Chapter 10 - Key Person and Business Protection Flashcards
How would you describe Key Person insurance?
Use of traditional life assurance policies to insure against a key individual within an organisation dying, becoming ill or being unable to work
What are the 3 main reason why Key Person insurance might be needed?
- Replacement costs – costs of replacing individual including agency fees, training time etc
- Business interruption – morale may suffer, key projects may be compromised, business contacts lost
- Financial implications – profits may fall, creditors may not be as willing to lend
What are the 2 ways of calculating the sum assured on a Key Person insurance policy?
Multiple of salary
OR
Proportion of profits
How do you calculate profits on a multiple of salary basis?
Salary of the key person multiplied by an agreed factor
What are the problems of using a multiple of salary calculation for a Key Person insurance policy?
A salary may not be a true reflection of what the key person brings to the business.
How do you calculate profits on a proportion of profits basis?
The key person’s total package is considered along with annual profit and the time it would take to replace them.
Key persons salary x profit for last year x no. of years to replace key person / Total salary bill
What are the problems of using a proportion of profits calculation for a Key Person insurance policy?
Is the salary used in the formula net or gross
What additional underwriting may be required for Key Person policies with large sum assured?
Financial underwriting
What is financial underwriting?
Policies may also need financial underwriting so the sum assured can be justified, this may require the financial accounts to be submitted, a business plan, loan agreements and an extra questionnaire if the SA is over £250k
Briefly describe what share protection insurance is
It provides a sum of money for remaining shareholders to buy deceased shareholders shares on death.
Most shareholders leave their shares to their family in their will. This can be a problem for the family as they don’t really want the shares as they likely know nothing about the business and can be a problem for the business as they will want to retain control of the business.
Share protection insurance can play a part in ensuring the company does not lose control of the business and the family are not financially disadvantaged.
What are the articles of association?
The “will” of a company stating how everything would be distributed/valued on early death of a shareholder/partner
What are the 3 potential options for share protection insurance?
- Buy and sell agreement –
- Cross option agreement –
- Automatic accrual –
What is a buy and sell agreement?
This is where an agreement exist that the deceased’s heirs must sell their shares to the surviving shareholders who must buy.
Main advantage is that everyone knows exactly what will happen on death.
Main disadvantage is BPR relief is lost as there is a binding contract for sale.
What is a cross option agreement?
The shareholders have the option to buy the shares from the estate of the deceased within a certain timeframe.
The benefit of this is HMRC view this as an option to buy and not a binding contract for sale, therefore BPR is preserved.
What is automatic accrual?
The shares of the deceased pass to the remaining shareholders.
The family are normally compensated by a life assurance policy paying out in their favour.
Problems could be if the business grows faster than the sum assured then the family may fell they have been inadequately compensated.
