Keyman Insurance

We’ve found that, whatever business our clients may be in, the one thing no company owner wants to think about is how the death or illness of a key worker will impact their business. This can complicate the process of calculating the right level of cover.

Increasingly, it can be external investors or lenders that help to define the level of cover that is required.

Some will require a benefit that’s at least sufficient to protect the value of their investment. More demanding investors might also want to see their projected returns covered too. Even so, it often comes down to the business itself to decide who its key people are and upon who it depends most.

How do you value a business for Keyman Insurance?

One broad rule of thumb is that a key person should be covered up to either twice their contribution to gross profits or five times their contribution to net profits, but this isn’t a fixed formula. It will depend on your business and the people you’re insuring, which is why it’s always best to get expert advice.

A lot of the companies we speak to seriously underestimate the level of cover they need and risk under-insuring their key people.

Often, a good starting point is to calculate a key individual’s contribution to gross profits. In addition you will also want to make sure you’ve covered any business debts such as loans, overdrafts or directors’ loans.

Samantha Haffenden-Angear, Cert CII
Independent Protection Expert at Drewberry

The tax treatment of Key Person Insurance by HMRC will be dictated by the purpose of the plan and, ultimately, who is to receive the benefits. The rules can be complicated. How the policies and benefits are taxed can appear quite arbitrary depending on how they’re going to be used.

Protecting Shareholders…

If a plan benefits anyone other than the business – such as a lender or the company’s shareholders (including shareholding directors) – then, by definition, it won’t be ‘wholly and exclusively’ for the benefit of the business. For this reason it’s unlikely that the premiums will be eligible for corporation tax relief.

Meanwhile, payouts on plans that cover the company’s shareholders usually count as a trading receipt, which means that they’ll also be taxed. So it’s worth remembering that policies that benefit shareholders could be taxed on the way in, and on the way out.

Covering Employees…

By contrast, policies that cover employees are usually regarded as being for the benefit of the business, in which case the premiums should be tax deductible.

However, the benefits still count as a trading receipt (so they’ll be taxed). This means that these policies will also need to have their sums assured grossed up so the business is left with the appropriate amount to protect the business.

Protecting Business Loans…

Key Person Insurance policies to protect a business loan are taxed differently. As the cover benefits the lender (not the business), the premiums can’t be deducted against corporation tax.

However, as the payout from the policy is intended to rebalance the company’s capital account it’s not classed as a trading receipt and so isn’t liable to any tax. This means that there’s no need to gross up such policies, which naturally reduces the premium.

For business continuity purposes, the best policies will include critical illness insurance alongside a basic key man life insurance policy. This is because suffering a serious illness such as a heart attack, cancer or stroke is far more likely than a sudden death but can have the same devastating impact on your business.

The long-term loss of a vital employee through illness could exert a financial strain on the company and lead to uncertainty. For instance, you might need to hire and train an interim replacement, for instance.

Should a key person suffer a life changing illness, the capital injection provided puts the mechanisms in place to ensure that a business can meet these costs while continuing to trade.

By choosing both life and critical illness cover, the policy will pay out not just in the event of death, but also if the insured is diagnosed with a disease such as cancer, multiple sclerosis (MS) or Parkinson’s, or if they suffer a heart attack or stroke. This gives the insured individual the peace of mind that their company can cope without them so they can focus on recovery.

When setting up your policy you will need to decide how long you would like it to last for. There are no hard and fast rules for this, it comes down to how long a key person will remain business critical.

Understandably, companies can be tempted to look for the shortest term available as this naturally brings down the premiums.

However, doing so can often be a false economy. When the cover expires and needs to be renewed it will certainly be more expensive due to a key person’s older age.

A good rule is to always put the needs of the business first. While most insurers have a minimum term of 5 years for Keyman Insurance, you can get cover for longer periods.

Think carefully if you’re considering taking out very long-term cover.

• Will business requirements change significantly over a longer period?
• Will you need a higher benefit, or will the individual no longer be so key to the business as it grows?

Business requirements naturally change and evolve over time, most key person insurance policies are set-up for between 5 and 10 years and are then reviewed at the end of the term.

Although less common there are some insurers who provide a keyman income protection policy where the business would receive regular monthly payments should the key person suffer a serious illness or die.

You may wish to consider an executive income protection policy to provide a level of sick pay entitlement or cover the costs of an interim replacement if the key person is too ill or injured to work.

The policy is owned and paid for by the limited company or limited liability partnership.

There are certain circumstances such as if the company ceases trading or if it changes name where you may want to change the ownership of the policy. You are able to do this through a “deed of ownership” however to make such change you will need to consult your solicitor.

This is dependent on the age of the key person and the level of cover that is required. The older the key person or the higher the level of cover the more likely the insurer is to request their GP notes and a medical assessment.

If you anticipate needing more than £500,000 of cover it is likely that a medical may be required. The medical is undertaken by a trained nurse and takes place at a time and place convenient for you which can include your own home.