FAQ : Keyman Insurance Policy FAQ for Keyman Insurance Policy Q1 What is a 'keyman insurance policy'?

A1 There is no legal definition. In general, it has the following features. An employer takes out an insurance policy insuring against loss of profits arising from the death, sickness or injury of a key employee. The beneficiary is the employer. In the case of a life insurance policy, it is a term insurance, covering the life of the employee within the term of the policy, with no other benefits. The term does not extend beyond the period of the employee's usefulness to the employer. The purpose of taking out the insurance is to compensate the employer for the loss of trading income that may result from the loss of the service of the key employee in case of death, sickness or injury. Q2 Are the premiums paid on the policy by the employer deductible for profits tax purpose? Are the proceeds from the policy taxable? A2 The premiums are deductible (provided the policy has the features as mentioned in A1). The proceeds are taxable as trading receipts of the employer, being compensation for loss of profits. Q3 If the employer is a sole proprietor or a partnership and the insured person is the sole proprietor or a partner, are the premiums paid on the policy by the employer deductible? Are the proceeds from the policy taxable? A3 No, the premiums are not deductible. Even though the policy may be named as a 'keyman policy', the Department would not accept that it is a real keyman policy as described in A1 above. This is because a keyman policy is applicable only in the case of an employer and employee relationship. A sole proprietor or partner is not an employee. The premiums are regarded as private expenses. The proceeds are not taxable. Q4 If the employer is a limited company and the insured person is a director who owns substantial shares in the company, are the premiums paid on the policy by the employer deductible? Are the proceeds from the policy taxable? A4 No, the premiums are not deductible. The situation is, in substance, similar to the case where the insured keyman is the sole proprietor or a partner. The Department considers that the purpose of the policy is to protect the value of the shares because the life or well-being of the director, being the keyman, would significantly affect the value of the shares. The premiums are of a capital nature. In this connection, generally a shareholding of 20% would be regarded as substantial.

The proceeds are not taxable. Q5 If the proceeds of a "keyman insurance policy" are payable to the family members of the employee or the employer is contractually required to pay the proceeds to the family members of the employee, are the premiums paid on the policy by the employer deductible? Are the proceeds from the policy taxable? A5 No, the premiums are not deductible. The purpose of the policy is not to compensate the employer's loss of profits, but to protect the family of the employee. The proceeds received by the employee's family are not taxable. Q6 If the policy is not a term policy, but is a life policy carrying a surrender value or an endowment policy, are the premiums paid on the policy by the employer deductible? Are the proceeds from the policy taxable? A6 No, the premiums are not deductible. They are regarded as expenditure of a capital nature. The proceeds are not taxable. Q7 Sometimes, the policy may have an add-on element. For example, the employer pays extra premiums on top of the normal premiums so that on the death of the employee certain benefits (e.g. one year salary) would be paid to the family members of the employee. Are the whole premiums paid on the policy by the employer deductible? Are the proceeds from the policy taxable? A7 Only the normal premiums are deductible (provided the policy has the features as mentioned in A1). The extra premiums are not deductible. The proceeds received by the employer are taxable. The proceeds received by the family members are not taxable. Q8 If the policy is an investment-link policy, are the premiums paid on the policy by the employer deductible? Are the proceeds from the policy taxable? A8 The premiums for the investment portion are not deductible because they are of a capital nature. Only the premiums for the risk portion are deductible (provided the policy has the features as mentioned in A1). An apportionment of the premiums is necessary. The proceeds relating to the investment portion are not taxable. The proceeds relating to the risk portion are taxable. Q9 If the employer is required under the law to pay compensation to the employee on injury or death etc. and the employer takes out an insurance policy to cover

such legal obligation (e.g. workers' compensation under the Employment Ordinance), are the premiums paid on such policy deductible? Are the proceeds from the policy taxable? A9 Yes, the premiums are deductible, being normal business expenses. Such policy is not a keyman policy. The proceeds are not taxable. Q10If the employer paid premiums on an insurance policy taken out for the purpose of providing funds to any person (e.g. one of the partners), in the event of death of an insured person (e.g. the other partner), to acquire partnership interests or shares of a limited company, are the premiums paid on such policy deductible? Are the proceeds from such policy taxable? (Note: Normally, the main purpose of such insurance arrangement is to prevent cessation of business by reason of the death of an owner of the business.) A10 No, the premiums are not deductible. The premiums are regarded as private expenses or capital expenditure. Such policy is not a keyman policy referred to in Q1. The proceeds are not taxable.

Key man insurance, FAQ

In April 2010 the British Chamber Of Commerce commissioned research into the Business Protection Gap for Key Man Insurance and Ownership Protection, which produced startling results. The reported gap is approximately 400 billion. Surely this is an additional expense my business could do without? In times of austerity we all have to look carefully at what we spend, both as individuals and businesses. However, most of us insure our cars, our houses and it's contents, our pets, our mobile phones etc. It must make sense to insure the entity that makes it possible to have all the secondary items, as surely one may argue that losing a business would be a far bigger financial cost. What exactly is a keyman? A key man is any valuable member of your company who, should they pass away or suffer from a critical illness, will result in financial losses for the company. The most common types of a keyman are: Company directors, shareholders, CEOs, chairman, partners. Also a sales manager or top salesperson could be a significant loss to a company.

In a manufacturing environment the loss of someone with expert technical knowledge would impact negatively on an important project. The ability to hire an immediate replacement could mean the company carries on trading, or suffer damage to reputation and profit. How do I know what level of cover I need? There are many expenses that could be incurred, whether recruitment or lost of turnover and income. We have a selection of experienced advisers who can assist in helping you calculate the level of cover that is right for you. What type of policy is Ownership Protection? Ownership Protection is there for shareholders or partners in the firm, but of course the premium needed to cover the different owners will vary due to age and shareholding. How much cover is needed will vary dependent on the value of a Partner's or Director's shareholding which can fluctuate over time. Therefore, it's wise to evaluate the amount of cover needed on at least a yearly basis. The partners and directors pay the premiums. The company can pay on their behalf but this will usually be classed as a benefit in kind and the director / partner will then have a personal tax obligation. The premiums will normally depend on a few factors:

The age of the Directors with share holdings Possibly their medical conditions if the sum insured is large, and The percentage of shares the Partner/Director owns

As the directors will normally always be of different ages and have different shareholdings a premium calculation equation can be used. This means that each director's premium will vary. The premiums in most cases don't attract tax-relief and if the policy pays out this is usually taxfree. How would the policy be set up? If the business is adopting either a cross option or buy and sell arrangement (these are types of legal agreements allowing the swaping of shares for cash you adviser can explain in more detail) for the purchase of a business interest, each shareholding director or partner would take out a policy on their own life. Each policy should be written under a suitable trust (often called a business trust) for the benefit of their co-directors/co-partners. If partners are using the automatic accrual method, each partner would be expected to take out and maintain a term assurance policy, written under trust for the benefit of their family (as recompense for not inheriting the business assets). What is Business Loan protection insurance?

As its name suggests it's a form of insurance designed to repay all or part of a company's debts should a key employee die or suffer a critical illness. It is a more restrictive policy than another form of keyman insurance called profit protection as the money can only be used to repay debt, including an overdraft facility rather than for general use such as shore up profits or retrain and recruit staff etc.
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Key man insurance cover FAQs

Q1 Are the proceeds from the policy taxable? The proceeds from a key man insurance payout are taxable as a trading receipt of the employer, as the proceeds act as compensation for lost profits. Q2 If the employer is a sole trade or partnership and the insured individual is the sole proprietor or a partner, are the premiums paid on the policy deductable? And are the proceeds from the policy taxable? The premiums are not deductable as a key man policy is only applicable in the case of an employeremployee relationship. A sole proprietor is not an employee and therefore the premiums are regarded as a private expense. The proceeds are not taxable. Q3 If the employer is a limited company and the individual insured is a director owning substantial shares in the company, are the premiums paid tax deductable? And are the proceeds deductable?

The premiums are not deductable. The purpose of the policy is considered to be to protect the value of shares, as the life and well-being of a director is assumed to have a significant effect on the value of shares. The proceeds are not taxable. Q4 Are the premiums paid on the policy tax deductible if the proceeds of the cover are payable to the family of the employee or employer? And are the proceeds from the policy taxable? No, the premiums are not deductible. The purpose of the policy is not to compensate the employers loss of profits, but to protect the family of the employee. The proceeds received by the employees family are not taxable. Q5 If the policy is not a term policy, but is a life policy carrying a surrender value or an endowment policy, are the premiums paid on the employer deductible? And are the proceeds from the policy taxable? No, the premiums are not deductible. They are regarded as expenditure of a capital nature. The proceeds are not taxable We hope that this key man cover FAQ section helps you with any issues you may have. If you require any further information please do not hesitate to call our friendly and knowledgeable team on 029 2069 5937 or email [email protected].

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Key Person Insurance: Frequently Asked Questions

How does my business apply for key person insurance?

Once you have chosen the insurer you want to go with for your key person insurance, you will submit a quote request. The insurer will then review your industry, the marketplace, your application details and the benefit amount you have requested and provide you with a proposal for the policy.

How much will I get?

Policies will usually pay out up to 75% of your normal gross income.

Is it tax-deductible?

For an individual, Income protection insurance is tax deductible and the benefits when paid are considered taxable income.

When will I get paid?

Waiting periods (The time you must be unable to work before you start receiving payout income) range from 14 days to two years, the shorter the waiting period, the higher the premium. The cause of your sickness or injury does not need to be work-related.

Does my age affect the premium I have to pay?

Generally speaking, the older you are, the more likely you are to suffer illness, therefore the premium you pay will be higher; smoking is also seen as an added level of risk and usually sees your premium rise. You will then have the opportunity to review the proposal and ask any questions you may have. If you want to go ahead with the policy, you notify the insurer and they can help you complete the application over the phone, generally in less than half an hour. Once the application has been submitted, the insurance underwriter will review the application and issue a policy. Alternatively the underwriter may ask for additional information such as a medical history or a medical exam. When the policy is issued, there may be certain terms or exclusions applied to the policy depending on the circumstances, but most insurers will attempt to offer some form of cover.

How do I choose an insurance company?

It is important to match your insurance needs to your insurance company, so as you shop around for policies look for an insurer who has experience with your industry, or your type of business for example some insurers specialise in key person insurance for large corporations, while others focus on insurance for small businesses.

What do I need to know before taking out key person insurance?

There are four important points you need to consider to make sure you are taking out the right key person insurance policy: o Know why you need key person insurance. It is important to identify from the beginning the effects that losing a key person would have on your business operations and success. You will then more easily be able to estimate the cover amounts and inclusions you need. o Work out the benefits you need. Your key person insurance needs to cover the costs for paying out loans, paying off debts, personal guarantees, covering lost revenue, paying recruiting and training costs, and paying the salary of replacement employees. o Know the different types of cover. There are two main types of key person insurance, key person revenue cover replaces lost revenue within the company. Key person capital will pay a benefit amount to meet any loans or capital expenses. o structure of the policy. It is important that your key person insurance policy is structured correctly to avoid any complications with paying the benefit, or triggering capital gains tax implications. You also want to make sure the policy is structured to allow for tax deductible premiums.

How much key person insurance is enough?

You need to look carefully at your business in order to answer that, as the coverage amount will depend on your current business commitments, and the role of the key person. There are a number of ways you can calculate a coverage amount: Replacement cost method. Work out the costs to replace the key person. Contributions to earnings method. Take out key person insurance for the percentage their earnings contribute to company revenue. Multiples of income. Use the current salary of the key person, multiplied.

What is a business partner buy-sell agreement?

You will need to look at having a buy-sell agreement in place if you haven't signed a succession agreement, and there is no crediting provision for the transfer of assets to the remaining business owners in event of one owner's death. Without this the estate could ask for payment of the value of the business, even though insurance benefits have been paid. Therefore, it is important to have a succession agreement clearly documented. The business partner buy-sell agreement should also be reviewed annually to take into account when circumstances change. For example, debt levels may be higher or lower, business profits may be up or down, or new key persons may have come on board. As the value of the business changes over the years, there may be the need for 'put' and 'call' options. The purchase price of the business may be reviewed over time while the key business owners are still alive, and having a call option which can be exercised by the purchaser, and a put option which can be used by the vendor, it avoid disputes if one owner dies and either the purchaser or the vendor can exercise their options.

How long does it take for key person insurance to be approved?

In some cases banks will require key person insurance to be in place before approving a new business loan. Therefore, you will want your insurance to be approved as quickly as possible. Depending on the medical test required, and how long it takes to obtain health records from your doctor, approval can take around four to six weeks.

Why does my bank have an assigned interest on my key person policy?

In some cases banks will require key person insurance to be in place before approving a new business loan. Therefore, you will want your insurance to be approved as quickly as possible. Depending on the medical test required, and how long it takes to obtain health records from your doctor, approval can take around four to six weeks. When the bank has an assigned interest on your policy, you still retain ownership of the policy, and the bank is listed as an interested party. This means the bank is notified when a benefit is paid to your business, even if they are not the beneficiaries of the policy. Key person insurance is a valuable business asset regardless of your industry, business structure or size. If you want to protect your hard work and the efforts of your important team members, then key person insurance is an easy and affordable way to do just that.

You spend a lot of time and money sourcing the right people to work in your business, and as a good business owner you know the true value of the right staff goes far beyond the sales they

make or the money they save you. The key people in your business are important for morale, for inspiration, for motivation and for support, and if you were to lose a key member of your team, you'd be dealing with a lot of things, just one of which would be the financial implications. Then there is the personal contribution you make to the business, which is something you may not think a lot about, because your dedication and commitment to the success of your company just comes with the territory of being a business owner. However, if you weren't there to contribute yourself to the business processes, would your team be as productive; would your business be as successful? Therefore, to help ensure the effort you've put into your business in a million different ways isn't in vain, insure one of your greatest business assets, yourself and they key people in your team, with key person insurance. Key person insurance is easy to obtain, and if you're worried about your cash flow or bottom line, then remember it's tax deductible too.
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