What would happen if a key person in your business died or was diagnosed with a critical illness?
It doesn’t take long to conjure up some of the many issues that you would suddenly be presented with…
Could anyone immediately replace them?
Would you need more time or resources to find a suitable replacement?
What would be the financial impact of losing the person and finding a replacement?
How long would it take for the business to recover from this?
Would the quality of your goods/services be negatively impacted during the turmoil?
Would creditors still be willing to lend you money if you needed it?
Key Person protection can protect a business from the detrimental financial impact of losing a person who is integral to a business’s operations. The policy will pay out a cash lump sum (the sum assured) to the business in the event of the key person dying, becoming terminally ill or being diagnosed with a critical illness.
Money paid out by the policy is not earmarked for a specific purpose, so the business can put the money to any use necessary. Examples of this could be to help replace the loss of profits following the key person’s absence, or to fund the recruitment and training involved in replacing the key person. It is an injection of cash at what is likely to be a difficult and disruptive time.
A key person could be:
A business owner
A director or senior manager
A technical specialist with expert knowledge of the business’s products or services
A salesperson who drives a large part of the business’s profits
A staff member who has long-lasting relationships with major clients
The above examples are by no means exhaustive. Anybody could be a key person, as all businesses are unique. It is important to look at the roles of all individuals within your business, to recognise where key person protection is needed.
A key person policy can be taken out by businesses of any legal structure, be it a limited company, limited liability partnership, partnership or sole-trader. Different legal structures will require different key person arrangements. The policy owner might have to be either the business or the key person themselves, and it may be necessary to put the policy into a trust to ensure the desired outcome.
There is no direct legislation relating to key person policies, so it is very important to double check the tax position of a policy arrangement with HMRC. Depending upon the circumstances, the policy premiums may attract corporation tax relief. If this is the case, then the sum assured would likely be subject to corporation tax as a trading receipt. On the other hand, if corporation tax relief is not allowable on the policy premiums, then it is unlikely that tax would be due on any money paid out by the policy.
This is only a rule of thumb, which is why it is best practice to check the tax treatment in advance. This is a task that your financial adviser would be happy to assist with.
Policies will be arranged to pay out the sum assured in the event of the key person’s death, but it is also possible for the policy to pay out if they are diagnosed with a specified critical illness. Please refer to our previous blog article for more information about critical illness cover.
Key person protection policies do not acquire a surrender value, nor do they have any cash-in value. If the premiums are paid and a successful claim is not made during the policy term, then the policy will expire without value. This is likely to be the optimum outcome, as it would mean that the key person (and your business!) is still alive and well.