Definition: Key person insurance (sometimes called “key man insurance”) is a policy that a business takes out on the life (and/or health/disability) of one or more “key persons” whose loss would significantly harm the business. The policy is owned by the business and benefits are paid to the business, not to the employee (or their family). (Gallagher)

Risks it covers:

• Death
• Total and permanent disability (TPD)
• Critical illness/trauma (e.g. heart attack, cancer) (Gallagher)
• Sometimes temporary absence (though that is less common in classic key person policies) (Gallagher)

Purposes / Uses of proceeds:

When a claim succeeds, the business may use the payout for:

• Compensating for lost revenue (sales, contracts, projects) while replacing or recovering from the loss of that person;
• Paying recruitment/training costs to find a replacement;
• Covering debts or liabilities that the key person may have guaranteed;
• Stabilising cash flow;
• Executing a buy-out / adjusting ownership if the key person was a shareholder or partner. (Gallagher)

Why Key Person Insurance is Vital for Businesses

Here are key reasons, with evidence and statistics, showing why many Australian companies should seriously consider key person insurance.

 

Reason	Explanation	Evidence / Data
Financial Protection	Losing a key person can disrupt revenue, delay projects, cause loss of clients, or raise recruiting/training costs. The insurance funds help bridge that gap.	AJG Australia notes revenue drops, extra costs from replacement/training, or instability are common after loss of a key person. (Gallagher)
Debt and Lender Relationships	If loans or financial obligations are tied to that individual (or the business is deemed high risk without them), having cover reassures lenders. Sometimes lenders require key person insurance as part of loan security.	Finder states that business loans or obligations often involve guarantees by directors, so the risk from losing them is material. (finder.com.au)
Tax Treatment	Depending on how the policy is structured and its purpose (revenue vs capital), premiums may be tax deductible; also, proceeds may be assessable or not. Understanding this affects cost/benefit.	Canstar Australia describes that premiums for “revenue purposes” can be deductible; for “capital” purposes generally not. (Canstar) IT Ruling IT 155 covers assessability of proceeds and deductibility of premiums in certain circumstances. (Australian Taxation Office)
Business Continuity and Stability	Helps maintain operations, client confidence, staff morale; avoids chaos in succession or ownership issues.	William Buck commentary: loss of a key person could lead to declining revenue, operational disruptions, lost client confidence, ripple effects on staff morale. (William Buck Australia)
Valuation, Succession & Ownership Issues	If a shareholder or partner dies, ownership interest might pass outside the business or to someone not active; to maintain control or buy out shares, funds may be needed.	AJG Australia describes how equity ownership protection / buy-sell agreements paired with key person insurance help avert ownership disruption. (Gallagher)

Real-World Examples / Situations Where It’s Essential

Below are hypothetical and real-inspired scenarios to illustrate when key person insurance becomes not just useful, but essential.

 

Situation	Why Key Person Insurance mattered or could matter
Top Salesperson Leaves / Dies	Imagine a business whose top salesperson brings in 30–40% of annual revenue, with long-standing client relationships. If they die or are incapacitated, revenue drops sharply while the business hunts for replacement. Insurance proceeds can cover lost margin, client retention efforts, or pay commission guarantees.
Young Talent or Specialist with Unique Skills	Suppose a tech startup employs a software engineer who holds vital knowledge of proprietary systems. Their loss (via illness or disability) could halt development, cause contractual penalties or delays. Having coverage for critical illness or TPD helps cushion the financial impact and gives time to recruit or train someone else.
Decision-maker / Founder	Founders often combine leadership, vision, and ownership. Their death or incapacity often hits hardest — without a clear succession plan, board, or management team ready, decisions stall, investors worry. Key person insurance plus a buy-sell agreement helps maintain stability.
Employee with Relationships or Reputation	In sectors like consulting, finance, law or creative industries, certain employees may have personal relationships with clients, or reputations that bring in work. Losing such a person risks client attrition or reputational damage. Insurance allows investment in retaining clients, PR work, or transition plans.
Critical Role in Debt or Guarantees	If a director or key person has provided guarantees for loans (say, business premises or equipment finance), their death could trigger lender demands. Insurance helps protect the business from default or being forced to sell assets.

 

Some of these are illustrated in Australian insurer / broker commentary: e.g. AJG’s “Does My Business Need Key Person Insurance?” discusses a top salesperson, a shareholder, and a CFO in scenarios where death, illness, or disability threaten the business. (Gallagher)

 

Data & What Is Known

While finding large-scale quantitative studies in Australia specifically on monetary losses from missing key person insurance is limited, there is useful data and rulings that illuminate the risk environment.

• Taxation Ruling IT 155 (Australia) lays out when premiums are deductible and when proceeds are assessable, depending on whether the purpose is revenue protection or capital protection. (Australian Taxation Office)
• Canstar Australia describes how many policies offer revenue & capital purpose options, with differing tax outcomes depending on which purpose(s) are declared or evidenced. (Canstar)
• Many small to medium businesses (SMEs) run with concentrated reliance on one or two individuals (owners, founders). The business risk from losing such individuals—financial, operational, reputational—is real. (findex.com.au)

 

Things to Consider / Risks / Limitations

Having key person insurance is very helpful, but it is not a cure-all. Businesses should consider the following:

1. Choosing the Key Person(s):
   Which people are truly “key”? Not just those with titles, but those whose loss would meaningfully damage revenue, operations, useful relationships, or financial stability. The business should map roles and dependencies.
2. Purpose (Revenue vs Capital):
   As noted, whether the insurance is for revenue protection (lost profits, costs of replacement) or capital protection (loans, buy-outs, ownership) affects taxation and how the proceeds are treated. Documenting the purpose and evidencing it matters. (finder.com.au)
3. Policy Types & Coverage:
   Policy should cover the relevant risks (death / illness / disablement), appropriate sums insured, waiting periods, exclusions. Sometimes combining trauma cover with life/TPD is necessary. (Gallagher)
4. Cost of Premiums vs Benefit Size:
   Premiums increase with age, health, occupation, policy size, etc. The business must balance cost vs the expected benefit. Also consider inflation, business growth, future dependency. Periodic review is essential.
5. Policy Ownership and Beneficiary Structure:
   Who owns the policy, who benefits, who controls it, and how the proceeds will be used (e.g. buy-sell) must all be set up legally and documented. Sometimes family members inherit shares if no buy-sell is in place, which can lead to control issues.
6. Tax & Legal Advice Needed:
   The tax implications of premiums (deductibility), proceeds being assessable or not, CGT (capital gains tax), how ownership transfers work (especially in partnerships, trusts, or companies) are complex. Legal advice is often needed, not just insurance advice.
7. Not Covering All Losses:
   Some damages are intangible (morale, brand, client loyalty), or indirect; some are hard to quantify. Insurance may not cover every cost or loss. The business should have contingency plans beyond just insurance (succession, cross-training, redundancy planning).

 

Australian Taxation / Legal Rules Highlights

These are especially important, because getting the structure wrong can have downside.

• IT Ruling IT 155: provides guidance on assessability of proceeds and deductibility of premiums. If the purpose is revenue protection, premiums may be deductible; if capital purpose, generally not. (Australian Taxation Office)
• Trauma / Critical Illness Cover: premiums for a trauma policy are not deductible if the policy is for capital purposes. (finder.com.au)
• Fringe Benefits Tax (FBT) and other considerations may come in if premium payments are arranged as part of remuneration or benefits. (finder.com.au)

 

Case Study / Hypothetical Example in Australia

Here’s a hypothetical but realistic scenario:

TechCo Pty Ltd is a small software business in Sydney with annual revenue of AUD 5 million. It has a highly skilled lead developer, Jane, who has designed a proprietary module that generates ~25% of revenue and is central to several contracts. She also has strong relationships with a few large clients. Jane holds no managerial title but is effectively a “key person.”

If Jane were to suffer sudden illness (e.g. stroke) and be disabled for long term:
 • The business risks losing revenue from her module contracts, possibly failing SLAs.
 • It needs to spend time and money recruiting and training someone of similar skill. That may take 6-12 months.
 • Other staff may be stretched, delaying other projects; client confidence could suffer.
Insurance structured to cover Jane’s disability, critical illness, and possibly death (if relevant) could provide a lump sum to cover the shortfall in revenue, fund recruitment/training, cover overheads during transition, and maintain financial stability while the business reorganises.

This kind of scenario is exactly what key person insurance is meant for. Many Australian business - brokers and insurers cite similar examples (top sales, CFO, founder, etc.) in their promotional materials. (Gallagher)

 

When Key Person Insurance Is Especially Important

• Businesses where much of the revenue or value depends on one or two people (founders, sales leaders, technical experts).
• Businesses with specialist knowledge or IP tied to individuals.
• Enterprises that have external debt, or where key persons have guaranteed loan obligations.
• Owner-managed or family businesses, especially during succession planning.
• High risk industries (where illness or disability risk is non-trivial).

 

How to Decide If Your Business Needs It

Here’s a practical checklist:

1. Identify key roles and people. Who would cause serious damage if they disappeared (for whatever reason)?
2. Estimate the financial impact. Loss of revenue, cost of replacement, cost of delay, impact on contracts or obligations.
3. Assess current safety nets. Do you have reserves? Is the business diversified? Is there ability to borrow? Succession plan? Cross-training?
4. Define the purpose(s) of insurance. Revenue, capital, or both. Clearly document the purpose.
5. Obtain quotes, compare terms. Age, health, policy type, waiting periods, exclusions matter.
6. Plan for ownership / beneficiary structures. Especially where shares are involved. Buy-sell agreements are useful.
7. Review regularly. As the business changes, roles / dependencies change, policy needs may shift.

 

Conclusion & Take-Home Message

Key person insurance is not just “nice to have” — for many Australian businesses, it’s a vital form of risk management. It helps businesses survive shocks to their human capital: the sudden loss of revenue, contracts, or relationships can threaten viability.

It does have costs and complexities (tax, legal, policy-structure), so businesses should not take it lightly. Before making a decision, seeking professional advice from:

• A financial planner
• A specialist insurance broker / provider
• Legal advice (for ownership / buy-sell / partnership issues)
• Tax adviser or accountant

These experts can help you design a policy that fits your business risks, is cost-efficient, and aligned with your financial and operational setup.

 

Summary in Brief

• Key person insurance = insurance by a company on someone whose loss would significantly harm business.
• Covers death, illness, disability; proceeds go to business.
• Benefits include protecting revenue, fulfilling debts / guarantees, enabling stable transitions.
• Tax treatment depends on declared purpose (revenue vs capital), policy structure.
• Essential in many small/owner-led businesses; especially where few people carry large parts of the value.
• Must be structured, documented, periodically reviewed.

 

References

1. AJG Australia. Key Person Insurance. (Gallagher)
2. AJG Australia. Does My Business Need Key Person Insurance? (Gallagher)
3. Findex Australia. Business key person risk overlooked in favour of cost of living. (findex.com.au)
4. Finder. Key Person Insurance (Australia). (finder.com.au)
5. Marsh. Key Person Insurance. (Marsh)
6. Canstar Australia. Key person insurance explained. (Canstar)
7. IT Ruling IT 155 (ATO). Assessability/Deductibility key man insurance policies. (Australian Taxation Office)
8. Westcourt. Is your keyman insurance policy tax deductible… (westcourt.com.au)
9. William Buck. Protecting your business with key person insurance. (William Buck Australia)