Key person insurance provides a safety net to safeguard a business’s financial stability, particularly small to medium-sized enterprises (SMEs), protecting businesses in the event it loses one of its key individuals due to death, disability or critical illnesses.

When considering the risks faced by a business when it loses a key person, it is important to assess the impact on the business, such as:

  • if that individual has provided a personal guarantee on business loans
  • likely reduction in revenue
  • effect on large fixed overheads.

In addition, it is important to ensure the means are available to fund the buyout of an equity partner who unexpectedly leaves the business.

Personal guarantees on loans

Many businesses, particularly SMEs, rely on personal guarantees from owners or key executives to secure business loans. If a business has such a loan in place, it is very important to consider what happens to that guarantee in the event of an untimely death of a guarantor. Typically, if the person providing the guarantee passes away, the lender may have the right to call on the guarantee requiring immediate repayment of the loan, which could place significant financial strain on the business, possibly even leading to liquidation.

Key person insurance can protect businesses by covering repayments if a guarantor dies, ensuring the business doesn’t face sudden financial instability or a collapse due to a lack of funds.

Impact on revenue and profit

In many companies, certain employees or executives play important roles in generating income, building relationships, or managing operations. The sudden loss of such individuals due to death or illness can have a severe impact on both revenue and profit.

Without a contingency plan, businesses may face a prolonged period of uncertainty, with a potential drop in revenue and profitability while replacements are found and trained. Key person insurance provides the financial cushion needed during this transition. The insurance payout can help the company cover operational costs, recruit new talent, or make up for lost revenue while adjustments are made to the new business reality.

Funding a buyout

If a business has multiple owners or equity partners, what happens if one partner unexpectedly passes away or suffers a debilitating health event? Without an agreement in place or the means to buy out the deceased or incapacitated partner’s equity, the business may be forced to sell that owner’s equity on the open market, or alternatively seek other sources of funding (such as additional debt) to buy out that partner.

Key person insurance can play a crucial role here, providing funds for the surviving partners to buy out the affected partner’s equity share. This avoids the potential disruption of bringing in an outside buyer or the financial burden of continuing without key support.

Large fixed overheads

Businesses often face large, fixed costs such as payroll, rent, and utilities, which rely on consistent business continuity to meet obligations. The sudden loss of a key person can jeopardise this continuity, especially if the business relies heavily on a small group of individuals to generate cash flow.

Key person insurance helps maintain stability by ensuring that the business has the resources to manage its fixed costs while adapting to a loss. This can be especially critical for businesses that rely on consistent leadership and specialised knowledge to remain competitive.

Key person insurance is essential for protecting businesses from the financial fallout that can arise from the loss of critical personnel. By planning ahead, businesses can ensure that they remain financially secure and capable of navigating unexpected challenges.

This article was first published in the Summer 2024-25 issue of Financial Times.