Almost half of businesses would fail if a key person in the company dies or becomes critically ill, according to recent Legal & General research. That is a startling statistic for any business owner or director but that is where keyman insurance comes in as it is a form of business protection insurance.
Many businesses will have a staff member or director who is crucial to their operation. It could be someone who helps make most of the profits or has a particular skill or knowledge that would be hard to replace.
Keyman insurance (sometimes called key worker protection) is a form of life cover that protects a business against the loss of an important staff member. This is typically defined as someone who is crucial to the financial success of a company.
Like a life insurance policy, it pays out if that person, or if one of a collection of people who are covered, dies. The payout is then used to cover the costs of finding a replacement or in place of lost profits.
Some banks may also require the cover to be taken out when accessing finance – known as business loan protection - so that the repayments can still be made even if a person who is critical to the firm is no longer around. The level of cover would typically reflect the amount that would be required to payoff a business loan, so in most cases would be provided on a decreasing basis as the debt will be getting smaller each month.
Businesses can also get key person insurance that provides critical illness cover, so if an important staff member or director was unable to work after being diagnosed with an illness such as cancer, the policy would payout.
Similar to a life insurance policy, the premium for key worker protection is calculated based on the age, health, occupation and lifestyle of the person covered, but it is actually the business, rather than the individual insured, that pays the premiums and receives the payout.
The price of the policy will depend on how long it is taken out for, so the company would need to calculate how long they think the staff member will work for the business and how much they would cost to replace. Usually, the longer a policy is taken out for, the more expensive it will be.
It is worth checking with an accountant or financial adviser regarding the tax treatment of the insurance as in some cases businesses will be able to claim the premiums as an expense, but there may be instances where the key person is a big shareholder – usually owning 5% or more of the company – where HMRC may see the policy as of personal benefit so there could be a tax liability.
What is shareholder protection and how does it work?
Losing a key employee or director can be hard enough, but more issues can emerge if an owner or part-owner dies.
Without an agreement in place about what happens to the shares of a deceased company owner, a business may enter a period of uncertainty which could harm its financial prospects. Family beneficiaries may argue with the other owners about the direction of the business or how the shares are distributed or other shareholders may want to buy the equity but could struggle to afford it or agree on a price.
A shareholder agreement avoids all these issues by setting out in writing what would happen to the shares in the event of an owner dying. The shareholder agreement sets out what happens if a stakeholder passes away while an appropriate Shareholder Protection policy provides payouts so the equity of the deceased shareholder can be purchased by their company owners under the terms of the Shareholder agreement (also known as a Cross Option agreement).
This provides peace of mind for all shareholders that they wouldn’t have to struggle to purchase the shares and the business can return to normality without too much disruption.
The Shareholder Protection policy will also ensure the family members get a sum of money at a fair and previously agreed price when the shares are purchased.
Shareholder protection doesn’t just have to cover death. It can also be used when a company owner becomes seriously ill, letting them sell their stake to others at a fair and agreed rate so the business can go on operating.
There are three main types of shareholder protection insurance
- Life of another policy gives each owner in the business their own policy, with a premium based on the usual age, health, occupation and lifestyle criteria. If one dies a payout is made from their policy to the surviving shareholder(s) so he or she can purchase the shares. This is typically suitable when there are two business partners.
- Another option is for each shareholder to have their own policy but it is written in the form of a business trust so when one dies the payout is shared among everyone equally.
- Alternatively, a company can buy and pay the premiums for the policy and the business then receives the payout when a shareholder dies.
What is relevant life insurance and how does it work?
Keyman and shareholder protection insurance are important forms of protection that cover a business in the event of the loss of a significant employee or company owner, but there is also a product that helps the family that gets left behind.
Relevant life policy (RLP) is a form of death-in-service benefit that is set up and paid by a company but pays out to a staff member or director’s beneficiaries on death.
The level of cover varies among providers but is usually a multiple of their salary and any bonuses.
Unlike some other company benefits, the insured individual doesn’t have to pay any tax for the policy and the company can also claim the payments as a business expense.
Relevant life insurance is typically used by businesses that aren’t big enough to establish a group life scheme but want to provide a perk for their directors and staff. A payout is made tax-free to the deceased’s family or dependants. Typically, a trust will be set up to mitigate inheritance tax and identify who the beneficiaries should be.
If a staff member leaves a company they can often take the policy with them but will need to pay the premiums.
Unlike other forms of business protection insurance, Relevant Life Insurance doesn’t usually have a critical illness option so some company directors may take out keyman insurance or shareholder protection at the same time to get the extra element if they were no longer able to work after diagnosis of a particular illness but wanted to keep the business stable.
The key differences between keyman, life insurance and shareholder protection
Keyman, life insurance and shareholder protection may sound similar but there are key differences, explained below:
- A relevant life insurance policy covers an individual and is set up to help the insured person’s family. It ensures that if the policyholder dies, those left behind can still meet their living costs such as mortgage payments or childcare.
- Keyman and shareholder protection are set up for the benefit of a business. They ensure a firm can continue running if an important employee or director passes away or can no longer work.
- Additionally, shareholder protection helps put a succession plan in place for when key investors in the company are no longer around so there are no disputes and the business can carry on operating.
How to decide which is the right choice for you and your business
There are various factors to think about when choosing the right type of business protection, such as knowing who to cover, how much and how long for. You also need to work out any potential tax liability as some payouts can be claimed as an expense, but others can’t if not for the sole benefit of the business.
Different providers will offer a variety of rates and levels of cover so it is important to compare keyman insurance, relevant life insurance and shareholder protection.
It's important to speak to a competent life insurance broker to find the most suitable policy (or combination of policies) for you and your business.
I have personally vetted the services of a specialist insurance broker*, who recommended and put in place business protection policies (including shareholder protection and keyman insurance) for my business, Moneytothemasses. They have specialist advisers that deal with shareholder protection insurance, keyman insurance and relevant life insurance. It is free to chat, just fill in the form via the above link, and there is no obligation on your part to take matters further. They also enjoy preferential terms from insurance companies meaning that they can guarantee to beat any shareholder protection, keyman or relevant life insurance quote.
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