Key Person Protection Flashcards
State the possible direct consequences for the business and their profits of the Research and Development Director contracting a long-term illness. (8 Marks)
- Finding a suitable replacement is expensive and time consuming.
- Ongoing and future developments may be delayed or shelved completely.
- Important business relationships, and consequent goodwill, may be lost.
- Staff morale may suffer and there may be an additional workload.
- Sales and profits may fall, potentially giving rise to cashflow difficulties.
- It may be more difficult to meet existing credit commitments.
- New credit may not be so readily available.
- The company may be obliged to continue to the pay the Research and Development Director’s salary.
Simple method of calculating Sum Assured -
Multiple of salary
• Key person’s salary is multiplied by an agreed factor, (1) usually between five and ten times. (1)
Benefits:
• Simple to calculate the level of cover, as it is a multiple of salary.
Drawbacks:
• Salary is only one part of total remuneration.
• Salary alone does not reflect the true value of the individual to the business.
• Salary does not allow for the time factor in relation to term to retirement.
Scientific method of calculating Sum Assured -
Proportion of profits
• Key person’s salary multiplied by last year’s profits (1) and time in years to replace, (1) then divided by the total salary bill. (1)
Benefits:
• A more scientific approach to the level of cover and more accurate reflection of key person value to the business.
• Gross or Net Profit may be used.
• Net Profit is a good reflection of the business performance although gross profit is a better reflection of loss of the key person’s contribution to the business.
Drawbacks:
• Can be difficult to determine a time factor e.g. for recruitment, training and settling in.
• Does not work where the company is showing a loss or deliberate low profit.
• Still uses a salary figure so has same problems as multiple of salary.
Identify three sources of evidence that may be required to be seen by the key person assurance provider as a means of justifying the level of cover applied for.
- Latest accounts.
- Business plan.
- A supplementary business questionnaire may need to be completed.
Outline the conditions laid down by the Anderson Rules that must apply for the premiums paid by an employer to be an allowable deduction from business profits for tax purposes.
- Sole relationship of employer and employee.
- Short-term/maximum of five years/annual contract.
- Cover is to replace lost profit through loss of services of insured life.
How does the Anderson Rules normally affect the tax treatment of premiums and benefits for (i) 2-yr Term Ass on life of controlling Director (ii) 2-yr Term Ass on life of senior employee (iii) on same as i but for loan protection
(i) The premium is not deductible, and the benefit will not be taxed. (because a >5% shareholder)
(ii) The premium should be deductible, but the benefit will be taxed as a trading receipt. (a non shareholder)
(iii) The premium is not deductible, and the benefit will not be taxed. (because for a loan and not a ‘sole relationship of employer and employee)