Different types of business protection

It can also be used to ensure repayment of a business loan in the event of death or critical illness of a partner, key person or sole trader. How the arrangement is set up will depend on the type of business and its particular needs.

Key person protection

(a) Limited companies and limited liability partnerships

There are two solutions for key person protection for companies – ‘life of another’ and ‘own life’ in trust.

Under the ‘life of another’ solution, the company takes out a policy on the life of the key person. If the key person suffers a critical illness or dies, the policy benefits would be paid directly to the company.

The funds can be used to meet the company’s financial needs while it re-organises or recruits a replacement. In the case of a critical illness claim, it is possible that the key person will return to work, so Mr Smart says the funds could be used to pay for a temporary replacement or replace lost profits.

Alternatively, if, for example, the key person is a shareholding director, Mr Smart says he/she could take out a plan on his/her own life and write it under trust with potential beneficiaries being the other shareholders. In the event of the key person suffering a critical illness or dying.

(b) Partnerships

There are two different solutions for partnerships depending on whether the key person is a partner or an employee.

Where the key person is a partner, Mr Smart says he or she could take out a plan on his/her own life and write it under trust for the benefit of the other partners in the firm. Usually, Mr Smart says the other partners in the firm will enter into reciprocal arrangements.

However Mr Smart says advisers should note that partnerships in England, Wales and Northern Ireland aren’t separate legal entities. Accordingly, if the key person is an employee, Mr Smart says the partnership cannot take out a plan on a life of another basis.

In this situation, Mr Smart says the key person could take out a plan on his/her own life and write the plan under trust for the benefit of the partners in the firm.

(c) Sole traders

A sole trader business may need protection both for himself and a key employee. The sole trader could take out a plan on his own life and write the plan in a discretionary split trust for the benefit of his/her family, according to Mr Smart.

Mr Smart says this would ensure that in the event of his death, his/her family would have funds available to settle any business liabilities like, for example, a business loan.

According to Mr Smart the split trust usually contains a carve-out provision so that in the event of the settlor of the trust (in this case the sole trader) surviving diagnosis of a critical illness by 30 days, the proceeds of the plan will be paid to the settlor.

Mr Smart says: “Clearly, the sole trader will be a key person in the business. However, it is possible that he may employ someone who is also key to the success of the business.

“In this situation, the sole trader could take out a plan on the life of that other key person so that there are funds available to meet the financial responsibilities of the business in the event of the key person’s death or critical illness.”

Ownership protection

The loss of a partner, member or shareholder can have a major impact on the success of a business in terms of ensuring continued control for the remaining owners.

(i) Individual purchase

Under an individual purchase arrangement, Mr Smart says each business owner takes out a protection plan on their own life for the value of their share of the business. The plans are written under trusts for the benefit of the other co-shareholder, members or partners.

In the event of the death or critical illness of one of the business owners, Mr Smart says the others would receive the proceeds of the plan from the trust to enable them to fund the purchase the shares of the deceased or critically ill business owner.

Mr Smart says it is recommended that a cross-option agreement is made between the business owners in order to regulate the sale and purchase of the share of the business.

According to Mr Smart the cross-option agreement usually provides that the options must by exercised within three months of the date of death or critical illness and once either party to the agreement exercises an option, the agreement becomes binding on the other party.

Alternatively, Mr Smart says if there are only two or three owners it is possible for each owner to take out plans on each other’s lives so that in the event of one of the owners dying or suffering a critical illness, the proceeds of the plan would be payable to the surviving business owners.

(ii) Company share purchase

The rules are strict in this area, Mr Smart warns, but it is possible for a company to purchase the shares of a deceased or critically ill shareholder.

In this situation, Mr Smart says the company would take out a policy on the life of the shareholder so that in the event of his/her death or critical illness, the proceeds of the plan would be payable to the company enabling it to purchase the shares of the deceased or critically ill shareholder.

A cross-option agreement should be made between the company and the shareholder, he adds.

Business loan protection

Dougy Grant, protection director of Aegon, says business loan protection should be a key consideration for firms with debts as this cover is similar to mortgage protection for individuals.

It helps make sure that a business can repay the money owed if a key person dies or is diagnosed with a critical or terminal illness. Mr Grant says it is particularly important for an individual of a business who takes on the role of guarantor.

Group protection for employees

The type of protection that employers can offer to their employees - which would provide the benefits of income protection, critical illness or a life policy for each individual - to attract and retain top quality staff is increasingly popular.

Where a small business doesn’t have enough employees to qualify for a group life scheme, or employees don’t want the death in service benefits to form part of their pensions’ lifetime allowance, Mr Grant says a relevant life policy can be used to provide death in service benefits, which exceed the amounts provided by the main company scheme.

Paul Avis, marketing director of Canada Life Group Insurance, says latest figures available show that in 2012 UK group risk premiums totalled £1.68bn, covered 10,692,526 employees and 67,749 schemes.

He says the marketplace is currently broken down as follows:

• group life has 48,068 schemes and 8,389,579 employees;

• group income protection has 17,224 schemes and 1,963,874 employees; and

• group critical illness has 2,457 schemes and 339,073 employees.

(a) Group life assurance

According to Mr Avis group life assurance policies provide benefits on an employee’s death, either in the form of a lump sum, as pensions to spouses, civil partners and/or other financial dependents, or both.

Benefits are paid to the trustees of the employer’s scheme, who pay the benefit to the employee’s beneficiaries. The trustees have discretion as to who the benefit is paid to and will take into account the scheme rules and the employee’s wishes.

Employees often gain additional support from services such as bereavement and probate helplines, Mr Avis adds.

(b) Group income protection

With group income protection policies, Mr Avis says a continuing income, based on a proportion of an employee’s salary, is provided if an employee is unable to work as a result of illness or accident.

Pay outs start after the absence has continued for more than a certain period (usually 26 weeks but it can be longer or shorter), according to Mr Avis. The benefit is paid to the employer, who then passes the benefit on to the incapacitated employee through the payroll system.

If the employee remains incapacitated, Mr Avis says the payment could continue to state pension age, or for those employers on a budget, benefits can be payable for a limited period of between two and five years.

Additional services are often included alongside the benefits which employees and employers can use on a daily basis and specifically vocational rehabilitation from two weeks onwards supports absence management, Mr Avis adds.

(c) Group critical illness cover

Group critical illness however is a lump sum benefit that is paid directly to an employee if they suffer an insured condition such as cancer, a heart attack or a stroke and survive for a specified length of time (often 14 days).

Mr Avis says the conditions covered will be specified in each insurer’s policy and can usually be either a set of core illnesses or an expanded list should the client wish to offer enhanced cover.

Additional help and support is provided for the employee and their immediate family on the practical and emotional issues that result from a member being diagnosed with a critical illness as well as a second medical opinion referral service.

Mr Avis says: “Group life assurance is the most common group risk product purchased, mainly because of its link to pension schemes, followed by group income protection and then group critical illness.”

All group risk products can be tailored to provide an affordable, tax efficient, form of employee benefit that allows an employer to show that they care about the welfare of their staff, Mr Avis says.

He says: “Benefits also support staff attraction and retention and are under-penetrated in terms of the employees and employers that could be covered and hence provide advisers with a consulting opportunity.

“Each product has its own particular strengths and often is aligned with a set of service propositions that support the financial benefit. Also each has its own challenges that intermediaries need to be aware of and hence this does imply the need for advice on employer-specific scenarios.”