Key person insurance is a life policy the business owns on someone whose death would cost the company real money, with the business as beneficiary. To size it, owners usually run three methods and compare: a multiple of the person's total compensation (many carriers start at 5 to 10 times), the profit the business would lose while it recovers, and the cost to recruit and train a replacement plus any debt the person personally guarantees. Carriers want the number to be explainable, and the business must get the employee's written consent before the policy is issued.
Want to run your own numbers? Use the key person calculator →
We are licensed insurance brokers, not CPAs or attorneys. Treat the tax and legal points on this page as general education, and confirm them with your own CPA or attorney before acting.
On this page
Who counts as a key person
A key person is anyone whose sudden absence would cut revenue, stall operations, or spook a lender or customer. In a business with 2 to 25 employees that is usually the owner, but not always. Common examples:
- The rainmaker who brings in most of the new business or holds the biggest client relationships.
- The technical expert: the licensed professional, estimator, lead engineer or head chef the business cannot operate without.
- The operator who runs day to day so the owner can sell, and who knows where everything is.
- The guarantor: the person whose signature backs the line of credit or the lease.
A useful test: if this person died tomorrow, would you have to borrow money, turn down work, or sell? If yes, they are a key person, whatever their title.
Three ways to put a number on it
There is no single formula. Underwriters and advisors use a few methods, and the honest answer is usually a range. Running all three, as our key person insurance calculator does, gives you a figure you can defend.
1. Multiple of compensation
The simplest method multiplies the person's total compensation (salary, bonus and the value of benefits) by a factor. Carrier guidelines for key person coverage commonly run around 5 to 10 times compensation; one large carrier describes 10 times as its standard and will consider 15 to 20 times for well-established businesses or unusual circumstances. It is fast and familiar to underwriters, but it ignores how much profit the person actually drives.
2. Contribution to profit
Estimate the share of annual net profit that depends on this person, then multiply by the years it would take the business to recover. If a salesperson drives 40% of a $500,000 profit and it would take two years to rebuild, the exposure is about $400,000. This method lines up the coverage with the actual financial hit, and it is the one owners tend to find most persuasive.
3. Replacement cost
Add up what it would take to replace the person: recruiting fees, a signing bonus or higher salary for an experienced hire, training time, and the lost productivity while the new person ramps up. Then add any business debt the person personally guarantees, since a lender may call the loan or demand a new guarantor.
An HVAC company's operations manager earns $95,000 plus a $15,000 bonus and $12,000 of benefits ($122,000 total). She runs scheduling and the service crews, and the owner estimates 30% of the $400,000 profit depends on her, with 18 months to recover.
Compensation multiple at 5 to 8 times: $610,000 to $976,000. Lost profit: 30% of $400,000 for 1.5 years is $180,000. Replacement cost: $40,000 recruiting and training plus six months of lost productivity, about $100,000.
A sensible request here is around $500,000 to $750,000 of 10 or 15 year term: above the profit and replacement estimates (which tend to undercount), comfortably inside the carrier's compensation guideline.
What carriers will approve
The underwriter is trying to confirm that the business really would lose roughly the amount requested. Expect them to look at:
- Compensation and role, often confirmed with a short business questionnaire or financial supplement.
- Business financials for larger amounts: revenue, net income and net worth, sometimes tax returns.
- Ownership: if the key person is also an owner, the carrier checks that key person and buy-sell coverage together are not more than the business could justify.
- Other coverage on the same person, personal and business, in force or applied for anywhere.
The key person goes through normal medical underwriting, so their health and age drive the price. Term insurance is usually the right tool, matched to how long the business would depend on them.
Setting it up correctly
- The business applies, owns and pays. The company is the owner and beneficiary, so the death benefit lands in the business, where it is needed.
- Notice and consent come first. Before the policy is issued, the employee must get written notice and sign a written consent under Section 101(j). Skipping it can make most of the death benefit taxable. See our 101(j) guide.
- File Form 8925 every year with the business tax return while the business owns the policy.
- Write down the plan for the money. A short board or member resolution saying what the proceeds are for (cover losses, recruit, pay down debt) helps everyone later.
Premiums are not deductible when the business is the beneficiary. Our post on whether key person insurance is tax deductible explains why that is usually the better trade.
Don't forget disability
A key person is far more likely to be out for months with an injury or illness than to die during their working years. Key person disability coverage pays the business while the person cannot work. We compare both in key person disability and overhead expense insurance.
Frequently asked questions
Can a business buy key person insurance on an owner?
Yes. Owners are often the most important key person. If the owner is also part of a buy-sell agreement, keep the key person coverage separate from the buy-sell coverage so each has its own purpose and the business does not count on the same dollars twice.
What happens to key person insurance when the employee leaves?
The business still owns the policy. It can keep it (with the consent signed, coverage can continue after employment ends), surrender it, or transfer it to the employee. Transferring to the insured person is an exception to the transfer-for-value rule, so it is a common way to reward a departing employee.
Is the death benefit taxable to the business?
Generally no, if the 101(j) notice and consent rules were followed before the policy was issued and one of the exceptions applies (such as the insured being a director, a highly compensated employee, or employed within 12 months of death). For C corporations, larger estates and buy-sell situations, ask your CPA about how the proceeds affect the company's value.
Start your life insurance request
Tell us what the coverage is for and who it would cover. For most requests we ask for each person's date of birth and sex so Erik can prepare for the call. We do not ask health or tobacco questions in this initial request. This is a request for help, not an insurance application or a promise of coverage.
Written by Erik Moran
Erik co-owns Moran Insurance Group with Amanda Moran and handles the agency's life insurance cases, from key person and buy-sell coverage to trust-owned policies. He works alongside clients' CPAs and attorneys, who make the tax and legal calls. More about Erik.
Sources
- Principal: underwriting update on key person coverage amounts
- 26 U.S. Code 101: certain death benefits (Cornell LII)
- 26 U.S. Code 264: premiums not deductible when the payer is a beneficiary (Cornell LII)
- IRS Form 8925, Report of Employer-Owned Life Insurance Contracts
- 26 U.S. Code 6039I: returns for employer-owned life insurance contracts (Cornell LII)
Moran Insurance Group is a licensed insurance agency. Our brokers are not CPAs, attorneys or tax advisors, and nothing on this page is tax, legal or investment advice. Tax figures and rules reflect our understanding as of October 2026 and can change. Coverage is subject to carrier underwriting and state availability. Confirm anything tax or legal with a licensed CPA or attorney before you act on it.