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Insurance & Social Security > 07. Business Insurance > Flashcards

07. Business Insurance Flashcards

1
Q
  1. What are the three basic business protection needs that typically apply?
A
  • Business expense protection
  • Asset and revenue protection
  • Ownership protection
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2
Q
  1. What is the key financial problem (3 components) that business insurance aims to provide?
A
  • the right amount of cash
  • for the right person
  • at the right time
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3
Q
  1. What is business expenses protection?
A

Insurance for loss due to sickness or injury for that proportion of their gross income that normally meets the business’s regular operating expenses.

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4
Q
  1. What is the benefit payment period for business expenses protection and what percentage does it indemnify for?
A

Up to 12 months. These can indemnify the business for up to 100% of actual regular normal expenses.

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5
Q
  1. What is asset and revenue protection?
A

Insurance to ensure that there is sufficient income for the business to meet its obligations in the event of disability, death or trauma of a key income-generating person

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6
Q
  1. What are the risks to the business if they do not have asset and revenue protection?
A
  • Business could be forced to sell assets to maintain cash flow
  • Losses may result while finding and training a suitable replacement
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7
Q
  1. What are the five ways that a business can raise cash to manage business expense risk?
A
  1. Realising business assets
  2. Borrowing cash
  3. Creating a capital reserve
  4. Absorbing the loss from current business profits, or
  5. Transferring the risk to an insurer
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8
Q
  1. Which is the best of the five options for a business to raise cash to manage business expense risk?
A
  • Insurance - it is the cheapest.

The other options pose risk, inefficient use of capital, removal of assets etc.

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9
Q
  1. What is ownership protection?
A

This insurance ensures the smooth succession of ownership between shareholders in the event of death, TPD or trauma of a partner in the business.

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10
Q
  1. Who does ownership protection benefit the most?
A
  • Partnerships - Death of one partner automatically dissolves the partnership, and leaves two options - liquidate or reorganise.
  • Proprietary companies - the death of a shareholder will transfer the shares to the heirs as an inactive interest.
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11
Q
  1. What will the ownership protection do, and why is this a benefit to partnerships and proprietary companies?
A

It sets up conditions and provides for the surviving owners to buy out the interest of the heirs of the deceased partner or shareholder. This enables the business to continue.

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12
Q
  1. What are five ways of funding the required purchase price of a business after the death of a partner or shareholder?
A

1) realising business assets
2) realising personal assets
3) borrowing cash
4) paying off the heirs gradually, or
5) utilising business protection (expense) insurance

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13
Q
  1. Describe the tax treatment of whole of life or endowment policies?
A

Premiums are not deductible and the proceeds are not assessable

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14
Q
  1. Describe the tax treatment for accident and term insurance policies?
A

Premiums are deductible and the proceeds are assessable if the purpose for effecting and maintaining the policy is of a revenue nature, otherwise premiums are not deductible and the proceeds not assessable.

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15
Q
  1. What are the further rulings the Tax Commissioner has made regarding the deductibility of revenue purpose insurance policies?
A
  • Loss of the key person would result in a significant loss of profits
  • Business would continue to operate while a replacement is sought and trained (not deductible if loss results in termination of business)
  • The amount of insurance is baed on a reasonable estimate of the loss of profits likely to arise a the time the policy is entered into.
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16
Q
  1. Death claim proceeds are exempt from capital gains tax provided they are received by who?
A
  • the original beneficial owner of the policy, or

* a person who did not acquire the rights or interest in the policy for consideration.

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17
Q
  1. TPD and critical illness claim proceeds are exempt from CGT if they are received by who?
A
  • the insured person under the policy, or

* a spouse or relative of the person insured.

18
Q
  1. Examples of key person indicators include what five factors?
A
  • Significant remuneration
  • Executive influence
  • Significant facilitators
  • Capital influence
  • Creative influence
19
Q
  1. What are the most immediate problems created for a business in the loss of a key person?
A
  • profitability is adversely affected
  • additional capital is required to recruit and replace
  • business efficiency is lost,and/or
  • goodwill is lost
20
Q
  1. What are the benefits of having a policy of insurance on the life of a key person?
A
  • cash to offset loss of profit
  • cash to resource a successor
  • cash to offset the cost of loss of goodwill
  • cash to extinguish debts owed to the key person
  • cash to facilitate business plans, and
  • cash for working capital.
21
Q
  1. What are the alternatives to key person insurance?
A
  • Drawing on profits
  • Establish a cash reserve by accumulating profits
  • Borrow funds from lending institutions
  • Sell business assets
22
Q
  1. What are ways a business can minimise the need or amount of key person insurance?
A
  • Spread its management responsibility among a number of individuals
  • Have a well thought out management training program
  • Have sufficient liquid surplus to meet emergencies, and
  • can borrow money in its own name without the personal guarantee of any owners.
23
Q
  1. Life insurance is often the foundation to many key person insurance solutions. These have add on features that may be useful when taking out life insurance for the purpose of mitigating key person risk. These add ons include (4)?
A
  • Future insurability options
  • Business loan cover options
  • Partnership protection
  • Protecting the business from additional life risks
24
Q
  1. What is future insurability?
A

These provide for certain conditions where insurance may be changed including:

  • when an increase can be exercised
  • the types of events that may trigger a future insurability opportunity
  • the amounts of each increase, and
  • the maximum total value of all increases.
25
Q
  1. What is a business loan cover option?
A

Provide a single benefit payment that may cover a number of lives that personally guarantee business loans.

26
Q
  1. What is partnership protection?
A

It covers the business for multiple lives either for a single or multiple benefits to fund the consideration specified within a succession or buy-sell agreement between business partners.

27
Q
  1. What options may be considered in a life policy to protect the business from additional life risks?
A
  • TPD

* Critical illness etc.

28
Q
  1. Who may be interested in taking out key person insurance?
A
  • A Creditor / Investor
  • A partner
  • The company (for directors and key shareholders)
  • Beneficiaries or founders of a trust
29
Q
  1. What are the ways to sell key person insurance?
A
  • Identify clients that own businesses
  • Advertise for new prospects
  • Use centres of influence (eg accountants)
  • Provide information highlighting the risks
30
Q
  1. With respect to key person insurance, what factors need to exist in order to achieve an insurable interest, which is required in order to take out the policy?
A

With respect to the key person they were:

  • a body corporate in the life of an officer or employee
  • an employer and employee in each other’s life, or
  • a person likely to suffer pecuniary or economic loss from the death of another.
31
Q
  1. When determining the value for key person insurance, what must be considered?
A
  • debt that may need to be repaid if a key person leaves
  • any clients or contracts that will be lost
  • amounts payable to the key person or their estate
  • working capital required to continue operations
  • costs associated with location and training of a replacement
  • any loss of profits
32
Q
  1. What are the three methods of determining the amount of insurance required for a key person loss?
A
  • Present value method
  • Debt cancellation method - loans outstanding and trade credits
  • Multiple method
33
Q
  1. What is the present value method of quantifying the amount required for key person insurance?
A
  • salary and salary premium to attract new employee
  • expenses of training courses
  • expenses of locating / relocating a new employee
34
Q
  1. What are the five basic rules to calculating the multiple method (to quantify the amount of insurance required for a key person)
A
  • Revenue - sales rev x key person factor
  • Gross Profit - 3 x (gross profit x key person fact)
  • Net profit - 8 x (net profit x key person fact)
  • Liabilities - liabilities x key person factor
  • Remuneration - 10 x (total remuneration x key person fact)
35
Q
  1. What are the two fundamental factors that an underwriter must consider in assessing the amount of insurance required?
A
  • The method chosen to value the key person is in accordance with industry practice
  • The level of cover reflects the value of the key person in the business.
36
Q
  1. What are the common problems with financial underwriting for key person insurance?
A
  • evidence is needed (to prove the insurance wouldn’t place the company in a better position)
  • Evidence is hard to substantiate
  • It is difficult to obtain evidence
  • Requests for further information can be unclear
  • Company may not agree with level underwriter will accept
  • multipurpose needs
37
Q
  1. How is the tax deductibility of insurance for key persons generally determined?
A
  • Whether the purpose is of capital or revenue nature. Paperwork is used to firm up this determination, and the absence of such paperwork will generally lead to a presumption that the life cover was not taken out for revenue purposes.
38
Q
  1. What is the advantage of being able to claim a tax deduction on key person insurance?
A

Relative cost is reduced if a tax deduction is claimed

39
Q
  1. What are the disadvantages of being able to claim a tax deduction on key person insurance?
A
  • Higher premium payment/sum insured may lead to more stringent underwriting requirements
  • Tax deduction may not be available (due to income level or tax commissioner ruling)
  • Record keeping requirements are increased so may increase costs
  • Costs may be increased due to use of advisers and accountants
  • Higher initial cash flow is required to service the agreement.
40
Q
  1. Permanent and temporary key person insurance can be considered. What are the main differences?
A
  • Premium cost - permanent is higher
  • Cash value - is pid after a certain period for permanent
  • Taxation treatment - permanent are generally not available for tax deduction
  • accounting treatment - permanent policies should be shown in the balance sheet as an asset

Insurance & Social Security (10 decks)

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