We spend so much time and effort covering the basics of insurance, health, car, home & contents, that a majority of the time we totally miss areas that are the most important. One of these being Key-Person Insurance or Shareholder Protection.
Key-Person Insurance
So you’ve built the business, operating profits are strong, but you’re worried that most of that profit is generated by a small number of employees/directors, you may be in a position that you or a colleague are the main breadwinners of the firm, even to the point that the knowledge and experience that generates profit is also with a select few.
How could you cope with this within the firm if one of these individuals had a sudden death or even extended or permanent incapacitation? How do you cover the cost of this missing person? This could be specialist recruitment costs to find a replacement. How do you cover the revenue loses while adjustments within the firm are made? Losing this individual could also have a major effect on terms within any debt liabilities, are you in a position to cover any early recall of this debt?
There are so many uncertainties that need to be covered and, using Keyman/Shareholder Protection you can make sure that the firm can continue as a going concern through these issues or wind the company down in a calm and orderly fashion if this is what the remaining partners and beneficiaries wish.
Losses To Cover
- Costs for temporary replacements when Key Person can no longer work, this could also cover costs of longer term recruitment and training of replacements staff/directors.
- Cover to protect profits/revenue. Lost sales income, losses from delayed or canceled business projects. Loss of skills or intellectual property.
- Cover business loans or any debt liabilities that the Key-person/Director is a Guarantor of.
- Also consider cover to protect shareholders – partnership interests.
Who To Cover
It’s essential to cover anyone within the business who has a major impact on the direction of the company and is directly connected to the financial success of the company. This could be those who have direct responsibility for intellectual property, specific skills, experience and leadership roles within the firm. This could also be your lead sales person if that individual is generating considerably more revenue than the rest of the sales team.
Who would have a serious impact on the firm if you lost them. Company directors, IT specialists, Managing Directors and Head of Product Development. Assess the individuals and what could be the potential loss or disruption to the company if suddenly they were missing.
Calculate A Value to the Key-Person
Here we need to think about loss of revenue/profits, how much to replace with temporary or permanent staff, also costs to cover any debt or debt restructuring. below are tow simple ways to calculate basic coverage.
Multiple of Salary Method
The multiple of salary method is very simple – it is usually based on a calculation of either five or ten times the key person’s salary. Although simple to work out, it does have drawbacks, including: the salary may not reflect the person’s value to the company, salary is not usually the total earnings of a key person – total remuneration is often made up of other benefits, such as pension contributions.
Proportion of Profit Formula
The second method is the proportion of profit formula. Again, this uses the key person’s salary but also takes into account profits and the time it might take to recruit a replacement. The formula is: (Salary x last year’s profit x number of years to replace)/Total salary bill
Policy Ownership
The key-person insurance policy can be owned by the Company, the individual covered or by a third party, most commonly known for the company to hold the policy. In some jurisdictions the tax issues need to be considered on the most tax effective way to hold the policy.
Advantages
- Lump sum paid to cope with loses.
- Able to buy deceased partner/directors shareholding.
- Premium paid can be a business expense in some jurisdictions.
- Term plan, premiums remain at set amount.
- Safeguards beneficiaries/family from business shocks or cycles.
Disadvantages
- Some countries have no exemptions from income Tax on a claim amount or maturity.
- Policy surrendered amount endorsed could be taxed in hands of key-person as profit in lieu of salary.
The above is a basic overview of what to consider when you are running a business within the SME world. There is so much more to consider when looking at the level of cover, how to hold the policies, whether a trust would be suitable, how to cover a number of partners within a company and how to structure those policies.
For more information or to discuss in more details please contact enquiries@businessclassasia.com and visit our page for businesses.