The Key To Your Business Success

In the world of business, where success often hinges on the unique talents and expertise of certain individuals, Keyman Insurance (also known as key-person insurance) plays a crucial role in safeguarding a company's future. This specialized insurance policy helps mitigate the financial risks associated with the loss of a key employee.

In this blog post, we will explore the benefits of having Keyman Insurance, its tax implications, and how to determine the appropriate level of cover.

Who are Key People

These are the individuals who are paramount to a businesses success. In smaller companies it is often the owners who are the key people as they are the ones who lay down the vision for the business and how it will move forward but it could also be a company's IT specialist who has an in-depth understanding of their systems, a sales-person, who is responsible for the majority of sales and who holds long-standing relationships with the top cutsomers or it could be someone specialising in R&D of a new product or system.

It is not always those who bring the money into the business who are key. It can be those who drive that revenue in through other means.

Benefits of Keyman Insurance

Keyman Insurance offers numerous benefits to businesses of all sizes. Here are some of the key advantages:

1. Financial Protection: The loss of a key employee can result in significant financial setbacks due to lost revenue, increased costs, or disruption in operations. Keyman Insurance provides a financial cushion to help the company navigate these challenges.

2. Business Continuity: With a payout from a Keyman Insurance policy, businesses can cover the costs associated with finding and training a replacement, maintaining customer confidence, and stabilizing operations during the transition period.

3. Credit Assurance: Many lenders or providers of credit view Keyman Insurance as a sign of a well-managed business. Having this coverage can reassure stakeholders and make it easier to secure loans or investments, as well as retaining credit lines with suppliers.

4. Employee Morale: Knowing that the company has a plan in place to handle unexpected events can boost morale among other employees, reassuring them that the business is prepared to weather challenges.

Taxation of Premiums and Proceeds

For a premium to be tax deductible, generally, the following criteria must be met:

1. The cover needs to be 'short-term' ie. it must not run beyond the employees uselessness to the company. Historically this has meant that many keyman policies are arranged on a 5-year renewable basis but in more recent times longer term policies are becoming more acceptable, as long as the first sentence is applicable.

2. The policy must be to cover loss of profits. If the cover was to protect a business loan it is unlikely tax relief would be provided.

3. The employee must not be a significant shareholder in the business ie. they should not own a shareholding of 5% or more, since this is classed as a blurring of the employee:employer relationship since the individual would have a vested interest in the success of the business.

If these criteria are met then it is expected that the premiums can be treated as a deductible expense. It's worth noting that you would also expect the proceeds of a claim to be treated as a trading receipt and so suseptible to Corporation Tax. It is also worth noting that if the premiums aren't treated as a deductible expense thenthe taxation of the proceeds will not necessarily change.

Determining the Appropriate Level of Cover

There is no hard and fast rule over how the level of cover should be calculated for a key-employee, when the cover is being used to cover loss of profits. There are several industry standard methods, including the following:

1. Multiple of Salary: Sometimes a basic calculation of 10X an employee salary in the event of their death and 5X their salary in the event of suffering a critical illness is used, however, this does not work particularly well when the key employee isn't paid an amount that specifically aligns to their worth within the business. This can especially be the case for start-ups and their owners who may take little income in the early years.

2. Gross or Net Profit: The company's profitability is a critical metric in determining the coverage amount. A common approach is to calculate a multiple of the key employee's contribution to the gross or net profit, such as 5X their proportion to net profit or 2X their proportional contribution to gross profit. This arrangement works well for income generators so are involved directly in the revenue generated by the business but not so much for key employees who may be involved with things like R&D.

3. Proportion of Total Payroll. If a business is confident that their employees are all paid a proportinate amount, relative to their value within the business then this method can work well, however, it can easily be distorted by directors/shareholders taking smaller, or in some instances higher, than expected salaries.

Sometimes there needs to be a blend of these methods or a completely bespoke calculation due to the nature of the employee. Retaining flexibility is key to ensure sums assured are appropriate. The good news is that most UK insurers are quite flexible with the level of cover arranged until the amount is well into 7 figures.

Conclusion

Keyman Insurance is a strategic tool that offers businesses a safety net against the loss of essential personnel. By providing financial protection, supporting business continuity, and enhancing stakeholder confidence, it ensures that companies are better prepared to handle unforeseen challenges. When considering Keyman Insurance, it is crucial to work with both your insurance adviser and accountant to tailor the coverage to the company's specific needs and to understand the tax implications fully.

This proactive approach can make a significant difference in securing the long-term success and stability of the business.

Feel free to get in touch if this is an area of business protection you wish to look into.

Simon Dunn

simon.dunn@four-nations.co.uk

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