It’s quite usual and expected for most businesses to insure their machinery, buildings and other assets such as intellectual property. And yet, very often the most valuable asset that a business has is its people. The men and women working every day in the business are the ones responsible for generating the profits. It is therefore important for business owners to consider the risks and implications to their business if a key person or business owner were to die. The consequences can potentially be huge and ultimately in some cases it could mean that the business would cease to exist. Indeed 53% of businesses think they would cease to trade within one year if they lost a key person through death or illness. (Source: Legal & General’s State of the Nation SME’s Report).
Equally the loss of a shareholder or business partner through death or serious illness can create some unexpected and undesired circumstances that many business owners have not even thought about.
This guide has been created to raise awareness of the risks to the business and to encourage contingency planning. By offering some simple solutions that help to address and plan ahead for the issues they would face, we aim to enable businesses and their owners to protect the future.
After all, plant and machinery can be replaced quite easily but replacing people can be a far more difficult (and sometimes impossible) thing to do.
Key person protection
Who is a key person?
If a person’s death or serious illness would cause significant financial loss to your business, they are likely to be key. Often a key person has unique skills and experience that would be difficult to replace. For example, they might be someone who has all of the business contacts and maintains relationships with suppliers and customers, or perhaps they may be a technical expert in their field.
Death or serious illness of a key person – the effect on the business
Although rather morbid, think through the consequences of the death or serious illness of a key person in your business. Some of these are likely to be:
- Reduction in sales and loss of profits whilst the business is disrupted
- Low staff morale resulting in lower productivity
- Penalties for non or late delivery of goods and services
- Difficulty in maintaining loan repayments
- Increased use of overdraft with associated costs
- Needing to use cash earmarked for other purposes
- Incurring recruitment costs to find a suitable replacement
- Adverse effect on future growth plans
- Less favourable terms from suppliers
- In case of illness, wanting to continue to pay the person who is ill whilst at the same time needing to pay someone to do their job
What is key person protection and why is it important?
This is a life insurance cover policy, owned by the business who insures the key employee’s life in the event of death or serious illness. In the case of a claim the proceeds are paid to the business to compensate it for the financial loss and/or increased costs that it suffers. Usually this is a lump sum but in the case of the illness of a Key Employee, it can be an income.
Key Person protection gives the business time to recover and to survive. The alternative could be a setback affecting the business for many years to come and sometimes even, needing to cease trading.
How much cover is needed?
Your Chase de Vere adviser will help you calculate the right amount of cover for your business. They will take into account how long you estimate the business will take to recover from the catastrophic event. They will discuss with you whether loans will need to be repaid to lenders, or in the case of the death of a Director with an outstanding Director’s loan, how repayment can be made to their personal estate.
Tax treatment of key person policies
Your adviser will guide you, as the tax treatment for a policy set up to cover liabilities and those set up to cover lost profits can be very different. This is why it is important that debt cover and loss of profits cover are set up as separate policies. We would also recommend consulting your Accountant in this respect as the FCA (Financial Conduct Authority) does not regulate tax advice.
A tip from Chase de Vere
Reviewing the risk to the business of the loss of a Key Person can be a good time to put other business contingency plans in place. Once you have identified that someone is “key”, in what other ways can you reduce your risk? Could you for instance ensure that other people are trained so they can cover some of the key person’s duties? This will mean that over a period of time the business will become less reliant on the key individual.
Shareholder and partnership protection
Death or serious illness of a shareholder or partner
Many businesses are owned by more than one shareholder or partner. Most people are aware of the need to make a personal Will, even if they have not got round to doing it yet. However, many people have not even considered the consequences to their business assets if they died or became seriously ill.
Why is protecting a shareholder/partner important?
In most cases if a business owner were to die their spouse, family or estate will inherit their share in the business. And if this default position has been discussed, thought through, agreed and documented, nothing further is needed. However, very often this is not what happens and a business owner can find themselves owning a business with a deceased shareholder’s (or partner’s) spouse and family, a situation which can cause conflict and resentment.
Firstly, the spouse or family may not have had prior involvement at all in the business and therefore will have no knowledge or experience of it. However, as a part owner they may decide they will start to get involved which can frequently cause difficulties. Equally, they may decide that they cannot take an active role, but would still of course have an entitlement to a share of the business profits.
Alternatively, the spouse or family may need to sell their business share to raise capital. At this stage it will depend on whether the remaining shareholders/partners have the funds to purchase or, in the case of a company, if it has the legal capacity (and funds) to purchase its own shares. Is there a shareholder or partnership agreement which dictates who can have first refusal? If there is no provision, potentially a deceased business owner’s spouse or family could sell their share of the business to any other willing purchaser. This could potentially be a competitor meaning that ultimately the ongoing control of the business is threatened.
What is shareholder and partnership protection?
It is life insurance cover taken out on the life of a shareholder or partner. It ensures that in the event of their death, the funds would be available to the remaining shareholders or partners to facilitate the purchase of their business share from personal beneficiaries if they choose to exercise their option to do so. Critical Illness cover can be included if desired and this would pay out if a shareholder/partner were to be diagnosed with a serious or life threatening illness and wanted the option to sell their shares. The cover makes sure that the ongoing control of the business remains in the right hands at the right time. How much cover is needed? Each shareholder or partner needs to be insured for the amount of the value of their shareholding so that sufficient funds are available to buy them. Your Chase de Vere adviser will work alongside your Accountant where needed to establish what is the right amount.
Correctly setting up shareholder and partnership protection policies
There are a few different options for setting up these types of policies but the most common is for a Cross Option Agreement to be set up and for the policies to be written in Trust. Your Chase de Vere adviser will work with your Solicitor or Legal Representative to ensure that the correct framework is established to support the policies. This means that the proceeds pass to the right hands at the right time in the most tax efficient manner.
A tip from Chase de Vere
Your Shareholder Agreement or Partnership Agreement is in effect your Business Will and should be regularly reviewed to make sure it correctly reflects the wishes of all owners. It is important to always have an up to date Personal Will too.
How your business can protect your family
Typically, if someone else employs you they may also provide you with employee benefits as part of your remuneration package. By law employers need to auto-enrol their eligible employees into a workplace pension but many choose to offer other benefits such as Death in Service. With this in place it means that a business can give a deceased employee’s beneficiaries a tax free lump sum based on a multiple of their salary thereby providing financial security. Being able to do this in such circumstances, particularly when there are dependants, is something most businesses like to be in a position to do.
But what about you? When you own your own business who will provide this for you? Well the good news is that if you are an employee of your business it is possible for it to put cover in place and pay for it as an allowable expense. This cover is called Relevant Life Cover.
What is Relevant Life Cover?
This is not actually Business Protection as such. It is a term assurance life cover plan designed to pay out a tax free lump sum to dependants if the insured person (who is an employee) dies. A Relevant Life Plan is paid for by the business and is viewed as an allowable expense.
It can therefore provide an individual “death in service benefit” to directors meaning that their financial dependants are looked after in the event of their death. Also, for businesses wishing to put in place a group scheme for their employees, but with too few employees to be able to do so, it provides a solution.
For high earning individuals who are looking for lump sum benefits that will not affect their Pension Lifetime Allowance Limit, it is also attractive.
What is the Benefit?
For a business owner who is also an employee it means that a lump sum for the benefit of their families can be provided for via the business. Usually it will be more cost effective for the company to fund the premiums for such cover, rather than a director meeting the cost personally from their salary, as it saves both National Insurance and personal income tax costs.
It allows smaller businesses to provide a death in service benefit to individual employees which demonstrates that they are valued, and can aid the attraction and retention of high calibre people.
(*It is also possible to provide benefits to valued employees by way of income if they are unable to work due to accident or illness)
How Much Cover?
This is based on a multiplier of salary or defined total remuneration and varies depending on age of the life assured and the provider. However, typically it ranges between 10 to 30 times salary.
Tax Treatment of Relevant Life Policies
The policies are set up in Trust and the benefits are paid free of income tax. The benefits also usually fall outside of the deceased’s estate for Inheritance Tax purposes. This means that proceeds can be paid quickly to the beneficiaries without being caught up in probate.
Unlike lump sums paid under a registered scheme, Relevant Life plan benefits do not form part of the employee’s lifetime allowance for pensions.
The employer pays the premiums which are usually classed as a trading expense as long as the accountant/local tax inspector accepts they are “wholly and exclusively for the purpose of trade”.
Premiums paid by the employer are not treated as a P11D benefit for employer or employee.
A higher rate tax payer drawing a salary on which they pay tax and National Insurance can find a significant personal cost advantage in the business funding the cover.
N.B. The FCA (Financial Conduct Authority) does not regulate tax advice.