QUESTION: I am just starting a business and have heard about the need for key person insurance. Could you explain what this is and how I would go about putting it in place?
ANSWER: There are many issues to consider when starting a business. Having put together a business plan, as directors and owners consideration needs to be given as to the legal status of the company, the trading year end and the list goes on and on.
One consideration that is often overlooked is adequately insuring the key people that the business will rely upon in order to bring that theoretical business plan into life. Businesses don't think twice about the need to insure their buildings, machinery, cars etc, but when it comes to insuring the most important asset the business has, its people, this will typically be neglected.
Over 90% of businesses in the UK employ less than 10 people and these are exactly the types of organisations most at risk by the loss of a key person due to long term illness or death. The loss of a key person within a business can cause a major financial crisis and may ultimately put the entire business in jeopardy. Therefore, it is important to consider who within your business will be key to its initial and ongoing success.
The aim of key person insurance is that it is in place to provide funds to help with the following issues.
Firstly, it can provide an income to the business whilst the key person is away from the business or help train or recruit a replacement. Secondly, it can inject cash into the business to help protect profits that may otherwise seriously diminish.
Finally it can be used to repay any outstanding loans or overdrafts to the bank.
The amount of cover that needs to be put in place will ultimately be dictated by the loss in profit, or the additional costs the business will face in the event of a key person dying or falling ill. It may be based on a multiple of the individual's salary for example, or it may be based on their contribution to overall profit levels of the company. In any event these types of arrangements should be set up for a fairly short period of time, probably a maximum of 10 years.
The tax treatment of the premiums and any lump sum that may ultimately be received will be at the discretion of the local inspector of taxes. Broadly, however, providing certain criteria are met, the premiums of any policy should be eligible for tax relief, with any payout being treated as a trading receipt and therefore subject to tax.
In addition to protecting key people within the business, any company should also consider how it protects its shareholders or partners in the event of long term illness or death. In this scenario the death of a shareholder will alter the balance of power within a business and can create financial difficulties for the surviving shareholders, partners or dependents.
Again these issues should be addressed at the formation of the business. Consideration should be given to putting an agreement in place which would mean that in the event of death or illness of a director/shareholder, funds are put in place to allow dependents to receive their share of the business, whilst at the same time protecting the remaining shareholders from receiving unwanted members on the board or potentially disruptive shareholders running the company.
These issues can be easily addressed by working closely with your accountant, solicitor and financial adviser, and in many instances provide peace of mind for little cost.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact firstname.lastname@example.org or (028) 9022-1010