The World Cup has been host to some Oscar-winning ‘diving’ with very few athletes incurring any injury whatsoever… or sick leave! However, what happens if one of your key members of staff gets seriously injured or is signed off with a long term illness? Here we explain all about Key Person insurance, what it does and why it could benefit you, including a case study of how it can work in practice.
Key Person Insurance
Have you ever wondered what would happen if your business partner died, or your sales manager became seriously ill. What would be the impact on the business? If the answer to these questions keeps you awake at night, it’s probably time to consider keyperson insurance.
This is designed to compensate a business for the financial loss should a key member of the business die or become critically ill. A key person may be someone who brings money into the business, someone with specialist skills and knowledge or someone on whom the business depends for loan finance.
The first step is to envisage different scenarios and their impact on the business.
- Loss of a partner – insuring the lives of partners against death or illness can provide the remaining partners with the money to buy the deceased or ill partner’s share of the business. This way the partnership’s assets remain under the control of the surviving partners and the deceased partner’s beneficiaries receive the full value of their share.
- Loss of a key shareholder – should the shareholders wish to retain control of the business, it can be worthwhile insuring the life of key shareholders. In their death, the insurance pay out can be used to buy the deceased’s shares. This is a highly specialised area, and worth discussing with your accountant or financial adviser.
- Loss of a key person – if your business relies heavily on one or two members of staff, the impact on the business should they become or ill or die can be serious. Insurance is available that pays out the estimated financial loss to the business.
- Loss of a personal guarantor – it may be that a business loan has been personally guaranteed by a partner or shareholder in the business. Should this person become seriously ill or die the lenders may be in a position to call in the loan. Insurance can be structured to pay off the loan, thus securing the business and freeing the guarantor’s family from major worry.
This type of insurance is not available “off the shelf”, given the number of variables at play. However, insurers are likely to justify the sum insured on the basis of
- Multiple of salary – while this is straightforward, it may not reflect the true value of the individual to the business
- Proportion of profits – this takes into account annual salary, annual profit and the amount of time it would take to replace them, and is perhaps a better measure of the individual’s worth to the business
- Term – the term of the policy can vary, but would normally be based on five years cover
While there is no direct legislation on key person insurance, you should bear the following in mind:
- Should the premiums qualify for tax relief then it is likely the benefits will be treated as a trading receipt
- If the key person has a shareholding of 5% or greater then tax relief is unlikely to be granted on the premium as the policy is partly for the assured’s own benefit.
It is usually a good idea to consult your accountant before committing to any particular type of insurance cover.
An example – shareholder protection
Bob and Andy are both 45. They are co-directors of Bobandy Engineering Limited, in which they are each 50% shareholders. All of their capital is invested in the Company, which is currently valued at £500,000. It is a profitable business, and it earns them a good living, but it is never cash rich because it always has a continuing requirement to reinvest in materials and state-of-the-art machinery.
Bob and Andy are worried about the financial consequences if one of them died prematurely. Their wives, Roberta and Andrea, would not want to get involved in the business. Engineering has never really been their thing. They would much prefer just to receive a cash payment for the 50% share of the Company they would inherit. Where would the money come from though? Neither of the two families has anywhere close to £250,000 in cash to buy the 50% share, nor does the Company, and it is unlikely that they or the Company would be able to borrow that amount of money from their Bank.
The solution is simple. On the recommendation of their accountants, Bobandy Engineering Limited sets up life assurance cover of £250,000 on the lives of Bob and Andy. The cover runs for fifteen years, taking them up to age 60 at which time they plan to sell the business. The Company owns the insurance cover and it pays the premiums, which are only £30 per month for each director. If either director dies before age 60, the Company will have the cash available to buy back the shares from the deceased director’s widow, leaving the surviving director able to continue with the business. Now how neat and tidy is that?
To help you identify the type and level of insurance you may require and help you negotiate the best deal, contact Craig Campbell on 01383 628800. We’re in a league of our own!