Insuring Your Business Against the Loss of Key Staff
Almost every business has staff or business owners who are integral to the success and profitability of that organisation. Many such businesses would suffer adversely if one of these employees was to die. This could be loss of profits through loss of confidence in the company, withdrawal of credit, or the loss of contracts. Key person insurance seeks to provide a cost effective and tax efficient way to protect against these losses.
What is key person insurance?
Key person insurance seeks to ensure that the business can continue, even with the loss of that key employee, either through death or disability. It is simply another form of protection, such as life assurance, critical illness cover, or income protection insurance.
Who is a key person?
This can be anyone who is vital to the profitability of the business, and whose loss would cause the organisation to suffer financially. This does not necessarily mean the owner or shareholders.
Typical key people:
Business owners
Technicians/experts
Senior directors
Senior sales people
Main reasons to consider cover
Loss of profits
This is the main area of concern for most businesses. The loss of a key person could lead to the reduction of profits in
any of the following ways:
Loss of sales/lack of new sales
Loss of confidence with suppliers
Loss of expertise
Projects delayed
Other managers need to cover
Lowering of morale
Recruitment costs for replacement
Profits could be affected if a key person dies or is too sick to work.
Loan Protection
The loss of a key person can lead to a company being unable to service existing debts. As this is often a key part of growth plans, it is important to consider protecting existing company debts.
These could be:
Commercial loans from banks
Directors' loans
Personal guarantees
If your company is liable for any debts you should consider protecting these debts.
Management buy-outs
After company restructuring it is common for the organisation to be vulnerable if key people are lost to the business. Cover can be arranged to cover the losses the company may suffer.
Sole owners
Where there is a sole owner of the business, the loss of this person can be catastrophic both for the business and the owner's family.
For example, without a manager, the business could go under as the owner probably took on many roles within the business. The family of the deceased may have no wish to become involved in the business. Without the owner, the business could fold, leading to statutory redundancy payments for the staff.
Solutions to these problems
These depend on the specifics of the situation, but the most common solutions are as follows:
Term assurance
Life cover to provide a lump sum, for example to repay a loan, or cover loss of profits.
Critical illness
A lump sum payable on the diagnosis of a serious illness, to cover for the loss of the staff member.
Income Protection
A regular income to cover loan repayments, or to provide a replacement member of staff on a temporary basis.
Taxation
Each case is treated according to its merits by the local tax office, and you should always seek guidance from them.
Generally the premiums are deductible against corporation tax, and capital sums received under policies are taxable. This is dependent on 3 criteria being met:
The sole relationship is that of employer and employee
The insurance is intended to meet a loss of profit resulting from the loss of the employee's services
The contract is short term (probably less than 5 years)
Generally, where tax relief has not been allowed on premiums, the benefits will be tax-free (income protection proceeds will be taxable). Guidance and advice on this area is vital as the level of cover will be affected by whether tax will be levied on the proceeds or not.
Dan Woodruff is a Certified Financial Planner based in Colchester, Essex, UK. He regularly writes articles on financial planning and investments aimed at UK business owners and investors. Go to http://www.woodruff-fp.co.uk to find more content, or sign up for his free newsletter or financial planning blog.
Woodruff Financial Planning is authorised and regulated by the Financial Services Authority.
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