C11 Business Protection

Key person insurance is when

A business uses insurance products to protect itself against financial loss in the event of a key person becoming ill or dying

The 3 needs for key person insurance

• Replacement costs

• Business interruption

• Financial

What are the two ways key person can be calculated

• 5 - 10 x salary

• More scientific approach as considers salary, profit and how long to replace the person

Formula is:

Key person’s salary x profit for last year x

number of years to replace the person

This figure is then divided by the total

salary bill

What do underwriters use for key person policies

business accounts, supplementary financial

questionnaire, business plans etc. to ensure level of cover is appropriate

How does taxation of key person work

No specific legislation but:

• Generally, if tax relief is given on premiums, then benefits are taxable

• Tax relief is given on most term policies

• Practices of local tax offices can vary

• To be treated as business expense premiums must be ‘wholly and exclusively’ for purposes of trade

What may be required for higher levels of cover

Medical underwriting

4 types of key person available

Term assurance

whole of life

CIC

Sickness and accident

Key person term assurance points

• Most obvious choice

• Convertible, renewable, renewable convertible

• Only issue is period of cover and potentially no inflation protection

• Separate cover for CIC and increase options may not be available

Flexible whole of life points

• Useful if key person important to the business over a long period

• Standard cover avoids premium increases but higher premiums

• Maximum cover – regard as 10-year reviewable plan

• More expensive than term assurance

What basis is key person cover

Life of another basis. The company is the proposer and owner. Key person is the life insured.

Key person CIC points

• Benefit paid to employer after 14 or28 day survival period

• Can combine with term

• Help if sudden need for cash, repay overdraft, help business to maintain turnover

• Severity-based benefit – pays out more, the worse the condition is

Key person accident and sickness points

• Premiums paid by employer and benefits paid to employer

• Less expensive than IP, but taxed in same way

• Pays for limited period (usually up to 2 years)

• Reviewable at least annually

Share protection insurance provides

Funds to buy company shares when a shareholder is very sick

Articles of Association is

like a company’s will

What are the problems for the family of key people

• Shareholders generally leave shares to family, but they are often unconnected with the business (no interest/aptitude)

• Family would generally prefer cash lump sum to shares

• Family may wish to sell shares, but no market for them

What are the problems for the businesses of key people

• Remaining shareholders generally want to retain shares and control of the company

• Funds may not be available to buy shares (could borrow but costly)

Solution 1 - ‘buy and sell agreement’ is

All shareholders enter into it

Deceased’s heirs must sell, and surviving shareholders must buy

Share valuation basis previously agreed and documented

Business relief for IHT is lost

Solution 2 - ‘Cross Option Agreement’

Surviving shareholders have option to buy

Deceased’s estate has option to sell

Both sides must agree if it is to go ahead

Timescale in which to exercise agreement

Retains business relief for IHT

Solution 3 - ‘Automatic Accrual’ is

• When shareholders leave shares to surviving shareholders in their will

• Directors take out life assurance to compensate their family as in the event of their death the family wouldn’t receive shares

What other basis of cover is there

Own life in trust

An absolute trust doesn’t allow

For future changes to shareholders

Co-Shareholder Flexible Trust can

Adapt to changes, trustees have power of appointment

How do partnerships work when a partner dies

• Partnerships automatically dissolved on death/capital accounts distributed to partners

• Clause in partnership agreement stating what happens on death allows partnership to continue

• Remaining partners would need funds to pay estate and buy business share (if required)