If the main person in your business was unable to continue in their role could your business continue to run smoothly or even survive?
All businesses should consider the use of life insurance to compensate them for any financial impact on their income as a result of the loss – through death, disablement or critical illness – of key employees who are responsible for the ongoing success of the business.
Who is a key person?
A key person is an individual whose continued association with a business provides that business with a significant and direct economic gain. This could be a director, partner, employee or any other person who makes a substantial contribution to the profitability of a business.
What is key person insurance?
The loss of a key person can cause income to decrease, and business costs to increase. Key person insurance proceeds can be used to fund one or more of the following:
- the loss of income the key person would have generated;
- the extra costs the business would have in finding a suitable replacement; and
- additional salaries, wages and training costs
Impacts on a business following the loss of a key person include:
- Sales income: the loss of a key person directly responsible for sales can mean a fall in sales until a replacement is found and starts to generate similar results
- Recruitment: the costs incurred to find, attract and recruit a suitable replacement may be considerable and will impact on business profits
- Training: the replacement key person may require extensive and expensive specialist training
- Stability: The loss of a key person may also indirectly affect business income, leading to short-term restructuring and extra pressure on other staff and may affect their morale. This loss could also impact on suppliers and associated businesses.
Determining the level of cover
The aim is to determine the loss of profit or income and the cost of replacing the key person.
There is no one formula to calculate the sum insured.
Formulas can include multiples of income, gross or net profit, or liabilities based on the key person’s contribution to the business.
Another method to value the loss of a key person to the business is to use a multiple of his or her remuneration, including salary, bonus and super, to cover the recruitment and training costs of a replacement.
You need to determine what impact the loss of a key person would have on the profit or income of the business, and how long it would be before a replacement is found and trained to produce the same results.
Could a suitable candidate be found locally?
Would there be recruitment and relocation costs?
Would a financial inducement be required to attract the right person?
The best funding vehicle?
You will also need to work out how the loss of income and replacement costs would be funded. It is unlikely that there will be excess profits available which could be used for this purpose.
It is also unlikely that the business would have non-income producing assets that could be readily liquidated or that a financial institution would provide credit to fund loss of profits and key person replacement costs. The most logical and cost-effective funding solution is life insurance in the form of term life, TPD and trauma cover.
Tax treatment of premiums
The taxation treatment of key person insurance depends on the purpose for which a life insurance policy is taken out – for income or capital purpose. It is necessary to establish the intent when the policy was effected (and any change of purpose during the life of the policy) and the purpose for which the policy proceeds are actually used.
If you are concerned about the vulnerability of your business due to an unforeseen illness, accident or untimely death of your key-person please call us today to arrange a meeting to organise a solution.
General advice disclaimer
The advice provided is general advice only as, in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product.
Only financial planning advice provided by Ceebeks Financial Solutions is associated with MyPlanner Professional Services.
Chris Beks is a director of Ceebeks Financial Solutions and an Authorised Representative of MyPlanner Professional Services Pty Ltd, ABN 51 159 969 830; AFSL 425542 and is authorised to provide personal financial advice.