ProtectionDec 14 2017

Counting the cost of business protection

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Counting the cost of business protection

Costs take profit out of the bottom line and, as the old maxim goes, ‘turnover is vanity, profit is sanity’. Therefore it is understandable why many owners do not consider protection to be a business imperative but an expense.

Already the home or office space will be insured against fire, loss or theft; pensions are paid out, professional indemnity is paid for, along with all the various regulatory fees and taxes that apply, regardless of the industry in which one works.

So is business protection just another expense? 

“Expensive relevant to what?”, asks Johnny Timpson, protection specialist at Scottish Widows in response to this question.

“Given that, as a sole trader, you are your business, and there is no distinction between your personal and business assets, nor your personal and business liabilities.”

He continues: “Being self-employed, you have no entitlements to statutory sick pay, limited entitlement to working-age welfare benefits, and will be unserved by Universal Credit, as it does not support the self-employed and those with fluctuating earnings particularly well.”

Business protection is about the survival of the firm should the worst happen, while IP kicks in to help keep up with your daily living expenses if you as an individual cannot work due to illness. Tom Conner

Mr Timpson points out a self-employed client may seem the “simplest of business protection management opportunities”, but as the adviser drills down into the financial detail, it will become clear that a bigger discussion on personal and business risk and resilience is required.

Moreover, as Andy Simmons, senior protection specialist at Vitality Life, says: “Small and medium-sized firms are often highly dependent on a few specialist individuals, and key person cover is designed to help protect the business in the event of death or severe illness of one or more key employees.”

Advisers doing their fact-finding missions will be able to ascertain the business risks of their self-employed or small employer clients, and be able to make the distinction between the perceived expense of a monthly premium and the long-term expense of replacing or rehabilitating a key person – especially the client themselves.

Isn’t income protection enough?

Some small business owners might have taken out income protection in case they get ill or unable to work, so they can cover their living expenses and lighten the financial load on their family.

For sole traders and the self-employed, business protection may not be the right choice, as Richard Kateley, head of intermediary development for Legal & General, explains.

“As the business will fold without their involvement, the focus should instead be on protecting the family.

“In such scenarios, income protection would be another choice, offering protection levels tailored to the client’s budget, including low-cost options where the claim is paid for a maximum of two years.”

However, he also stated individuals should consider other policies, for example a relevant life plan, if they are eligible, and benefit from the tax benefits which can help reduce the cost to the business.

For many clients, income protection policies alone will not cover the risks to the business, especially if they have other members of staff.

“Income protection and business protection cover two different risks – comparing the two is like comparing apples and pears,” exclaims Tom Conner, director of insurance for Drewberry.

“Business protection is about the survival of the firm should the worst happen, while IP kicks in to help keep up with your daily living expenses if you as an individual cannot work due to illness,” he says.

That said, one might not need IP if they have key person insurance (KPI) in place, as this is about “ensuring a continuation of profits”, Mr Conner adds.

“This could theoretically allow for the individual to continue drawing down an income from the business/the KPI payout, if they become critically ill.”

Education 

While some may think protection is costly or unnecessary, there are those business owners who might not even have considered getting cover, let alone calculated whether it is too expensive for them. 

As Emma Thomson, life office relationship manager for Lifesearch, comments: “Most people do not know what they need to buy, which is why getting advice is so important.

“We introduce the concept of income protection to our clients, who typically get personal income protection, unless they have a limited structure, which allows them to get executive income protection.”

Getting good advice is always essential – and it would pay for advisers to carry out a thorough check of new clients’ business protection policies to see whether there are any personal or corporate protection gaps that need to be filled. 

Taxation 

When considering potential costs, it is worth also discussing taxation of healthcare or insurance benefits with potential and existing clients, or passing them to a qualified tax adviser for specialist cases.

Some cover will be classed as a taxable benefit under HM Revenue & Customs, but not all policies will be. Others will qualify for tax relief, and some may not. This also applies to individual plan types: some key person assurance may qualify, and some may not - it all depends on individual circumstances.

Perhaps unhelpfully, there is currently direct legislation covering the taxation of key person policies, but the principles applying were set out in 1944 by the then Chancellor of the Exchequer, Sir John Anderson and are still used as guidelines today.

Full details on the HMRC rules for business income can be found online.

In addition to useful case studies, many providers such as Aegon and Zurich provide useful information aboout how the rules work in practice. 

Zurich's adviser business protection hub also provides several documents and frequently-asked questions, as well as a breakdown of the tax position of key person assurance.

It states: “One key question is whether the business will obtain any tax relief on the payments it makes to the plan.

“Obtaining this can be an important consideration, although if a payment is deductible, the sum assured is likely to be taxable." 

But not every key person plan will benefit from this relief. 

Broad guidelines from HM Revenue & Customs:

The sole relationship between the insuring party and the key person must be that of employee and employer.

The plan must be intended to compensate for loss of profits. If, for example, it has been taken out to also repay a loan, it is unlikely the payments will get tax relief.

The plan must be a short-term or annual insurance. HMRC will generally regard a term assurance plan as short-term if it has a term of five years or less.

Basic example: How tax is calculated if the sum assured is taxable. Source: Zurich

1. If the plan pays out £100,000, this is added to the employer’s profits for the tax year in which it is received, and calculated as if this were part of the profits.

2. The impact on the tax liability for the year will depend on the extent to which the profits of the company have been diminished by the loss of the key person.

3. A company could arrange for the sum assured to be paid in installments, so only the amount received in a year will be subject to tax in that year.

4. Tax relief on payments is balanced by the tax on the proceeds. For example: If the payment is £100 and the sum assured is £10,000, a company paying tax at the small companies’ rate of 20 per cent (unchanged since 2014 - see the table below), the firm will effectively pay £80 after tax relief and receive £8,000 in proceeds after tax.

5. In order to insure a larger sum, a larger payment will usually be necessary.

This is, of course, a simple example and there are many nuances – not least the potential threat of corporate tax changes in future Budgets.

Therefore, any advisers or clients considering business protection to help ensure the smooth running of the firm and continuity of business, should also consider seeking specialist tax advice.

Corporation Tax bands as at 2017 (Source: HMRC)

 2017201620152014
Small profits rate (companies with profits under £300,000)---20%
Main rate (companies with profits over £300,000)---21%
Main rate (all profits except ring fence profits)19%20%20%-
Marginal Relief lower limit---£300,000
Marginal Relief upper limit---£1,500,000
Standard fraction---1/400
Special rate for unit trusts and open-ended investment companies20%20%20%20%

Expenses of not insuring 

As pointed out in previous articles to this guide, the risks of not insuring can turn out to be far more expensive in the long run. 

Consider the financial implications of losing your main contact-builder and money-winner; being unable to cope with the workload or unable to recruit someone of sufficient calibre, in sufficient time, to replace a key person.

“At Lifesearch, we always point out the risks if the business owner does not protect themselves,” Ms Thomson adds.

“While any insurance can be seen as a cost,” says Paul Moulton, small-medium enterprise director at Axa PPP Healthcare, “it should also be considered in terms of the impact to the business.”

According to him, advice on protection should explain the costs to businesses, large or small, of key personnel being able to access support and treatment in a “timely and convenient way”.

Mr Moulton adds: “Insurers understand this and even offer healthcare cover specifically intended for sole traders.”

Having the conversation

Small firms who have taken out business loans might benefit from a business loan protection, which is, in simplistic terms, like a life insurance policy paid for by, and for the benefit of, the business.

This can be “surprisingly cheap”, says Mr Conner, especially if the sole trader is young and healthy and the loan amounts are not “astronomical”. 

However, failing to ensure a firm can repay the loan can be business critical – and should be pointed out to clients and potential clients.

As Legal & General’s Mr Kateley comments, business protection is no more expensive than family protection, as it is, in most cases, “simply term assurance”.

He says: “It might be a better question to ask whether, should the worst happen, whether the individual could afford NOT to have the cover. In reality, it can be a great deal cheaper than people think.”

simoney.kyriakou@ft.com