The loss of a key person can have a big impact on any small business, yet often owners are so focused on achieving financial success they forget to ensure the continuity of the company in case a key person drops out due to illness or even death, warns Lumin Wealth.
A case study supplied by the advice business highlights how insurance can help when the loss of a key person threatens to lead to reduced sales, wasted time, profit reductions, and disrupted development plans.
Such protection is often more cost-effective than people realise, says Will Harries, financial consultant at Lumin Wealth, as he warns that smaller companies are the most in need of business protection, but the least likely to have insurance policies in place.
This view was echoed by Roy McLoughlin, associate director at Cavendish Ware, who told FTAdviser earlier this month that the number of business protection policies written was "woefully short".
"This is a particular problem for smaller businesses, which make up the vast majority of businesses in the UK. A lot of the larger ones may have relationships with employee benefits companies," he said.
Choosing between the different types of policies can be complicated, says Will Harries
Business' insurance needs vary but they typically depend on the ownership structure, key personnel and the company's valuation or size, says Harries.
The case
A company is valued at £2mn with two directors and three highly valued employees. No existing business protection cover is in place.
The directors’ family members do not have the interest or experience or skills to become actively involved in the business.
On the other hand, neither director would have sufficient funds to buy out their business partner’s stake if they were to pass away or become seriously ill.
The solution
One solution Harries recommends is a key person policy taken out for each of the directors. This gives the company a lump sum benefit to cater for an anticipated loss of future revenue.
The amount needing to be covered will depend on the perceived value the individual brings to the business, or the damage their loss would cause.
For instance, what would the recruitment cost be to replace them, how long would it take to find a replacement, how much money are they bringing into the business, and are there any loans secured against the business by that person that might need to paid back?
Illustration provided by Lumin Wealth
With this type of cover the proceeds in the event of a payout would go to the business. Key person insurance is written on the life of another, with the company being the owner of the policy and the life assured the key employee.
Another option is shareholder protection, which is taken out under an own life policy to the value of the individuals’ shares. Each shareholder can take this out, and the policy is written under a business trust, says Harries.
"This type of insurance policy is placed in trust and benefits the other shareholders and the shareholder’s family. This policy ensures that the proceeds are made available to the other shareholders to buy the company shares from the deceased’s or critically ill shareholder’s family.
"It is therefore immediately available to fund the purchase of the former business partner’s stake."
A cross-option agreement can be put in place to ensure that if one of the shareholders were to die or become critically ill, the company can purchase the business interest from the shareholder's estate using the policy payout.
A cross-option agreement grants the surviving director a ‘call option’, which is a right, not an obligation, to purchase the deceased’s shares at market value.
On the other hand, it gives the deceased’s estate a ‘put option’, again not obligatory, to sell the shares to the surviving director at market value.
In this case, only one of the parties needs to exercise their option to buy or sell the shares for the agreement to be binding.
Finally, three relevant life policies can be created for the valued employees. The premiums are usually classed as a deductible business expense and hence attract corporation tax relief for the company.
On a successful claim the sum assured is paid into a relevant life trust for the benefit of the beneficiaries who are named, for instance a family member, and not for the business.
As such it can be seen to benefit those working for the company more than the company itself, Harries says.
However, the company will benefit from the tax relief, and this allows an employer to provide life cover where they do not have a sufficient number of employees to offer a group scheme, or only want to cover a small number of employees.
Cost
As with most protection policies, the cost will depend on a number of factors, including age, lifestyle, health and so on.
The premiums can also become cheaper by using a renewable clause option.
For £1mn of life cover, a relevant life policy for a 35 to 40-year-old could cost around £35 to £75 a month with renewal clause, and around £100 to £150 without, Harries says.
Key person or shareholder protection for the same person (but this time including £500,000 of critical illness cover) could come to about £140 to £200 a month, though CI can be removed to reduce the cost.
Harries says any company researching business protection should become familiar with the tax implications of the policy, as there may be tax reliefs to be claimed. But what tax relief is awarded, and how and when tax would become due, depends on a number of variables.
A company should also consider whether CIC is needed alongside life cover, as relevant life does not include CI, Harries says.
He adds: "To conclude, when choosing to future-proof a business it is important to review the business protection insurance that is in place.
"Choosing between the different types of policies can be complicated, therefore business owners should engage with a professional when assessing the suitability of each product."
carmen.reichman@ft.com
