Key person income protection

In many smaller businesses a few people bring in most of the work: a founder who wins the clients, a specialist whose skills are hard to replace, or a director who holds the key relationships. A long absence through illness or injury can hit the business before anyone thinks about a death or a critical illness.

Sales may slow, projects may stall and the business may need to pay for a contractor, a locum or extra hours from other staff. If the absence continues, it may need to recruit. Meanwhile the fixed costs carry on.

The business takes out the policy on the key person, pays the premiums and is the beneficiary. If that person cannot work because of illness or injury, and the claim meets the policy's definition of incapacity, the insurer pays a monthly benefit to the business after a waiting period.

Payments normally continue until the key person returns to work, the benefit period ends or the policy ends, whichever comes first. The business can use the money to:

• •Make up for profit lost while the key person is away
• •Pay for temporary cover, such as a contractor or extra staff hours
• •Meet recruitment costs if the absence becomes long term

How this differs from protecting the person's own income

Personal income protection pays the individual a replacement for part of their earnings. Executive income protection is paid for by the company, but its purpose is to continue the employee's salary during sickness. Key person income protection is different: the benefit covers the business's own financial loss. Some businesses need more than one of these, because they solve different problems.

If the bigger risk is the business losing someone permanently, lump-sum key person insurance on death or critical illness may be the first priority.

• •The key person's contribution to the business and their remuneration, which insurers use to set the maximum benefit
• •The waiting period before payments start: a longer wait usually lowers the premium
• •How long the benefit can be paid for each claim
• •The key person's age, health, smoking status and occupation
• •How the policy defines incapacity, which varies between insurers

It is worth choosing a waiting period that fits how long the business could manage on its own reserves, and a benefit that reflects a realistic estimate of the loss rather than the highest figure an insurer will allow.

Fewer insurers offer key person income protection than offer key person life or critical illness cover, so the choice of policy can be narrower and terms can vary more. Benefit limits are set by each insurer, and they will usually ask how the figure has been calculated.

The policy only pays while the claim meets its definition of incapacity, and only after the waiting period. It does not pay a lump sum on death, so it is often considered alongside key person life cover rather than instead of it.

Start by working out which people the business depends on most, and what a few months without each of them would cost. We can then check which insurers on our panel offer this cover for your circumstances, compare their benefits and terms, and explain how it fits with any other business protection you already have.