Key Person Insurance
Keyperson Cover:- When business owners are asked what company assets are insured they always list their premises, plant and machinery, vehicles computer equipment and so on. They recognise that cover is required for the cost of replacement, potential loss of profits and ultimately to minimise any business disruption However, what would happen to the company if a key employee, director or shareholder were to die or become critically ill? The cost to the company could be devastating. Consider for example the sudden death of the head engineer of a private company when it is in the process of tendering for a major project. His death could result in the loss of that contract which may be critical to the company's future survival. Who is a key person? A key person is anyone whose death or disability would have a serious effect on the company's future profits. Some companies will have several key individuals. Others only one, but to identify who is key requires a thorough understanding of the business itself. In some cases, it may be immediately apparent that the majority shareholder and figurehead of the company is the only key person. In other cases, one of the directors may be key despite only being a minority shareholder. The size of an individual's shareholding level is not necessarily a good indicator of who is a key person, as a non shareholding employee could easily be a key person to the business. How much cover is required? There are no specific rules when assessing the financial value of a key person. Each key person must be dealt with on his or her own merits. Insurable interest must be demonstrated, and there are several options available to guide you in assessing a reasonable amount of cover. These are outlined below: Multiple of profits This is the primary method for calculating a key person's worth. The normal multiples are : 2 x gross profit or 5 x net profit The profit may need to be split where there is more than one key person Higher multiple may be justified for a rapidly expanding business Multiple of salary A multiple of gross salary including benefits in kind can give a useful guide to the amount needed to buy a replacement. Up to 10 x gross salary may be considered. The disadvantage of this method is that, for other than non-shareholding employees an accurate measure of a key person's worth to the business may not be related to his or her remuneration. Proportion of salary roll This method covers the key person's contribution to the business turnover. It can be distorted by a shareholding director taking a low salary with a dividend as a substitute, so that profits can be reinvested, or by a director taking a relatively high salary. The formula used would be: Key person's salary x Turnover x years to recruit and train a replacement Total Salaries Special Circumstances Business Start Up - the working capital at risk must be calculated, along with the key person's proportion of this risk Loan Security - The outstanding loan will need to be covered (divided between the relevant key people as appropriate) Management buyout - as in loan security the amount at risk, should they lose the key person, must be calculated Tax Implications The key person On the basis that the company is the owner and the key person is simply the life assured, then there are no benefit in kind or other taxation implications on the individual. If however, the company subsequently chooses to pay out the proceeds to the individual or their family then tax implications would arise on that event The company There are two aspects to consider - paying the premiums and receiving the proceeds Tax implication on paying the premiums There is no specific provision in the tax legislation that guarantees corporation tax relief for the company . Instead, principles for the tax treatment were actually set out in 1944 by the Chancellor, Sir John Anderson. This statement indicates that the proceeds will generally be taxable and the premiums tax deductible where:- The life assured is an employee Thus no tax relief is likely on premiums where the life assured is a shareholder. Working directors (although not shareholding directors) are considered as employees The logic behind this is that to be tax allowable , premiums must be "wholly and exclusively for the purposes of trade. Where a plan is written on the life of a shareholder, there is considered to be an element of self interest in taking out the plan ( i.e. preserving your own shareholding value) and therefore the wholly and exclusively test can be failed The insurance is to meet a reduction in profits resulting from the loss of services of the key individual For example, consider a company which borrows money to buy a factory. If the company then takes out a key person plan to repay the loan on that person's death. Then the plan would not meet this criteria. It is being taken to repay the loan and not meet loss of profits. It is annual or short