Key Person Assurance
Many business owners recognise their staff to be their most valuable asset and invest large sums of money in retaining them. However….
What would the financial impact on the business be should a key staff member die or become permanently disabled?
How can the business protect itself?
The solution for the business is to take out keyperson insurance on the lives of key employees.
Business owners have to accept that some business risk is necessary in running their businesses However, Keyperson insurance is an effective method of transferring the financial risk related to the loss of key employees to an insurance company. Keyperson insurance also provides contingency capital to fund the costs of recruitment, retraining to the replacement of a key person.
Without keyperson insurance, the following serious business implications could arise:
- Profits may be affected, temporarily or permanently.
- Clientele may be lost.
- Creditworthiness of the business may be affected.
- Huge recruitment and training costs can be incurred.
Where key employees contribute to the success of the business, the business can take out insurance on the lives of these key people. Should a key person then die or become permanently disabled, the business will receive the policy proceeds and can use them to offset the loss of profit or expenses associated with the loss of that person’s contribution to the business.
The value of the life cover should represent, in monetary terms, the value of the key employee to the business. (This can be a difficult to evaluate). Should the key employee then die or become permanently disabled, the business receives the policy proceeds and utilises it to reduce the financial strain on their cashflow and profits.
Keyperson insurance provides business owners with peace of mind, knowing the business will survive the loss of a key person because it provides immediate capital for the business. The plan also makes financial sense because the monthly cost is small in relation to the significant benefits.
Keyperson insurance offers the following specific benefits:
- The policy proceeds will cover the costs of recruiting and training a new employee.
- The business replaces any loss of income and profits.
- The creditworthiness of the business remains intact.
- Directors’ loan accounts can be repaid.
Depending on the choice of the business, contributions may be tax deductible or not. If the policy conforms to the requirements set out in section 11(w) of the Income Tax Act, a deduction can be claimed. If this occurs, the policy proceeds will be taxable in the hands of the business. It would then be prudent to increase the cover by the amount of tax to be paid in order to ensure that the required capital amount is still available to the business. Should the business prefer a tax-free payout, the policy can be structured to be non-conforming and therefore no deduction will be permitted for the premiums. A claim on a policy will also be classified as a disposal of an asset. Although the basic result is that capital gains tax is payable on any gain, an exemption is available where the policy proceeds are received by one of the original beneficial owners or, by the insured life in circumstances where the premiums were deducted from tax.
While insurance policies are normally estate dutiable, keyperson policies can be exempt if they comply with certain provisions of the Estate Duty Act. The relevant exclusion applies only to policies:
- that were not taken out at the request of the insured life, and
- of which no premiums have been paid by the insured life, and
- where no proceeds will be paid to the insured life’s estate or for the benefit of a relative or person who was dependent on the deceased for his or her maintenance, or to any company that was at any time a family company in relation to the deceased.