Key person insurance

Transcription

1 Key person insurance

2 KEY PERSON INSURANCE Most businesses and other organisations have people whose departure could have a serious financial impact on the business. Naturally, this includes the business owners. Key people can include people such as: A controlling director who has personally guaranteed bank loans made to the firm. A sales director with extensive business contacts and influence. The technical director. A director who has recently been headhunted at considerable expense. The production director. A key designer. Short term absences can usually be managed, and if the key person leaves, the business should be able to recruit a suitable replacement quickly. The real issue for many firms is what happens if the key person dies suddenly or cannot work for some weeks or months because of a serious illness or disability. Key person insurance allows businesses to take out insurance against the financial consequences of losing a key person in this way. In other words, it is a type of business continuation insurance. How does key person insurance work? The firm can take out an insurance policy on the life of the key person which will pay out to the firm if the key person dies, is diagnosed with a specified critical illness or is unable to work because of illness or disability. The main types of cover are: Life insurance pays out on death. In some cases, it also pays out on diagnosis of terminal illness, where the insured person has less than 12 months to live. Critical illness insurance pays out on diagnosis of a critical illness within the policy definition. Critical illnesses are life-threatening conditions, but which people often now survive thanks to developments in medical science. The conditions covered include cancer (excluding less advanced cases), heart attack (of specified severity) and multiple sclerosis (with persisting symptoms), and can also include more than 20 other potentially life-threatening illnesses and disabilities. Income protection insurance pays a regular (usually monthly) income to the firm if the key person is unable to work (usually after three months, depending on the policy) because of illness or disability. In some cases, a policy may include more than one of these elements; in others, we shop around to get the best options, which might mean using more than one provider or individual policies to meet a particular need. Do we need key person insurance? To decide whether you need key person insurance, think about the individuals who are key to the success of the business. They may be senior people but not always. For example, a researcher who is developing a new product may be relatively junior but difficult to replace quickly or without delaying a new product or otherwise affecting future profits. All Rights Reserved Page 1 of 3

3 Draw up a list of anyone who might be such a key person, then estimate the financial consequences if, tomorrow morning, they died suddenly, could not work because of a critical illness, or were expected to be off work for months or years. The costs might include: The recruitment expenses, salary and other costs of employing the right person to take over the role (temporarily or permanently). Loss of profits. Delays in introducing new products or ideas. Loss of customers. Replacing lost business. Repaying business loans. The impact is bound to vary according to the business and the individual, so this cannot be a comprehensive list. If the sums involved are relatively small or easily managed, you probably do not need key person cover for that individual. But if the loss of the key person would create a need that would be hard to manage, you should consider key person protection as a priority. How much cover is needed? The basic principle under insurance law is that an employer can only insure an employee for the financial cost that might be incurred as a result of their death or illness. For example, you might decide that if a particular key person died, the additional costs to the business might be 150,000. If so, you could take out a life insurance policy up to that amount. Or, if a key person became disabled following a car crash and was expected to be off work for a year, you might conclude that the additional costs would run to 10,000 a month. If so, you could take out income protection insurance, usually for up to around 60% of that figure. We can help you determine the amount of cover you might need in each case. How much will the cover cost? The cost of key person insurance will depend on a range of factors, including each individual s: Age. Gender. Health and medical history (which can also include family history). Precise occupation. In practice, we find that the cost of key person insurance is usually only a very small proportion of their annual salary and benefits costs (and an even smaller proportion of the firm s total turnover), and is rarely a prohibitive factor. Before making any firm decision, you would need to weigh up the costs against the risk of not having such cover and the potential financial costs that could arise. All Rights Reserved Page 2 of 3

4 What is the tax position? For life insurance and critical illness insurance, there is generally no tax relief on the premiums. There are some exceptions to this, but most key person policies do not attract tax relief. The proceeds are normally not taxed. For key person income protection, the situation is normally reversed, with premiums counting as a business expense but regular payments to the firm counting as a trading receipt. It makes sense to get a ruling upfront from your firm s tax inspector with regard to how he or she will treat each key person policy. We can advise you further on this and/or work with your accountants or finance director as appropriate. What else do we need to know? If you start a key person policy and later no longer need it you could continue the policy and carry on paying the premiums, but would probably want to stop it. There is no financial penalty on stopping a key person policy, although of course the benefits stop too, and most policies do not build up any cash value if they are stopped early. Key person cover is usually arranged for a fixed period (e.g. ten years) or to run up to the key person s likely retirement age. Before recommending any particular policy, we would look to find the best match for your needs and would explain any options and choices you would need to make. A director or other suitable official of the business will need to complete and sign the application form, and the key person will need to answer the insurer s medical and other questions and to sign the form. As with all insurance policies, full disclosure of all material facts is essential. In some cases the insurer may request medical information from the key person s doctor, or require a medical examination. If so, the insurer will pay the doctor s fees for these reports. A final thought From past experience, we know that many firms are good at insuring things, but perhaps less good at insuring people. The idea of key person insurance is sometimes thought to be expensive, difficult or even impossible! One helpful factor is that life insurance in the UK has become considerably less expensive in recent years. Key person insurance can be essential in helping to ensure that a business survives and thrives if a key person is no longer able to continue working whether because of illness, disability or death. Levels and bases of, and reliefs from, taxation can change and the value of tax reliefs depends on your individual circumstances. The Financial Conduct Authority does not regulate tax advice. This publication is for general information and is not intended to be advice to any specific person. You are recommended to seek competent professional advice before taking or refraining from taking any action on the basis of the contents of this publication. The Financial Conduct Authority does not regulate tax advice, so it is outside the investment protection rules of the Financial Services and Markets Act and the Financial Services Compensation Scheme. This publication represents our understanding of law and HM Revenue & Customs practice as at April All Rights Reserved Page 3 of 3

5 Thank you for your interest in this Essential Guide. For further information or if you would like to discuss any aspect of the guide, please contact us. EA Financial Solutions Ltd 869 High Road Finchley London N12 8QA +44(0) The Financial Conduct Authority (FCA) does not regulate tax advice. Tax rules are subject to change. All Rights Reserved