Case Study 2 Protection Planner

Transcription

1 Case Study 2 Protection Planner Objectives Anthony and Alan are keen to implement some form of succession planning for their business because neither of them have children nor any obvious management successors. They would like continuity to ensure a long- term future for their business in the event of illness or death. They would also like to ensure that their wives are adequately covered with a minimum of 2m being paid to each of them. Assumptions Antony and Alan wish to retire at age 65 Assumed dates of birth for Antony: 10/02/1966 Alan: 27/05/1966 It is normal practice that lenders insist on a decreasing term assurance policy at the point a mortgage is set up. I ve assumed cover relating to their substantial mortgages is in place because the outstanding mortgage is unknown and they do not want personal advice at this stage. 1) Options available to insure their lives in the event of illness or death There are numerous types of insurance policies available in the UK market and it is important to assess your circumstances, requirements and needs to identify the type (or in many cases types) of polices suitable for your circumstances. I ve set out below the types of polices, I recommend you both consider: i) Shareholder Protection allows the remaining shareholding director to remain in control of the business following the death of a fellow business owner. In the event of a business owner dying or being diagnosed with a terminal illness within the term of the policy shareholder protection can provide a lump sum to the remaining business owner which could be used to help purchase the deceased shareholding director s interest in the business. If a business owner dies with no share protection in place their share in the business may be passed to their family. This means that the surviving business owners could lose control of a proportion. The family may choose to become involved in the ongoing running of the business or could even sell their share to a competitor. A share protection policy if correctly implemented can help avoid these issues. ii) Keyperson Cover (key man or key person insurance) is a business insuring itself against the financial loss it would suffer if a key person in their business died or were diagnosed with a specified critical illness, throughout the duration of the policy. The loss of a key person in your business could have a severe impact. The business could suffer badly, with sales and profits falling and increased workloads for the remaining staff. Key Person Protection is designed to

2 pay out a lump sum on the death of the insured key person, during the length of the policy. The proceeds can be used to help find, hire and train a senior executive and cover a potential loss of profit in the short term. iii) Relevant Life policy is a term assurance plan available to employers to provide an individual death in service benefit for an employee. It is designed to pay a lump sum if the employee dies whilst employed during the policy term. A Relevant Life Plan is paid for by the employer and can be claimed as a business expense but the benefit would pass to the employee s beneficiaries. This cover could be used over and above the shareholder protection policy to ensure both directors have sufficient cover in place to achieve their target minimum payout to their wives of 2m. iv) Income Protection (IP) will pay out a regular income in the event of you being unable to work due to injury or illness. IP usually pays out until retirement, death or your return to work, although short- term IP policies are now available at a lower cost. IP doesn t usually pay out if you're made redundant, but will often provide 'back to work' help if you're off sick. Income protection payouts are usually based on a percentage of your earnings: 50% to 70% is the norm. Payments are tax- free. IP policies only pay out once a pre- agreed period has elapsed, generally ranging from one to 12 months after you submit a claim. The longer the 'deferral' period you choose, the lower your premiums. Given the low level of state benefits available, everyone of working age should consider IP. This type of cover is more personal protection and protects your monthly income, although this is personal cover (and I appreciate Antony and Alan do not require personal advice) it is worth considering as this would take the financial pressure off the company and the remaining director

3 2) Suitability of existing arrangements and how they meet business objectives An extremely important point to clarify for Antony and Alan is that shares will not automatically be transferred to the remaining director to keep or distribute to suitable employees as seen fit. They mentioned they would like to ensure their wives are adequately compensated for selling on the company shares following the director s death. Antony and Alan should ensure they have a shareholders agreement in place. The purpose of a shareholders agreement is to make sure that shareholders are treated fairly and that their rights are protected. It should describe how the company should be operated and the shareholders' rights and obligations. It also includes information on the regulation of the shareholders' relationship, the management of the company, ownership of shares and privileges, protection of shareholders and what action is required on the death of a shareholder. It would be advisable to seek legal advice to ensure all the appropriate permutations are covered and mutually agreeable. The only existing life cover the directors have mentioned is the company s death in service scheme. Each director should therefore have life cover of 3 x (salary 100,000) = 300,000 payable on death. It may be worthwhile contacting the provider of the death in service scheme as sometimes it s possible for directors to have a higher level of cover i.e. 5 x salary. Group death in service schemes are a very cost effective way of providing life cover therefore it could be beneficial for the directors to investigate this course of action. (For the purposes of the report I am assuming it s not possible to alter the scheme). However even at 5 x salary it still falls short of their 2m target. Both directors have SIPPs - Antony (current value 880,000) and Alan (current value 600,000). In the event of their early demise prior to age 75 the full fund value would pass to their wife free of tax. It s essential to ensure however that they have completed an up to date nomination of beneficiary form for their SIPPs. From the details provided there is currently no cover in place for Antony or Alan in the event of a short term or long term illness.

4 3) Meet Objectives We use an online research tool system which covers the whole of the protection market, the providers I ve selected below, offer the most competitive premiums for the type of cover you require. Please note the costs outlined are based on acceptance at standard/normal rates. However, due to Alan s recent illness this many result in his monthly premium being rated or the insurance company specifying certain exclusions. We will only know details of any ratings/exclusions once the application has been submitted to the provider and underwriting is complete. Please see my recommendations below: i) Shareholder Protection (Business) The business was recently valued at 3m split 65:35. I recommend Antony and Alan set up a shareholder protection policy with a sum assured corresponding to their shareholding split. For this level term assurance policy, the monthly premiums are guaranteed and would be paid by the company Owner Life Assured Type of Plan Sum Assured Term Alan Antony Shareholder protection (Term assurance) Antony Alan 1,950,000 (Antony s 65% shareholding) 1,050,000 (Alan s 35% shareholding) To age 65 Monthly Premium & Provider (Aviva) (Aviva) It should be written into their shareholding agreement that the sum assured is paid to the surviving director who in turn will pay the deceased s widow in exchange for his shareholding. A cross option agreement should also be completed by each director. This type of agreement normally creates a 'call' option for the surviving owners to buy a deceased owner's shareholding, in the event of death. It also creates a 'put' option for the personal representatives of each owner to sell their share to the surviving owner/s. It is possible to add indexation to the sums assured outlined above however a discussion with Antony and Alan is required to gauge their thoughts on the valuation of the business over the next years. For the purposes of my recommendation I will assume they do not want to include indexation to this policy. ii) Keyman Cover (Business) Anthony and Alan mentioned that there are a couple of potential employees who could be trained to take over some of the management functions. The directors should consider implementing a training program to free- up some of the key tasks carried out by them so that in the event of something happening to one of the directors, the other director is not picking up all the strain. Alongside this training program I recommend the business sets up Keyman cover for each director. Owner Type of Plan Sum Assured Term Monthly Premium & Provider DG Ltd Keyman cover (Term Assurance Life & Critical Illness first event) 300,000 To age (Bright Grey) The rationale behind the sum assured is that it would allow the business to cover a replacement executive for three years which should be long enough to train a replacement.

5 iii) Relevant Life policy (Business) The directors have targeted a minimum amount of 2 million to be payable to each of their wives in the event of their death. Given the uneven split of shareholding and thus the sum assured for the shareholder protection, I am recommending a relevant life policy for Alan as there is a shortfall on the targeted amount. I therefore recommend he considers a relevant life policy term assurance policy with a sum assured of 650,000 written to age 65. The monthly premium paid by the business would be via Scottish Provident. This can be claimed as a business expense. Although the monthly premium is paid by the business, the sum assured would be payable to Alan s nominated beneficiary i.e. his wife. iv) Income Protection (Personal) In order to take some pressure off the company for continuing to pay a salary to Antony and Alan, in the event of them being unable to work, they may wish to consider insuring themselves personally for income protection. I recommend the policy is written to age 65, with a 3 month deferred period, the maximum benefit payable to Anthony and Alan personally, based on their salary of 100,000, would be 54,996 pa tax free. The monthly premiums is 180 offered by LV. Summary of Recommended Cover A summary of the sums assured payable in the event of each scenarios: Scenario 1) Diagnosis of a Critical Illness Anthony Alan Business Personal Type of Cover Business Personal Shareholder Protection 300,000 Keyman Cover (1st event) 300,000 Relevant Life Policy Death in Service Income Protection 300,000 54,996 pa TOTALS 300,000 54,996 pa Scenario 2) Death Anthony Business Personal Type of Cover Business Personal Paid to 1,950,000 Anthony s wife Shareholder Protection 1,050,000 Paid to Alan s wife 300,000 Keyman Cover (1st event) 500,000 Relevant Life Policy Alan 650, ,000 Death in Service 300,000 Income Protection 300,000 2,250,000 TOTALS 300,000 2,000,000

6 The types of policies and sums assured are recommendations to be discussed further, we can adjust the level of cover to suit and we can discuss this further at our next meeting. With these recommendations I ve managed to achieve the following objectives: Company shares could pass to a surviving director with a corresponding payment passing to the deceased s wife/beneficiary A minimum of 2m will be inherited by the survivor s wife in the event of death A lump sum will be paid to the company from the key man policy, in the event of long- term illness. At the same time, a regular income will be paid to the individual director from the income protection plan. It is essential to assess the affordability of any new proposed protection plans. I ve therefore looked at affordability at business and personal level. Type of Plan Antony: Monthly Cost Alan: Monthly Cost i) Shareholder Protection ii) Keyman Cover iii)relevant Life policy iv) Income Protection (LV) Business Cost (pa) 5, , Personal Cost (pa) 2,160 2,160 Business affordability The additional cost for DG Ltd would be 10, (for both Antony and Alan s policies). There is likely to be a one- off solicitor s fee for the Shareholders Agreement. The company s turnover has been between 2.5m- 2.3m over the last three years with stable costs of 2.1m. There is therefore scope for the business absorbing the extra ongoing costs of 10,951.92pa for the different types of cover recommended. As well as earning reasonable profits on an annual basis the Company has significant cash reserves of 1m. Personal Affordability Although both directors each draw a salary of 100,000 pa from the company, each director has a different level of personal expenditure so I have looked at each director individually. 100,000 gross equates to 65,326 in net take home pay ( 29,403 paid in tax and 5,271 in national insurance) Antony confirmed his annual expenditure is modest at 45,000 including mortgage repayments. Therefore his disposable income is 65,326-45,000 = 20,326 The proposed additional annual expenditure for Antony is 2,160 for the income protection policy, therefore I believe this will be affordable for Anthony. Alan confirmed his annual expenditure is 65,000 therefore he only has disposable income of 65,326-65,000 = 326. The additional annual expenditure for Alan is also 2,160. It would appear that this is not currently affordable by Alan. I require a further discussion regarding Alan s thoughts on this type of cover, his current level of expenditure and perhaps discuss areas where he could make some savings eg:

7 There is a budget income protection plan which would pay out the same level of benefit 54,996 but only for a 2 year period rather that until age 65. The monthly cost is (or pa) Scope for reducing personal pension contributions ( 20,000 pa gross) I appreciate Alan has substantial mortgage repayments, however are there other areas where Alan can cut back on his expenditure due to the importance of the proposed plan? The Next Step Should Antony and Alan wish to proceed we can complete the relevant paperwork at our next meeting. Should you have any questions please do not hesitate to contact me. Topics for next review meeting: Discuss Antony & Alan s thoughts on retirement and the ultimate disposal of the business at retirement. Will they train successors or sell the business as a going concern? Although Antony and Alan do not require personal financial advice at this point, their mortgage repayment strategy should be discussed WORDS: 2,498