Protection

Question 1

What might a business want to protect against? (4)

Answer 1

Protect a loan
Recruiting a replacement
Replace lost profits
Death/serious illness

Question 2

How do you work out the key man cover with the proportion of profits method?

Answer 2

Years to replace times their salary times last years profits
divided by total salary bill

Question 3

Disadvantages of using proportion of profits method (6)

Answer 3

Salary doesn’t include other benefits like bonus
So they may under insure
Doesn’t reflect their value to the business/sales
So doesn’t reflect true loss to business
Time factor is hard to quantify
It’s unknown how long it’ll take to train someone to their standard

Question 4

What is the tax position of key man premiums and conditions for this?

Answer 4

Deductible expense for the business because it’s to protect loss of profit
As long as it’s a short term policy (5 years max), the life assured‘s relationship is purely employer-employee, and the sum assured is reasonable

Question 5

What would be the tax position if a business included loan repayment as part of their key man policy?

Answer 5

Not tax deductible, key man is only given tax relief if purely for loss of profit. They should do two separate policies

Question 6

What are the 2 options for a valuation clause and what is a disadvantage of each?

Answer 6

Fixed value: needs regular revaluation

Market value: uncertainty at time of death

Question 7

How should shareholder protection be set up?

Answer 7

A shareholder agreement should be made
Referring to a cross option agreement
For the purchase and sale of shares.
One party can sell if they wish or the other can buy if they wish.
It becomes binding on one of those decisions
The arrangement has an own life policy (to keep the arrangement simple)
Written under a business trust
For the value of the share holding.
As it’s not a binding agreement, business relief is available so no IHT.
There should be an agreed basis for valuation (to ensure all parties receive fair value) and a timescale for the options

Question 8

Why should a business trust be used?

Answer 8

(Trust so the proceeds are outside of the estate and there’s no IHT
Surviving shareholders will get the funds to purchase the shares in a timely manner)
Provides flexibility
Excludes non business owners to preserve tax relief
Treated as a commercial arrangement
Policy can revert if anyone leaves the business
Life assured should be excluded as a beneficiary in order to avoid POAT

Question 9

If wife leaves 50% shareholding to husband in will. How are these shares treated on her death?

Answer 9

Shares passed to husband via the will. Husband then controls 50% of the company’s shareholding

Question 10

What are the three parts to a shareholder protection arrangement?

Answer 10

Policy, trust and agreement

Question 11

What implications should be discussed when setting up key man insurance?

Answer 11

Potential loss of profits
Cost of temporary replacements
Cost of finding permanent replacements
Possible redundancies that may be caused
Possibility of bank requesting loans to be repaid

Question 12

What are the two calculations for key man insurance and when should each be used?

Answer 12

Multiple of salary for those who’s salary is a high proportion of the payroll
Proportion of profits for those who take low profits/have additional benefits/responsible for creating profits

Question 13

Describe how a stand alone critical illness policy should be set up to protect a business.

Answer 13

Policy set up under a business trust
Trust allows trustees to make the fund available to buy the shareholding of ill director
Sum assured to match value of shareholding
Single option agreement giving option to ill director only
Time limit set for right to exercise option

Question 14

What difficulties may a business face if someone is ill?

Answer 14

They may not be able to cover that person’s work and therefore be unable to fulfil services with customers. This means they may be in breach of contract and have to pay fees
They may have costs of taking on extra staff, loss of profits of subcontracting/a locus with another firm.

Question 15

What information would you need as an advisor to set up company protection in the event of death? (6)

Answer 15

What they want to happen on death
What is in the directors wills
Is there an agreement in place regarding transfer
What are the terms of the agreement
Is there a valuation method
Are the directors insurable/health

Question 16

Explain the potential problems for minority shareholders if the majority shareholder dies with no protection in place (8)

Answer 16

Shares would go to a spouse/beneficiaries
They are in control of the business
They can control dividend payment
They could remove directors
They could sell shares to a third party
Minority shareholders are powerless to decisions
The value of their shares could decrease
They could make running the business difficult

Question 17

What information would underwriters want to set up a life policy for a director/shareholder? (5)

Answer 17

Value of the company/shareholding
Turnover
Level of company debts
Director remuneration over last 3 years
Existing protection/sum assured

Question 18

What are the options for paying own life premiums?

Answer 18

The company can pay the premiums but this is treated as a P11D benefit so they will pay NIC and Income Tax on this. They could increase their salaries to combat this.
They could pay their contributions personally however they may want to equalise their payments if one director’s are higher due to health

Question 19

What are the drawbacks of using a life of another policy for life cover? (3)

Answer 19

It’s inflexible if shareholdings/ers change
Complex for more than 2 directors
Reliant on other directors maintaining premiums

Question 20

Outline how directors wills should be set up for a transfer of a business share

Answer 20

Make reference to the shareholding
Refer to shareholder protection arrangements
Separate business executors may be appointed

Question 21

How should fixed valuation be set up to avoid tax implications?

Answer 21

Should be on a commercial basis reflecting current market value.
Fixed price agreement must be between unconnected persons of similar ages.
Fixed price for max 3 years.
Needs regular review.

Question 22

Recommend and justify the key elements of a suitable business succession plan to allow Pete and Julie to buy Martin’s share on his death

Answer 22

Level term assurance on Martin’s life
Sum assured to match his shareholding
Indexation to protect against inflation
Term to his retirement
WOP to protect premiums if he can’t work due to illness
Under a business trust to benefit Pete and Julie
Cross option agreement which allows for purchase/sale of shares maintains BR as not binding
Allows for Pete and Julie to have full ownership of the business whilst compensating his family