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What is key person insurance?

19th Aug, 2016

By Robert Little

Very few businesses in the UK have a key person insurance policy, yet this type of cover is incredibly important for businesses with staff who are integral to the success of the company. In this post I will use a short case study to demonstrate the importance of this type of insurance policy.

Who needs key person insurance?

Key person insurance is vital for any Limited company, partnership, sole trader or Limited Liability Partnership (LLP) with one or more important members of staff.

Important staff will often include the owners/managers of a business but it can also cover other staff such as sales people. Essentially any person who contributes to the profit of your business is a key person.

What does it do?

It provides a lump sum if the key person either dies or experiences a serious illness (such as a heart attack, stroke or cancer diagnosis). This lump sum is paid to the business (not to the family of the key person). The business can use the money to buy replace lost profits or to hire a suitable replacement.

Why is it important?

It can help to ensure business continuity and reduce the financial impact of the loss of an important person.

Case study

Mr Jones owns and runs a limited company with an annual turnover of £500,000. He employs 3 people: 2 administration staff and a saleswoman named Mrs Adams.

Mr Jones tends to contribute around 50% of the turnover of the business and Mrs Adams contributes the other 50%. Mrs Adams has worked for Mr Jones for a long time and she knows the business inside and out.

Mrs Adams passes away suddenly. This leaves Mr Jones in a tricky situation: he is faced with double his normal workload and the revenue Mrs Adams was earning stops on day one. He would like to hire a new salesperson but he knows this will take time and he does not want to lose Mrs Adams’ customers in the meantime. He considers taking out a business loan to cover short-term cash flow but the bank is hesitant to lend him any money – after all his business has just lost a vital member of staff who contributed 50% of the total turnover.

Summary

Without key person insurance:

  1. The business experiences an immediate fall in turnover.
  2. Mr Jones has to invest time and money into hiring and training a new salesperson.
  3. The new salesperson will take a long time to build up relationships with the existing clients and bring new clients to the company.
  4. Bank financing might be available to cover short-term cash flow but this adds to the expenses of the business.

With key person insurance:

  1. Mr Jones claims on the policy and receives a lump sum.
  2. He can then use this money to cover the loss in turnover following the death of Mrs Adams.
  3. Alternatively he can use this money to pay for finding and training a suitable replacement for Mrs Adams.

Taxation

The tax treatment of the lump sum payment and the premiums payable depends heavily on the circumstances in which the policy is taken out. If the business intends to use the lump sum to replace lost profits and the person insured is an employee the premiums may be able to be deducted as an expense against corporation tax but any lump sum received from a claim could be taxable. Our advisers always recommend speaking to an accountant before taking out a policy like this.

Advice

If you would like to discuss this type of policy with one of our advisers please visit our Contact us page or call 01642 477758.

We offer a free initial meeting to all new clients. If you then decide to proceed with an insurance policy we will receive a commission from the insurance provider and so you will not owe us a fee (although you have the option of paying a fee if you prefer).

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01642 477 758

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