What sort of business protection policy works best?

It is worth getting to know not just your corporate client but their whole business – and the people who make the firm the success that it is.

The type of cover will depend in part on the employees, the size of the firm, the cashflow and liabilities and the structure of the firm. 

As Richard Kateley, head of intermediary development for Legal & General, says: "It depends on the make-up of the business, what they are seeking to protect and, in many cases, the age of the firm and where it sits in the business lifecycle."

Key man cover

Key man cover – or, to be more politically correct, key person cover (KPC) – is one of the most go-to areas for protection advisers.

Alan Lakey, adviser for Hertfordshire-based Highclere Financial Solutions and founder of CI Expert, thinks this is usually the “first consideration”, and explains: “KPC is usually the first consideration because for many businesses the death of non-availability of the key person could mean the death of the company.”

But who is this key person? For some firms, it might be the owner, or the chief operating officer, or maybe the sales manager. For some firms, it could be all of these roles – because one person does nearly everything.

Losing an owner can have a huge impact on the daily running of the business, and can quickly result in financial difficulties. Johnny Timpson

It doesn’t matter what the job title is, effectively. If the company cannot continue to function or to function successfully without that person or persons, then this is a key risk.

Mr Lakey continues: “Most businesses have one or more people without whom the company cannot remain profitable and the company should insure them to provide for its own continuing future.”

According to Johnny Timpson, protection specialist with Scottish Widows, this is a “financial safety net” if a key person dies or – if critical illness cover is also selected – is diagnosed with a serious illness.

He comments: “Although clients cannot predict the future, KPC can protect against many business risks.”

Protecting profits and mitigating the effect of debts are two key risks. Mr Timpson outlines what KPC can do on both counts: 

Protecting profits:

• Recruitment costs to find a suitable replacement.
• Loss of profits while the business is disrupted.
• Paying penalties for non or late delivery on goods and services.
• Paying any company sick pay to the key person if the claim is related to a critical illness.

Protecting debt:

• Being unable to repay a loan.
• Paying back a business overdraft.
• Nervous suppliers may demand payment of an account upfront.
• Covering owed salaries, dividends or loaned money through a director's loan account.
• KPC can also protect sole traders who are personally liable for business debt. If they died unexpectedly, any debt would be inherited by their next of kin.

Mr Kateley says: "Talking to a client about the risk of losing a key person is likely to have more success. For these companies, the death or critical illness of an owner or director can have a catastrophic effect on its future."

He points to research earlier in 2017 among 800 small-medium-enterprises, carried out by Legal & General, which found 67 per cent of new businesses would cease to trade if a key person died or was unable to work.

Business loan protection

Tom Conner, director of insurance at Drewberry, advocates putting business loan protection into place, as this can be used to cover loans of many sizes to suit businesses and their borrowing practices, no matter how large or small.

He says: "From director's loans to inject cash into a start-up to large corporate finance or commercial mortgage debt, business loan protection can be there to repay the loan, should a key person responsible for the loan or for generating profit to repay the loan fall ill or die."

Relevant life cover

This is another type of tax-efficient insurance policy, which allows a firm to offer a death-in-service benefit to staff, including salaried directors. 

It is not available to sole traders or partners, as it is an employee benefit.

Typically it is set up by the company and pays out a tax-free lump sum on death or the diagnosis of a terminal illness of the person insured, and the proceeds go through a trust to the family or the employee or any financial dependants.

In a nutshell, this counts as a tax-deductible business expense, and businesses can choose whether to have a one-off payment, or annual, quarterly or even monthly payments.

Premiums are guaranteed and the benefits are usually free from inheritance tax - although, of course, with taxation it always pays to seek specialist tax advice.

Instances where relevant life cover may be right:

• Businesses too small for a group life scheme.
• High-earning staff who might exceed their personal pension lifetime allowance, as registered group life schemes are included in pensions legislation, which means any paid claim is included in the employee's pension fund. Claims under relevant life cover do not count towards a person's lifetime allowance.
• Members of group life schemes who want to top up their benefits.

Mr Timpson says if relevant life cover is the right recommendation, advisers should make sure that it is written into a discretionary trust. 

He also warns: "There is no cash value at any time, and if the client stops paying the premiums, the related cover may end."

With relevant life cover, the person covered must be a UK resident, and an employee of a UK business and the cover stops at 75 - which means keeping an eye on key staff, many of whom might want to continue working as long as possible.

Director protection

There is also a valid argument for insuring the directors of a company, especially if they have very different roles or they are shareholders in the firm.

Often this is not something a business owner may consider. Director protection is also important - how will the fellow directors buy out the shares of a dead or critically ill fellow director?

Do they want his widow as a shareholding director, entitled to dividends/salary yet not putting anything into the business?

In this instance, each director insures the other so that he/she is able to purchase the leaving director's shareholding.

This is usually done in tandem with a double option agreement whereby the widow has to sell her shares and the other directors have to buy them.

Owner's insurance and shareholder protection

If the shareholder or partner is diagnosed with a critical illness, having business share and partnership insurance cover - sometimes called owner's insurance or ownership insurance cover - in place can help the remaining owners/partners buy the affected individual's share of the business.

On the death of a shareholder, some potential conflicts could occur: 

• If the shares are sold on the open market, a new business owner could take control of the daily running of the business. Mr Timpson says: "The new owner could be a competitor or completely unsuitable for the business".
• If the deceased owner's family are willing to sell the shares, the surviving owners could have trouble raising the money, or disagreements about the terms of the sale could cause friction.
• Uncertainty over ownership could give lenders, such as banks and other investors, concerns about the viability of the business and they could restructure the firm or cancel any funding.

Protection means while the family of the deceased can still be supported, the business has funding enough to continue. 

Moreover, shareholder/partnership/ownership cover can be flexible - as it can include life insurance or life insurance together with critical illness cover.

Either the fellow shareholders or the company as a whole takes out insurance policies on the lives of each shareholder. Should a shareholder die, policy pay-outs can be used to purchase the shares of the deceased holder.

In the UK, there are three main types of this: Life of another, company share purchase and own life policies, held under business trust. 

1) The first one, life of another, is usually adopted when there are just two shareholders.

2) Company share purchase enables the business itself, rather than the other shareholders, to buy back the shares.

3) Own life is where individual shareholders take out a policy, held under a business trust. Should a shareholder die, other shareholders can then use policy pay-out funds to purchase their shares. 

Obviously each business is different so no one-size-fits-all method applies, but in the interests of protecting the business through a transition when it comes to shareholders, and especially when there’s a long-term succession plan in place, having some form of protection is very useful.

"Losing an owner can have a huge impact on the daily running of the business, and can quickly result in financial difficulties," says Scottish Widows' Mr Timpson.

"Boardroom confusion can lead to conflict in decision making, as the surviving owners and the deceased's family may have very different ideas about the future of the business.

"I recommend advisers review their client's protection requirements regularly to take into account any changes in business value or shareholding."

Of course this won't be applicable to all: "For an adviser meeting a client that runs a start-up business, share protection is unlikely to be relevant to their needs," says Mr Kateley. 

This is why the role of an adviser is so important, to make sure the client gets not just protection, but the right sort of cover.

simoney.kyriakou@ft.com