A key element of Business Continuity Planning and safeguarding your assets in the case of unforeseen circumstances is Key Person Insurance.
What makes a business successful is often down to the knowledge, experience and skill sets of the key people in the company. However, have you considered the risk if you or another person in your business suffers an untimely death or is struck down with an illness? What impact would their departure have on your business?
The consequences could be far more distressing than expected, as the loss of this key person could cause business disruption, the loss of important business networks or the erosion of potential profits.
Many small- and medium-sized companies are dependent on a few specialist individuals. The loss of these individuals as a result of death or severe illness could therefore be highly disruptive. Key Person Insurance helps protect the business and its profits in the event of the loss of one or more key employees.
What is Key Person Insurance?
Imagine you are running a successful business and you have worked with your Head of Sales for many years. She has access to wide network of local business and is well liked and trusted by all of her contacts, around 50% of your profits are directly attributed to existing clients she has brought to the business and new clients she generates each year.
How do you think your business would cope with losing this key individual? Although not irreplaceable it would certainly be challenging to find an equally well-connected replacement. Maybe as an alternative you could find a less experienced head of sales, although it might take a while for them to develop their network. How long would the business be affected for?
In order to protect your business, you could set up a Key Person protection policy so that the business receives a sum equal to 50% of your profits. This will give the business that vital breathing room and the ability to access the money needed to cover lost profits, loan repayments and the costs of employing a new member of staff. It is prudent to have this type of protection in place for each individual that you believe is key to your business.
How it helps
If the key person were to die or suffer from a severe illness, the Key Person Insurance policy pays out a lump sum to make up for any loss in your revenue or profits, or to cover borrowing costs, helping to keep your business on track.
Who is a ‘key person’?
An individual whose skill, knowledge or experience contributes to the continuing financial success of the business. For example:
You should also consider the impact on the business of losing someone who might not have any financial stake in the business, but nevertheless plays a fundamental role in its success.
We recommend asking yourself the following questions to determine what type of Key Person Insurance would be valuable to your business:
If a key person died, what would be the effect on your business value?
How long would it take for you to replace a key person?
How much would it cost to replace a key person?
Do you have any outstanding loans against the business?
Will your business be able to service your existing loans on the loss of one or more key persons?
How is it facilitated?
Firstly, it is vital to identify who is key to your business and to determine the amount of cover that would be needed. This is often a multiple of their salary or how much profit or turnover they create and how long it would take to recover from their loss. Alternatively, some businesses look at direct costs of replacing the key person (i.e. finding new staff and paying their salaries) and how long it would take to replace lost revenue.
Engaging with your accountant and a financial adviser will help you determine what type of Key Person Insurance is appropriate for your needs, and the cost of the policy. The tax treatment of Key Person Insurance can be a relatively complicated area; however, with the right financial advice and a good accountant you can easily navigate the tax treatment of this vital type of protection. The policy is for business continuity and therefore the proceeds are paid to the business, not to the key person or their estate.
Here at Wellesley, our dedicated advisers will work closely with you and your business to identify any vulnerabilities and to ensure ongoing business operations in the event of the loss of a key person. We can also advise you on the tax treatment of this insurance policy.
While is important for a business to protect itself in the event of the death of an owner or a key employee, it is also important to ensure that the family and loved ones of said employee are adequately looked after in the event of death or critical illness. Find out more about Death in Service cover here.