The key points of key person cover

Key person cover is a company-owned insurance policy taken out to protect the company from the illness, injury or death of someone who is key to its success.

That may be the owner or owners, or it may be a key employee. For example, a skilled cabinetmaker may be key to a bespoke furniture company or a computer programmer may be indispensable to a business that has been streamlined by custom-built software.

Benefits

• Protect profits - The loss of a key person can severely hamper a company’s productivity and therefore its profits. The greater the contribution of the key person, the more acutely this will be felt. This makes key person cover best suited to small and medium-sized enterprises (SMEs) where the contribution of one or a small number of people tends to be proportionally higher. Key person cover can help to replace lost profits while the business gets back on its feet.
• Meet liabilities - Key person cover can protect against any liabilities that a business may have – a bank loan, for example. Debt repayments would still need to be met even if someone key to a company’s operations became ill or died and profits dwindled. In the event of such unfortunate circumstances and without cover in place, a lender may feel uneasy about the outstanding debt and call in the loan.
• Fund recruitment - Key person cover can fund the recruitment of a replacement. Getting the right individual may take some time and involve advertising and recruitment agency fees. The new employee may benefit from training, and key person cover can help to meet these costs, too.

Tips

• Identify a business - There are 5.7 million private sector businesses in the UK. Some 52% of the country’s small businesses think they would cease trading within one year of losing a key person and 51% have some form of debt, the average being £176,000, according to the Legal & General 2019 ‘State of the Nation’s SMEs’ report. Despite that, only 20% use an insurance policy as security. There is a clear opportunity for advisers to help SMEs – and grow their businesses in the process. Advisers who want to write more business in this area need to find good ways of getting themselves in front of small company owners. That may include attending networking events – virtual or in person – developing professional connections and marketing themselves in this area, including the use of social media.
• Convey the value - Key person cover is about contingency planning. Zurich calculations based on official mortality and morbidity tables show that in a company with four key people whose average age is 40, there is a 15% chance that one will die before the age of 65 and a 39% chance that one would become critically ill. Without cover in place, there is likely to be a ripple effect. To illustrate this point, make sure you ask the right questions. How would your business function if a key person or people became ill or died? What kind of hit could profits take? And what would the impact be on the rest of your workforce? Many small business owners have a sense of responsibility towards their employees, so it can be an emotive subject.
• Understand a business - Above all, an adviser should take time to understand a business before creating a solution. Often, key person cover sits alongside other protection products. Firstly, undertake a comprehensive business fact-find. A conversation with the key stakeholders, generally the owners of the business, will enable you to identify the key people. In many circumstances, it is the business owners themselves, but it may be them plus others or only others. In some cases, an owner may have established a business and recruited a managing director or shop floor manager to handle the day-to-day operations, enabling them to take a back seat and become less relevant to the profitability of the company.
• Ask an expert - Zurich is here to help advisers who are writing business in this area. Sometimes advisers fall into the trap of having a pre-conceived idea of which products a business may need or talking immediately about product solutions. Having gathered all the relevant information, you can call on your business account manager to run through some scenarios and discuss potential options. We are always on hand to help advisers looking for information or support. Our new business protection guide is also a source of information.
• Think about the level of cover - Deciding on the level of cover is most straightforward where you can ascertain the level of profit that a key person is accountable for. Cover can be taken out to directly replace that profit, say for a year or two. You may want to add some contingency. Where cover is designed to meet recruitment and training costs, the level of cover is often a multiple of the key person’s salary.
• Don’t let the tax tail wag the protection dog - Premiums on key person policies can be tax deductible. This can be established by referring to the Anderson guidelines. The tax treatment of proceeds of policies comes down to whether they are treated as capital receipts or trading receipts. Proceeds used for a revenue purpose (loss of profit and replacement costs) are treated as a trading receipt and taxed as such. Proceeds used for a capital purpose (repayment of business liabilities) are treated as a capital receipt and will be tax free. Tax benefits, however, should not be a key selling point. What matters is protecting a company’s operational ability and profitability.

James Peacock is a protection account manager at Zurich Insurance

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