Key person insurance, also known as key man insurance, is a life insurance policy that a business purchases on the life of an essential employee, founder, or executive. The business is both the owner and the beneficiary of the policy. If the key person dies, the business receives the tax-free death benefit, providing the capital needed to manage the transition, recruit a replacement, and stabilize operations. It is a core component of a corporate owned life insurance strategy.

For many businesses, the loss of a single individual - the founder, the top salesperson, the lead engineer - can threaten the company's very survival. Key person insurance provides a financial safety net that allows the business to absorb the shock and continue operating. For incorporated professionals, complementary coverage such as disability insurance for incorporated professionals can further protect against the financial impact of losing a key contributor.

Who Qualifies as a Key Person?

A key person is any individual whose death would cause significant financial harm to the business. This typically includes:

Founders and owners whose vision and relationships drive the business.
Top revenue generators who are responsible for a disproportionate share of sales.
Technical experts who possess unique skills or intellectual property.
Key executives (CEO, CFO, COO) whose leadership is critical to operations.
Professionals (e.g., dentists, physicians, lawyers) who are the primary service providers.

How Key Person Insurance Works

The Business Applies for Coverage: The corporation applies for a life insurance policy on the key person's life.
The Key Person Consents: The insured individual must consent to the policy.
The Business Pays the Premiums: The corporation pays the premiums using after-tax corporate dollars.
The Death Benefit is Paid to the Business: Upon the key person's death, the insurance company pays the full death benefit, tax-free, directly to the corporation.

How to Calculate the Right Amount of Coverage

Determining the right coverage amount requires assessing the financial impact of losing the key person. Common methods include:

Method	How It Works	Best For
Multiple of Salary	Cover 5-10 times the key person's annual salary.	A simple starting point for most businesses.
Revenue Contribution	Cover 2-3 years of the revenue attributable to the key person.	Businesses where the key person is a primary revenue driver.
Cost of Replacement	Estimate the total cost to recruit, hire, and train a replacement, plus lost revenue during the transition.	Businesses with highly specialized roles.
Loan Guarantee	Cover the outstanding balance of any loans the key person has personally guaranteed.	Businesses with significant corporate debt.

Term vs. Permanent Life Insurance for Key Person Coverage

Term Life Insurance

The most common and cost-effective choice for key person coverage. It provides a large death benefit for a specific period (e.g., 10 or 20 years) at a low cost.

Permanent Life Insurance

Can be used if the business also wants to build cash value within the policy for other purposes, such as funding a buy-sell agreement or supplementing the key person's retirement.

Tax Treatment of Key Person Insurance in Canada

Premiums: Key person insurance premiums are generally not tax-deductible, as the policy is not used for income-producing purposes.
Death Benefit: The death benefit is received by the corporation tax-free.
Capital Dividend Account (CDA): The death benefit (less the policy's Adjusted Cost Basis) creates a credit to the corporation's CDA, which can be paid out to shareholders as a tax-free capital dividend.