Do I Need Key Person Insurance? A Guide for Canadian Business Owners
Here’s the reality: 71% of small businesses depend on one or two key people for success. Yet only 22% actually have key person insurance in place.
That gap isn’t just a statistic—it’s real financial risk sitting in your business right now.
Lose that key person, and you could lose everything. Client relationships, supplier contracts, daily operations—they all hang in the balance when someone critical walks out the door. Whether it’s through death, disability, or simply moving on to another opportunity.
Key person insurance gives Canadian businesses a financial safety net during these transitions. Think of it as your business continuity plan with actual money behind it.
This guide walks you through the fundamentals: how key person insurance works in Canada, who actually qualifies as a “key person” in your business, how much coverage makes sense, what types are available, and how the tax treatment works.
Whether you’re trying to figure out if you need this coverage or calculating how much to buy, you’ll find practical answers here.
What is Key Person Insurance in Canada?
Key person insurance is exactly what it sounds like: insurance on someone who’s critical to your business success.
Your company buys a life or disability policy on that essential employee—the one whose skills, knowledge, or relationships drive your revenue. You pay the premiums, you own the policy, and if something happens to them, the money goes straight to your business.
Here’s what makes it different from regular life insurance: the payout goes to the company, not the employee’s family.
How Key Person Insurance Works
You identify someone whose absence would hurt your bottom line. Then you buy an insurance policy on their life or health. The employee needs to give written consent before any policy gets issued.
Once it’s set up, you pay the premiums and become the beneficiary.
If your key person dies, your business receives a tax-free death benefit. Use that money however you need: recruitment costs, replacing lost revenue, paying off business debts, or funding a buyout. If the loss means you can’t keep operating, the funds help pay investors, provide severance, and close things down properly.
You’ve got three coverage options. Life insurance gives you capital when someone dies—available as term or permanent coverage. Critical illness pays a lump sum if your key person gets diagnosed with a serious illness that affects their productivity. Disability insurance works two ways: it can continue their salary until age 65 or recovery, or it can fund your office expenses and other salaries during their absence.
Who Owns the Policy and Who Benefits
Simple: your business owns everything. You pay the premiums, not the employee. When there’s a payout, the cheque comes to you. Insurance people call this company-owned life insurance.
Premiums usually aren’t tax-deductible. But if you’re using the insurance as collateral for a business loan and meet certain CRA requirements, you might deduct part of the premium. The death benefit comes to you tax-free.
Key Person Insurance vs Personal Life Insurance
Personal life insurance protects families—pays mortgages, funds kids’ education, replaces income for surviving spouses.
Key person insurance protects your business operations. You control the policy and use the money to keep things running, not to support the deceased employee’s family.
Think of it this way: personal coverage takes care of the family when someone’s gone. Key person coverage takes care of the business.
Who Counts as a Key Person in Your Business?
Simple answer: anyone whose absence would hurt your company’s finances. But identifying these people means looking past job titles to actual impact.
The Business Owner or Founder
You’re probably the obvious choice. Most small business owners handle everything—bookkeeping, employee management, key customer relationships. Without you, operations could stop entirely.
Small businesses are often built around the strengths and skills of just a few individuals whose capital, energy, knowledge, or experience makes them valuable assets. Sound familiar?
Partners and Co-owners
Your business partners who manage operations, maintain client relationships, or oversee finances qualify. In partnerships, each member might recognise that without the other, the business cannot continue trading.
Co-owners whose death or disability would trigger a buyout also count as key people. That buyout money has to come from somewhere.
Top Revenue Generators
Got a salesperson who brings in a large chunk of company revenue? They’re a key person. Department leaders like your top salesperson or head of product management contribute significantly to organisational stability.
If losing someone would seriously impact your sales or finances, they need coverage.
Technical Experts and Specialists
Employees with unique skills that are hard to replace definitely qualify. This includes maintenance technicians, technology specialists, lead developers, researchers, and employees who operate highly specialised equipment.
As your business grows, individuals with considerable technical knowledge and expertise in your particular industry become invaluable.
Operations Leaders Who Keep Things Running
Think about employees involved in critical project workflows or important production line operations. Engineers, product developers, and equipment operators who keep daily operations functioning belong in this group.
The Numbers Don’t Lie
Remember that statistic? Seventy-one per cent of small businesses depend on one or two key individuals for success.
Bottom line: identifying key employees comes down to asking who your business would struggle to function or remain profitable without.
How Much Key Person Insurance Coverage Do You Need?
Don’t guess at coverage amounts. Your business—and your bank account—deserve better than that.
Insurance companies use three proven methods to calculate appropriate coverage. Here’s how each one works for your situation.
Method 1: The Salary Multiplier (5-10x Annual Salary)
Start with the person’s annual salary and multiply by 5 to 10. It’s the most straightforward calculation method. For truly irreplaceable positions, you might justify up to 20 times their current salary.
Your creative director earns £140,000? That’s £700,000 to £1,400,000 in potential coverage using standard multipliers.
Simple. Clean. Gets you in the right ballpark quickly.
Method 2: Revenue Impact and Replacement Costs
This method digs deeper into actual financial impact. Calculate what losing this person would really cost your business.
Start with their revenue contribution. Add replacement time (usually 12-24 months). Factor in recruitment expenses—expect to pay around 25% of the replacement’s salary to headhunters. Don’t forget training costs, signing bonuses, and lost sales during the transition.
One detailed example: a key person managing 20% of company revenue with a two-year replacement timeline could cost over £1,166,939 in total losses and recruitment fees.
Method 3: Outstanding Loan Coverage
If your key person personally guaranteed business loans, cover the full amount. Banks can call those loans if the guarantor dies, creating immediate cash flow problems you don’t need whilst dealing with their absence.
Real Example: Coverage Calculation for a Small Business
Creative director salary: £139,336 Client billing managed: £696,680 (40% profit margin) Annual profit contribution: £278,672 Replacement timeline: 18 months Lost profit during replacement: £418,008
Add recruitment costs:
- Headhunter fee: £34,834
- Signing bonus: £20,900
- Training: £20,900
- Guaranteed loan balance: £139,336
Subtotal: £633,979 Add 15% contingency: £729,076 total recommended coverage
What Most Canadian Small Businesses Actually Buy
Coverage typically ranges from £500,000 to £2,000,000 per key person, depending on their role and revenue contribution.
Your number will depend on your specific situation. But now you know how to calculate it properly.
Types of Key Person Insurance and Tax Treatment in Canada
Canadian businesses have three main coverage options. Each addresses different risks, so understanding the differences matters for your planning.
Key Person Life Insurance (Term and Permanent)
Term life insurance covers you for a specific period—typically 10 or 20 years. It’s cheaper upfront but the coverage eventually expires.
Permanent policies like universal life or whole life provide lifetime protection. Higher premiums, but the coverage never goes away.
Some insurers offer first-to-claim policies that combine life coverage with critical illness insurance. These pay out on either diagnosis or death, but not both. One payout, then you’re done.
Critical Illness Insurance for Key Employees
This pays a lump sum if your key person survives a major illness. The money helps offset lost productivity and revenue during treatment and recovery.
Think heart attack, stroke, cancer—conditions that keep someone off work for months but don’t necessarily kill them.
Disability Insurance Coverage
Disability coverage works two ways in Canada. It can provide salary continuation to the disabled person until age 65 or recovery. Or it can fund office expenses and salaries during their absence, usually for a limited time.
The choice depends on whether you’re protecting the person or protecting the business.
Tax Treatment: What You Need to Know
Here’s how the CRA treats key person insurance premiums and payouts:
Premiums paid by your business are generally not deductible for tax purposes. You pay them with after-tax dollars.
Death benefits arrive tax-free to your corporation. The excess over the policy’s adjusted cost basis credits your capital dividend account, allowing tax-free dividend distributions to shareholders.
The One Exception for Deductible Premiums
If a lender requires the insurance as collateral for a business loan and specific income tax requirements are met, you may deduct a portion of premiums.
This doesn’t happen often, but it’s worth knowing if you have guaranteed business debt.
When You Might Not Need Key Person Insurance
Businesses with distributed responsibilities across multiple team members face lower risk. If losing one person wouldn’t sink the ship, you might skip this coverage.
Companies nearing sale or transition may find shareholder insurance or buy-sell agreement insurance more appropriate for their situation.
The Bottom Line
You know your business better than anyone. If it would struggle without one or two specific people, that’s your answer right there.
The numbers tell the story: most Canadian businesses depend on key people, but very few actually protect against that risk. The calculation methods we’ve covered help you put real dollars on what that gap could cost you.
Whether it’s term life insurance, critical illness coverage, or disability protection, the right policy gives you breathing room when the unexpected happens. Time to find a replacement, stabilise client relationships, or even wind down operations properly if needed.
For businesses where responsibilities are spread across a strong team, key person insurance might be overkill. But if your company is built around essential individuals—and most small Canadian businesses are—this coverage deserves serious consideration.
Got questions about coverage amounts or which type makes sense for your situation? Let’s talk.
