Cutting costs is fundamental process for every business in order to reap the most profits possible. However, often many companies choose to overlook business insurance to save money, leaving them vulnerable should something suspect were to occur.
We spoke to one of our financial partners, Elliott Winner of KWM Wealth Ltd., about the relevance of business insurance, the main different types of business insurance and how to go about properly acquiring the right insurance policy for your business.
Why is insurance for businesses so important in this day and age?
Insurance is not something that springs to mind as an area people generally love to spend money on. It should, however, be considered a vital part of a business’s financial plan. An appropriate way to think of insurance, is that it is like an umbrella; you would not want to get caught in a storm without one.
Businesses and their owners need a base layer of protection for unforeseen events, now more than ever, given the events and uncertainties surrounding the pandemic. If we consider financial planning as a pyramid or hierarchy of needs, insurance should be that first layer, as it acts as a safety net for the layers above i.e. cash reserves, investments etc.
What is shareholder protection and who does it affect?
If a shareholder or partner dies, or becomes critically ill, the insurance policy ensures that funds are made available for the other business owners to purchase the business interest of the deceased/ill individual. The loss, or incapacity, of a shareholder can disrupt a company but by having shareholder protection in place the interruption to a business will be minimised by enabling:
- Business continuity
- Funds being made available to the individuals who wish to buy the shares
- An improved tax position on the death of a shareholder
- The deceased’s family/estate to receive funds in a timely manner
Without this kind of insurance policy, it could take months or even years to conclude a sale to a third party. Alternatively, the spouse of the deceased may decide to retain the shares and if he/she has no knowledge or understanding of the company, this could adversely affect the company.
The spouse will also have problems if their shareholding is small because they have no right to be employed, they cannot demand that a dividend is paid, and the shares may not be easy to sell. Borrowing money to purchase the shares is an option but it should be remembered that this would be done against the backdrop of a potentially traumatic period in time where the company has lost someone who is, perhaps, key to the business. Any lender would take this into account when arriving at the decision to lend.
The use of life cover to meet the liability to purchase shares ensures that the proceeds are available when required, on death or critical illness to ensure a quick conclusion to the succession problem.
The use of trusts and a cross option agreement when structuring shareholder protection help to ensure that the shares are purchased from the estate in a tax efficient way. The cross-option agreement that must be set up ensures that the existing shareholders have an option to purchase the shares from the deceased’s trust. Similarly, the deceased estate has an option to sell the shares to the surviving shareholders. If either party exercise their option, the sale/purchase is enforceable. There is a set time limit on when the shares should be purchased and an agreed process for valuing the company on the death of the shareholder. This ensures that the estate receives a fair value for the shares without a long delay.
Trusts are not regulated by the Financial Conduct Authority.
What is key person insurance and who does it affect?
A business could suffer a devastating financial loss in the event of the death, critical illness, or incapacity of a key individual. Key person protection is intended to cover future loss of profits, so a lump sum received by the business at this time could be critical to ensure continuity of the business. For example, it could be used to cover the cost of finding a replacement and training them or repaying a loan or overdraft that depends on that key person.
A Key Person is an individual whose death, critical illness or disability would have a serious effect on the continuing financial success of the business. For example:
- Partners
- Director(s)
- Senior Employee(s)/Specialist(s)
- Business Owner(s)
- Proprietor if a Sole Trader
The considerations for identifying a Key Person and their value to the business:
- How easily could the business replace their expertise?
- Would their absence affect business expansion plans or ongoing projects?
- Would the business be in danger of losing customer orders?
- Would it result in a loss of goodwill or hardening of suppliers credit terms?
- Would the business miss their administration or management contribution?
- Are there any loans or overdrafts dependent upon the key person?
When thinking about how much to insure for Key Person cover, some guidance can be formed basing it on:
- Multiple of profits
- Multiple of salary
- Proportion of salary roll
- Outstanding loans
What is a Relevant Life Plan and why is it important to both employers and employees?
A Relevant Life Plan (RLP) is a Term Assurance that provides a lump sum on death or diagnosis of a significant illness before age 75. The plan is established and paid for by the employer for the benefit of an employee and their family. Relevant Life Plans have been designed for use by any employee including the directors of a business.
A plan could be suitable for:
- Employees with (or who are likely to have) significant pension benefits
- Employers who wish to provide additional benefits not already provided by their Group Life plan
- Employees who do not (or cannot) have a Group Life plan
A key consideration for businesses is the tax treatment of RLPs:
For the employer
The premiums are treated as a business expense for corporation tax purposes and are not subject to employer’s National Insurance payments. The cover provided must meet the HMRC’s ‘wholly and exclusively’ test.
For the employee
Premiums paid by the employer are not treated as a benefit in kind and are not subject to National Insurance. If a claim is made on the policy, the benefits are tax free too.
What are some of the other business insurance policies which employers should think about?
Aside for the above insurances which cover the business and its key stakeholders, there are some insurances which a business should consider (and in some cases actually need in place in order to trade) and include:
- Employers’ liability cover (if businesses have staff)
- Public liability insurance (if businesses are dealing with members of the public)
- Professional indemnity insurance (if the business is offering advisory services)
- Buildings insurance (if the business operates from a premises)
- Business interruption insurance (to protect a business from loss suffered by damage from a fire/flood)
- Cyber insurance (this is a hot area right now because it covers the liability for a data breach involving sensitive customer information – there have been many recent high profile cases here)
What is the best way to go about finding a good insurance broker?
Word of mouth recommendations from associates/friends/family who have a good reputable person or company they trust tends to be the best way. There are the large insurance companies that business owners can go direct to, however, a broker or adviser is likely to be more appropriate because they can go to the marketplace to source the best cover to suit the business’ needs.
If business owners are considering the ‘DIY’ method without taking advice, we would always stress that buying insurance online is very risky. This is because often business owners do not always know what they are looking for, or could miss the small print, and these can end up being extremely costly mistakes that will only be found out as and when a claim is made.
We hope this has outlined to you the importance of business insurance and why they should be acquired. If you require any further information on other insurance policies, or anything accounting related for that matter, please don’t hesitate to get in contact with us at Nordens where one of our trusted advisors would be happy talking you through your query.
