Staff Matters

“Key person” insurance is one way businesses can protect themselves from the financial implications of these unfortunate circumstances, but it is often an option that is overlooked.

What is key person insurance?

Key person policies are designed to offset any negative impact on profitability to a business following the loss, through death, serious illness or an accident, of a staff member who is essential to its running. This type of policy only covers unforeseen problems and cannot be used if the person simply decides to leave.

It is often thought key person insurance only applies to company directors or partners. This is not the case, but just who can be covered will vary depending on your business. The policy can apply to anyone whose loss would have an immediate impact on profits, such as a senior practice manager or a specialist surgeon.

Some organisations have key person policies that pay out on death, but do not cover critical illness, which can be just as big a risk. If, for instance, a managing director (MD) of a small company had a stroke and was incapacitated, it could cause a loss of confidence among clients with whom the MD had a close relationship. If the company had included critical illness cover as part of its key person policy, it would have been able to make a claim.

Identifying a key person

To identify individuals who are key to the business, start by considering who creates and drives your business. This will vary, depending on your practice and any specialist areas, but in addition to directors or partners and senior staff, this might also include individuals in client relationship or practice management – without whom the business could lose clients or profits.

An individual can be essential to a business for a multitude of reasons. Perhaps, he or she is responsible for an area that brings a lot of revenue to your practice, or he or she has built up significant client relationships over a number of years.

Even when key personnel have been identified, whether key person insurance is the best way to proceed will depend on how the case is viewed by HM Revenue and Customs (HMRC).

Tax issues

Depending on the terms of agreement, payouts under key person policies may qualify for tax relief. HMRC decides on a caseby-case basis which payouts are eligible, but there are no official guidelines.

However, past cases indicate tax relief is most likely in the following circumstances:

• The only relationship between the company and the key person whose life is being insured is that of employer and employee (except in the case of shareholding directors).

• The policy covers loss of profits only.

• The term covered under the policy is reasonable. Periods of five years, and sometimes up to 10 years, are generally deemed acceptable.

• The employee being insured does not hold a significant shareholding in the company.

Tax relief will not usually be available if the policy is intended as security for a loan or is on the life of a proprietor.

These are general guidelines, so to clarify the situation for an individual business it is important to talk to the local inspector of taxes.

If the staff member to be insured is unlikely to be defined as a “key person” under these rules, it may prove more tax efficient to look into other policies, such as shareholder protection policies, as key person policies that do not qualify for relief can incur corporation tax of up to 40 per cent – leaving considerably less money in the pot to cover the losses incurred.

In all cases, professional advice is vital in ensuring the policy and cover are appropriate for each organisation’s unique circumstances.