When business owners are asked what business assets are insured they usually list their premises, machinery, vehicles, computer equipment etc. They recognise that cover is required for the cost of replacement, potential loss of profits and to minimise any business disruption.
But one valuable business asset is often left uninsured. Too few businesses have insurance to cover the one eventuality that can literally mean the end of the business and the income it provides – the death or illness (including critical illness) of a key person.
IDENTIFYING KEY PEOPLE IN A BUSINESS
A key person is someone whose absence from the business through death, or the suffering of a critical illness or long-term disability, would have a serious effect on the future profits of the business. Although the number of key employees will vary from business to business, there will be at least one, although usually more. You need to determine who the key people are by asking:
How easily could the business replace their expertise?
Would their absence affect business plans, on-going sales or projects?
Would the business be in danger of losing customers?
To give some examples a key person may be:
Without this person the profitability of the business would be affected, new customers would be more difficult to attract, and existing ones might leave.
Research and development specialist/Technical Expert
Without this person the development of new projects could be slow or cease.
Director/Manager (often, but not always, the business owner)
Without this person there would be severe implications on the finance of the business, mostly because this person creates the vision for, and the direction of, the business.
HOW DOES KEY PERSON INSURANCE WORK?
Key person protection, through a life assurance, critical illness, income protection insurance policy, or a combination of all three, can provide a cash injection (either as a lump sum or as a flow of income) to the business if a key person dies or suffers a serious illness, which will enable the business to continue trading at a time of considerable uncertainty and financial pressure. The policy is owned and paid for by the employer, so any pay-out is payable to the employer.
HOW MUCH COVER?
How much cover is needed will be different for every business, depending on who they are looking to protect, for how long, their priorities and, of course, affordability.
The exact amount of cover required may be difficult to quantify. There is no single way to calculate the financial value of a key person. However, the cover required under a key person policy should be founded on the amount that is estimated to be needed to replace lost profits, until they are restored to the required level, and to meet any additional costs. 3CS can help with these calculations.
There is no direct legislation covering this subject, but the principles applying were set out in 1944 by the then Chancellor of the Exchequer, Sir John Anderson. These principles have come to be known as the “Anderson Rules” and still remain valid today.
Providing the company is taking out a policy on the employee, to protect the business from a loss of profits resulting from the loss of that key employee and the insurance policy is annual or short term (typically 5 years or less), the company will usually be allowed corporation tax relief on the premium. If tax relief has been allowed on the premiums, then the proceeds (the payout amount) will normally be taxed as a company trading receipt, although it is important to note that tax treatment of proceeds of benefit may be treated differently depending on the judgement of the local Tax Inspector.
If you need help with any of the issues raised in this newsletter, please do not hesitate to contact your usual 3CS Consultant.