10.2 Advising Businesses on Protection Flashcards
Key Person Cover
Which businesses and individuals is this most useful for?
This is designed to cover the impact of losing somebody who is critical to the business.
It is most suited to smaller (SME) businesses and partnerships where the loss of one person can have a big impact.
Not only significant employees, but also directors and key shareholders (or director shareholders) or partners are likely to be key individuals.
Key Person Cover
Importance of covering large shareholders or partners
On the death of large shareholders or partners there may be a requirement that their shareholding or share of the partnership is bought out by the other owners (rather than being passed on to descendants of the deceased).
In this case there needs to be a source of cash to generate this payment which may be much larger than the available cash in the business.
Key Person Cover
How is the level of cover determined for a key employee?
This can be difficult. The salary of a key employee could be a starting point, but this might not reflect their value to the company.
A proportion of the companies profits based on the persons share of the total wage bill might be better, but if the company is young the profits may be small or even negative.
Also take into account the amount of time it would take to replace the person (loss of profits is based on how long the role is empty).
Key Person Cover
What is the tax treatment?
If the premiums are paid by a company they will usually be tax deductible, which means that the benefits would also be taxable (treat as trading income and charge corporation tax).
In line with usual tax treatment of insurance, if the premiums are tax deductible, tax must be charged on the benefits.
Key Person Cover
What kind of policy is suitable?
Term assurance might be best if the person is working on a specific project, or if the company is young and can’t afford a long term policy.
Convertible or renewable term assurance might be good so that the option is open to extend the cover.
Longer term or whole of life cover may be more appropriate for a partner or somebody who will be there for the long term.
Inflation linking or guaranteed increases may help keep the level of cover in line with the size of the business over time.
Other Key Person Insurance
What other insurance might be taken out against key people?
- IP - This would provide cash to cover a temporary employee while the key employee is away. Again the basis for level of cover is difficult but a salary or proportion of profits basis could be used.
- CIC - Similar rationale to key person life cover.
- Sickness and accident insurance - Might be more appropriate to get a lump sum if the person is unable to work, instead of an income stream.
What is share protection insurance?
Life cover written on a key shareholder to the benefit of the company or other shareholders, to enable them to buy the decreased out.
Issues for key shareholders
Solutions
Share protection insurance can provide funds to buy out a deceased shareholder, but there must be a legal basis on which they can make the purchase.
The articles of association of the company can be written in such a way that remaining shareholders have a right to buy the shares of the deceased.
Alternatively shareholders could leave their shares to the others in their will (share protection insurance wouldn’t be required as it is a gift, but then there’s IHT).
Or other legal agreements can be written between the shareholders.
How can the share protection insurance be set up?
- Life of another - Each director/shareholder can take out a policy on the lives of the other directors/shareholders.
- Own-life in trust - Each shareholder takes out a policy on their own life, to be held in trust for the other shareholders.
- Company takes out life policy on the shareholder - Then the company can buy back the shares.
- Shareholder trusts - A flexible trust is required since shareholder arrangements can change over time.
Level of cover for share protection insurance
It should be related to the value of the shares, but obviously this is variable.
The level of cover should be reviewed regularly to ensure it is appropriate.
Partnership Protection
What is the issue, what solutions?
The issue is the same as with key shareholders, if a partner dies the others need to be able to buy the deceased out so they can continue their business. They also need the funds to do so.
The partnership agreement is critical to them being able to buy the deceased partners share. Life cover can be used to provide the funds.
