has someone it cannot easily replace. Key person insurance pays the company — not the family — so operations survive the loss.
Key person insurance is a life or disability policy the company owns, pays for, and collects on. If the insured person dies or becomes disabled, the business receives a lump sum. That distinguishes it clearly from personal life insurance, which protects the individual's family.
The purpose is continuity. The money buys time — time to recruit a replacement, to reassure clients and lenders, to absorb a revenue dip, and to make good decisions rather than desperate ones.
Not the most senior person necessarily. The one whose absence would hurt most:
A useful test: if this person did not come in tomorrow and never came back, what would break, how quickly, and how much would it cost to fix?
There is no single formula, but several approaches are commonly used, often in combination:
Worth checking: if your business has bank debt, your loan agreement may already require key person insurance on the owner. Lenders often insist on it and it goes unnoticed until a covenant review.
Statistically, a working-age person is considerably more likely to be off work for an extended period due to illness or injury than to die. Yet key person planning frequently covers death only.
Key person disability coverage pays the business when the insured is unable to work, and business overhead expense insurance covers fixed operating costs — rent, staff wages, loan payments — during that period. For an owner-operated business, overhead expense coverage is often the more immediately practical of the two.
In Canada, premiums for key person insurance are generally not deductible as a business expense, because the corporation is the beneficiary. The death benefit is received tax-free by the corporation, and the amount above the policy's adjusted cost basis credits the Capital Dividend Account, which allows tax-free distribution to shareholders. The exception on deductibility is where a lender specifically requires the policy as collateral, in which case a portion may be deductible. Confirm the specifics with your accountant.
Ownership and beneficiary. With key person insurance the company owns the policy, pays the premium, and receives the death benefit, and the money is meant to keep the business running. Personal life insurance is owned by the individual and pays their family. Many owners need both, and they serve entirely different purposes.
Generally no, because the corporation is the beneficiary of the policy. There is a limited exception where a lender requires the policy as collateral for a loan, in which case a portion of the premium may be deductible. The offsetting advantage is that the death benefit is received tax-free by the corporation and largely credits the Capital Dividend Account.
Common approaches include five to ten times the person's compensation, the profit attributable to them multiplied by the years needed to recover, or the full cost of recruiting and onboarding a replacement plus the revenue gap in between. For businesses with debt, the lender's requirement often sets the floor. Most well-designed policies land somewhere between $500,000 and several million depending on the size of the business.
Yes, and most businesses with several critical people should. Each policy is underwritten separately on that individual, so amounts and terms can be tailored to each person's actual importance to the business rather than applied uniformly.
The corporation continues to own the policy and has several options: cancel it, keep it in force if there is a continuing insurable interest, or transfer ownership to the departing individual. Transferring a policy out of a corporation can trigger a taxable benefit, so it is worth planning that step rather than doing it casually.
If the honest answer takes less than five seconds, that is your key person.
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