Executive income protection vs key person insurance
Executive income protection and key person insurance can both protect a limited company when an important employee or director is unable to work, but they do different jobs.
For an owner-director, it may be necessary to have one or both types of cover.
What’s the difference?
The easiest way to compare the two is to look at who the money is intended to protect.
| Executive income protection | Key person insurance | |
|---|---|---|
| Main purpose | Replace income when the insured person cannot work | Protect the business against the financial loss of a key person |
| Policyholder | Usually the company | Usually the company |
| Who receives a claim? | The company | The company |
| What is the money for? | To fund continued remuneration for the insured person | To help the company deal with the financial consequences of losing a key person |
| Typical claim | Regular payments during incapacity | Usually a lump sum following an insured event |
The precise cover depends on the policy, so check what events are insured and how benefits are paid before comparing products.
What does executive income protection cover?
Executive income protection is designed to provide replacement income if an insured director or employee becomes unable to work due to illness or injury.
The company pays for and owns the policy. Following a successful claim, the insurer normally pays the benefit to the company, which can use the money to continue paying the insured person.
The cover may include salary, qualifying dividends, and certain employer costs, depending on the insurer.
Our guide to how much executive income protection you need looks at the amount that may be insured.
What is key person insurance?
Key person insurance protects the company rather than the insured individual’s income.
A key person could be a director, founder, salesperson, technical specialist or another employee whose loss would have a serious financial effect on the business.
Depending on the type of policy arranged, cover may be taken out against death, critical illness or other specified risks.
If there is a valid claim, the company receives the benefit and can use the funds to address the financial consequences.
For example, the business might need money to recruit a replacement, cover lost profits, meet ongoing costs or deal with disruption while responsibilities are transferred to somebody else.
Why isn’t executive income protection the same as key person cover?
Consider a small consultancy where one director generates most of the company’s revenue.
If the director develops a serious illness and cannot work for a year, there are potentially two separate problems.
The director has lost the ability to earn their normal income. Executive income protection can help the company continue paying them.
The company has lost the person responsible for generating much of its revenue. That creates a separate business risk which executive income protection is not designed to cover.
The fact that both problems arise from the same illness does not make the two types of insurance interchangeable.
Can a company have both?
Yes. A business may have executive income protection for a director’s earnings and separate key person cover to protect the company itself.
Whether both are needed depends on the business.
For a one-person limited company, the director’s ability to work may be closely linked to both their personal income and the company’s revenue.
A larger company may be able to continue trading without one particular director but still want executive income protection as part of their remuneration package.
Alternatively, a business might be heavily dependent on a particular employee but have no need to provide that person with executive income protection.
What happens when an executive income protection claim is made?
Executive income protection normally has a deferred period before payments start.
If the insured person remains unable to work and the claim is accepted, regular benefits can then be paid to the company.
How long those payments continue depends on the benefit period selected when the cover was arranged.
Our guides to income protection deferred periods and how long executive income protection can pay cover both points.
How does key person cover pay out?
Key person policies are commonly arranged to provide a lump sum if the insured event occurs.
The company receives the money because it is the business which has suffered the financial loss.
This is different from executive income protection, which provides an ongoing income replacement during a period of incapacity.
The amount of key person cover required will therefore be calculated differently from executive income protection.
What about tax?
The tax treatment of the two types of cover should not be assumed to be the same.
Executive income protection is arranged to fund employee or director remuneration during incapacity. Premiums and claim proceeds need to be considered in that context.
Key person insurance has different tax considerations, including the purpose of the policy, who is insured and how any proceeds would be used.
If tax treatment is important to the decision, take advice based on the particular arrangement rather than assuming that all company-paid protection policies are treated alike.
We cover the executive policy side separately in our guide to executive income protection tax.
Which type of cover does a company director need?
Start by identifying what you are trying to protect.
If the main concern is how you would continue to receive income if illness or injury stopped you from working, executive income protection is the relevant cover.
If the concern is how the company would cope financially without a director or employee who is important to the business, key person insurance addresses a different risk.
Some owner-managed companies face both risks and may therefore consider both types of protection.
For directors comparing executive cover with a policy held personally, see our guide to executive vs personal income protection.