What is business insurance?
Business insurance is designed to provide financial protection to a business against the loss of revenue or capital value of a business in the event a key person suffers a major illness, disability or death.
Often referred to as "key man insurance", key person insurance is designed to insure any significant person in a business, large or small, who's exit from the business due to medical reasons or death would significantly impact on the businesses future ability to trade. The individual could include people such as directors, sales managers, key investors, share holders etc.
A business may also regard an employee as a key person. Such an employee may have industry knowledge and expertise along with overall company contribution that deem them vital to the profitability of the corporation. If that individual's contribution was hindered through a major health issue or death then the company would suffer financial loss. It may be difficult to replace such a person depending on the industry as often positions of this nature become very business specific.
There are two common forms of business insurance.
1/ Insurance to cover the capital loss of the business
2/ Insurance to cover the loss of business revenue
How do you cover the capital loss to the business in the event a key person exits through ill health or death?
In the case of a company director or shareholder, key person insurance can provide a lump sum to pay out the value of the company shares, held by the director to the director's estate, as the estate of the deceased or disabled director has an interest in the value of the business through their share holding. In this case the key person insurance negates the need for the business to raise capital to pay out the estate of the exiting director.
The policy can be owned by the company, the individual being insured, cross owned by the remaining directors or separately owned by a trust known as a Bare Trust. The primary purpose of the insurance in this case is to relieve the financial obligation on the company by providing key person insurance to pay out the director's estate in the event they suffer a major health issue, become disabled or die.
This however is not the end of the process. In the event of the above, shares owned by the exiting director need to be returned to the company for distribution back to either the remaining directors or a new arrangement. This process is facilitated through the use of a buy/sell agreement which allows the share ownership to pass from the exiting director back to the company. This agreement is established prior to the death or disability of any director and exists to set a legal framework for the share transfer to occur. If this is not in place then an exiting director or their estate could receive payment from the key person insurance and retain their company shares.
In short, key person insurance provides the vehicle for the company to "Buy" the shares back from the exiting director or his estate and legally forces the exiting director or his estate to "Sell" the shares back to the company. The insurance along with the buy/sell agreement exist to protect the interests of all parties.
Considerations in determining the level and type of key person insurance
Level of benefit
• The capital value of the business, including premises, chattels, stock, equipment, kredittkort etc.
• The profit level of the business. Often a multiple of 3 times the gross profitof a business forms part of the business value calculation.
• The estimated loss of revenue to a business and the cost of replacing the exiting key person are also factors.
Types of insurance
Typically there are three types of life insurance used.
1/ Term Life insurance which pays in the event of death
2/ Total and Permanent Disability insurance used to pay in the event of permanent incapacity
3/ Trauma insurance providing a lump sum in the event of a traumatic medical event such an event does not always leave permanent incapacity and often the individual will return to their normal duties after a period of recovery.
Please note there can be taxation implications on the way key person and buy/sell arrangements are established so it is highly recommended that professional advice be sought in relation to this form of insurance.
For advice and assistance with all your business insurance needs please call: 1300 91 7735 or Request for Business Insurance Quote