While succession planning ensures large corporations are rarely dependent on individual employees, the success of small- and medium-sized companies (SMEs) is often reliant on one or two key members of staff. Business protection can help SMEs safeguard their future, but if one of these employees dies or becomes ill, few businesses have any cover in place.
According to research by Legal & General, the business protection gap is £1.35tn, up 18 per cent from its previous survey in 2011. This gap is made up of £683bn of shareholder protection; £440bn of key person protection; and £223bn of corporate debt protection.
Clare Harrop, head of specialist protection at Legal & General, believes the gap is a result of a lack of awareness about the products. “There is lots of cover that businesses have to take out such as employer’s liability, buildings and motor insurance so business protection is overlooked,” she says. “But it is crazy that a business will insure its company cars but not the person with all the contacts who is responsible for generating most of the profit.”
Business survival
Taking out key-person insurance, which Ms Harrop prefers to call profit protection, can ensure that if the individual is not around to generate these profits, alternative revenue is available. This can help to keep the business afloat while it looks for a replacement.
It can also provide reassurance to employees. Working for a small firm can pose risks much less likely to happen at a large company, so knowing that insurance is in place to cover wages if a key member of staff can no longer contribute to the running of the business gives staff security.
As well as helping safeguard future profits, business protection can also make sure the company’s owners retain control. For example, if a company has four owners and one of them dies, their share of the business would become part of the deceased’s estate. As such it could potentially pass to someone who may have little interest in the company or, worse, have conflicting views on how it is run.
To avoid this, the four shareholders could take out life assurance to cover their portion of the business, writing it in trust so the others could buy their holding in the event of their death.
Debt protection
Businesses can also take out cover for liabilities – including loans and overdrafts – that could be at risk if a key person dies or is unable to work due to a serious illness. Although the Legal & General research found that the size of the corporate debt gap had fallen by £41bn to £223bn over the past two years, there was an increase in the amount of debt that was unprotected, taking it up to more than half of all corporate debt.
This is due to a shift in borrowing patterns. As banks have tightened up their lending criteria, businesses have switched to more expensive forms of borrowing such as overdrafts and credit cards where there is less of a requirement to take out protection. But reliance on these short-term forms of debt potentially puts these businesses in a more precarious position if a key person is affected.
Product design
While the motivations for taking out cover are very different to those seen in the individual market, Ian Smart, head of product development and technical support at Scottish Provident, says the business protection market is actually very similar. The products are identical with insurers offering life assurance, critical illness and, in some cases, income protection and even the premiums are exactly the same. On top of this, many of the individual protection players are also involved in the business protection market. “The only real difference is the amount of cover a business would want and how you put it in place,” he explains.
Because of the nature of the market, cover levels do tend to be higher with businesses usually taking out a multiple of their profits on key-person and shareholder cover.
Although cover in excess of around £1m to £1.5m will require financial underwriting, the trigger point for this has increased significantly over the past few years.
But while the figures may be a multiple of those seen in the individual market, the real difference is how the insurance is arranged. Rather than paying the benefit to a family member, it is paid to the business.
This works well where key people and business liabilities are covered but becomes more complex when it is arranged to protect the interests of the shareholders.
When there are only two shareholders, taking out ‘life of another’ policies can work but if you have three shareholders you would need six policies to cover all possible relationships, and then even more as the numbers increase.
To simplify this, policies are taken out with a cross-option to ensure that if the insured dies, the money is divided equally between the surviving shareholders to enable them to take over the deceased’s portion of the business.
More complex options are also available, especially for critical illness cover where there can be more uncertainty about the future role of the insured.
For example, a deferred double-option gives them the option to decide whether to come back to the business or sell their shareholding. At the end of a set time period – typically 12 to 18 months – if no decision has been made, the other shareholders will have an option to buy the insured’s part of the business.
Opportunities
Although the legal arrangements around business protection do bring a new dimension to the individual products, IFAs are in an ideal position to tap into this market.
Existing clients can often include business owners and there are many indicators to help identify them. These include occupation with the heads of small businesses more likely to be directors, partners or the self-employed; and existing products such as commercial insurance, corporate mortgages and life assurance taken out to support a business loan.
IFAs can also nurture relationships with professional connections such as solicitors and accountants. These firms provide their services to SMEs and can be the source of a useful stream of clients looking for business protection.
Another common strategy for building a business protection portfolio is to specialise in a particular sector. “If you have connections to a sector, perhaps because you previously worked in it or you know someone in it, it can be worth taking advantage of this,” says Peter Hamilton, head of retail propositions at Zurich Financial Services.
“Many IFAs take this route and it enables them to demonstrate that they understand the specific needs of the business,” he adds.
Additionally, as many IFA firms are small businesses themselves, there is already an understanding of some of the issues facing their survival.
Insurer support
Unsurprisingly the insurers are keen to support growth in this market. Many offer training support either in the form of literature or seminars and Legal & General is also launching a campaign to raise awareness of the need for protection among SMEs.
Steve Casey, head of marketing and propositions at Ageas Protect, which launched its business protection proposition this May, says there are plenty of opportunities for IFAs prepared to raise awareness of the products. “After all the sales last year resulting from the gender directive and the ‘I minus E’ accounting changes activity is depressed in the individual protection market,” he says. “I do expect to see more IFAs turning to this market but also more virgin business as the message gets out there.”
With the recovery of the economy dependent on the fortunes of these small- to mid-sized enterprises, helping them protect themselves from the unexpected has never been more important. And, as business protection shares so many of the characteristics of the individual protection market, growth is on the cards.
