What happens to a small business when a co-owner of a key director dies or falls seriously ill? As Ian Harper explains, there is an insurance solution, but many firms are still unprotected ......
...... The existence of key person or shareholder protection insurance could spell the difference between the life and death of a company. ......
A “key person” is someone whose death or disability would seriously impact a business’s future profits, and insurance can cover their death, critical illness, or both. While life insurance pays out a lump sum on death of the insured, critical illness pays out on diagnosis of a pre-agreed serious illness. As such, key person cover provides the financial means to allow an individual to be replaced, to recover or leave without imposing a major financial strain on the company. Key person insurance can also be used for loan protection and may be a pre-condition for a bank loan. ......
Shareholder protection insurance pays out on the death of a shareholder and enables the other shareholders to buy the deceased’s shares. ......
Such insurance is usually used in conjunction with a cross-option agreement – where the payout must be used to buy the deceased’s shares from their family, who in turn are required to sell their shares to the other shareholders.
For small and medium businesses, a lack of suitable cover can cripple their finances. ......
The key is to identify the need for cover at the outset. ......
Fiona Middlemiss, a tax specialist at Alan Steel Asset Management, says: “There is a belief that if you do not claim tax relief then the proceeds of the policy will be tax free. This is not so. What matters for tax purposes is: does the policy qualify to be deductible, that is, meet the conditions for tax relief, and is the policy to replace profits? If a policy is tax deductible and it is to replace profits, then it is likely that the proceeds will be taxable on the company in the same way that profits would have been.”
So what does it cost? Middlemiss says that one client, a Scottish business valued at £1.5m, has three shareholder directors, all non-smokers and in good health. Each has £500,000 of cover with the two male directors, aged 40 and 45, paying £43 and £57 per month respectively, and the third, a woman aged 40, paying £34 a month. So the average cost per director is less than £540 a year, (or one per cent of the total cover per person).
In the absence of such an insurance policy the probable alternative might be a temporary bank loan. However, such finance is unlikely to come cheap - if at all in the current climate - to a business that has just lost a key person. Even then, the cost of the loan is likely to be well in excess of one per cent of the amount.
So why do so many businesses seemingly lack cover? The only answer can be ignorance and lack of advice - from the professional advisers, the trade bodies and relevant government departments. However, there is a growing awareness of the importance of putting adequate protection in place.
Quote courtesy of CA Magazine
March 2010
