Cov­er­ing the key peo­ple

RISKSA Magazine - - CONTENTS - Do­minic Uys

It has al­ways been true that the big­gest as­set to a busi­ness is its peo­ple. Los­ing the peo­ple who make up the cor­ner­stones of any busi­ness can have a dev­as­tat­ing ef­fect on the com­pany. While there is still no way of in­sur­ing your­self against key per­sons leav­ing the com­pany, key person in­sur­ance does of­fer some help when tragedy strikes.

Key person cover is a life in­sur­ance that en­sures busi­nesses are able to re­coup the fi­nan­cial loss to a com­pany af­ter one of its cor­ner­stones un­ex­pect­edly passes away. The fact re­mains that, es­pe­cially in a coun­try where skills are in short sup­ply, qual­i­fied peo­ple are dif­fi­cult to find and em­ploy­ees who con­trib­ute spe­cial­ist skills and knowl­edge are vi­tal to the prof­itabil­ity of their com­pa­nies. Recruitment, train­ing and down­time all cost sig­nif­i­cant amounts of money and there is usu­ally no quick way around it. Al­ter­na­tively, the cover can be used to pay salaries and debts if an ir­re­place­able mem­ber of the com­pany passes away. The loss of a direc­tor or a CEO in a small com­pany usu­ally spells the end of the busi­ness but com­pany debts and re­spon­si­bil­i­ties to em­ploy­ees does not go away. Prod­uct spe­cial­ist at Al­trisk, An­dre Frone­man tells RISKSA that struc­turally, key person in­sur­ance has been the same for quite some time, but it re­mains a very im­por­tant part of any

busi­ness struc­ture. “The only thing that changed re­cently was tax leg­is­la­tion re­mov­ing CGT from a key person life cover,” he says. “We do not have key man cover in place, as such but in the case of Al­trisk, we did put to­gether a num­ber of so­lu­tions to take care of this for busi­ness. The dilemma that the busi­ness sits with is just life in­sur­ance be­cause they prob­a­bly do not have a flush amount of R5 mil­lion lay­ing around for re­place­ment costs. The best thing to do is to take out an in­sur­ance pol­icy, and the com­pany be­comes the pol­icy owner,” he says. “You need a nor­mal life in­sur­ance pol­icy to do that. All we do from an in­surer’s per­spec­tive is at­tach an en­dorse­ment to the pol­icy say­ing that the pol­icy qual­i­fies for the rel­e­vant tax de­duc­tions,” Frone­man says.

Cal­cu­lat­ing a client’s cover

Ac­cord­ing to Al­trisk, un­der­stand­ing a client’s busi­ness dy­nam­ics is es­sen­tial to cal­cu­lat­ing the amount of cover re­quired. One needs to study the im­pact that a key person loss would have on the turnover of the com­pany. “What could the cost of recruitment or head­hunt­ing be? Re­mem­ber that, the more spe­cialised and en­trenched the person is in the busi­ness, the more dif­fi­cult it will be to find a suit­able re­place­ment. To suc­cess­fully cal­cu­late key man cover, dis­cuss the fol­low­ing im­por­tant points with your client: cal­cu­late the ac­tual costs in­volved in re­plac­ing the em­ployee and the cost of a con­sul­tant un­til a re­place­ment is in place; cal­cu­late the ap­prox­i­mate num­ber of years it would take for a re­place­ment to equal the key person in terms of prof­itabil­ity and knowl­edge, and con­sider a mul­ti­ple of the an­nual salary of the key em­ployee as a bench­mark of what it would cost to re­place them with some­one of the same cal­i­bre,” the com­pany ad­vises. “As the pro­ceeds of a key- man pol­icy are paid to the em­ployer or busi­ness part­ner, it is of­ten as­sumed by the in­sured in­di­vid­ual that there will be no es­tate duty im­pli­ca­tions for them. While this is of­ten true, there can be ex­cep­tions de­pend­ing on the struc­ture of the ar­range­ment. It is es­sen­tial to en­sure that any es­tate duty im­pli­ca­tions are care­fully con­sid­ered and that you man­age your client’s ex­pec­ta­tions in this re­gard,” Al­trisk adds.

The move away from large com­pa­nies

Just like life in­sur­ance, there is cur­rently no real way to insure the key po­si­tions in the com­pany, only key peo­ple. This means that the pre­mi­ums spent on key peo­ple are lost when they leave the com­pany. Chris Kil­foil, fi­nan­cial ad­vi­sor at Squier Fi­nan­cial Ser­vices tells RISKSA that larger or­gan­i­sa­tions are mov­ing away from this kind of in­sur­ance for key po­si­tions, opt­ing to rather in­sti­tute buf­fers within the com­pany and well de­vised suc­ces­sion plans in the event of death. “Smaller busi­nesses make up the ma­jor­ity of key person in­sur­ance sales for us, and they are still very much de­pen­dent on this model,” he starts. Though it is a grudge pur­chase, Kil­foil points out that loans at credit in­sti­tu­tions de­pend on hav­ing cover in place and it main­tains in­vestor con­fi­dence. It needs to be re­mem­bered that key person in­sur­ance is not an ‘ all or noth­ing’ sit­u­a­tion. “One must take into ac­count that death is not the only thing that can in­ter­rupt the busi­ness in terms of its key peo­ple. Sud­den dis­abil­ity is also pos­si­ble and if your key peo­ple are still able to func­tion in the busi­ness, but at a di­min­ished ca­pac­ity, hav­ing cov­ered for dis­abil­ity would make it much eas­ier to keep them in their roles while still com­pen­sat­ing for a mea­sur­able loss,” he says. This is how­ever one of the most im­por­tant fac­tors to re­mem­ber, ac­cord­ing to Kil­foil. “As an ad­vi­sor, you have to re­mem­ber that you can only cover your client for mea­sur­able dam­age to the busi­ness. There­fore, you have to get to know the busi­ness in­side and out, and you need to be able to put a mone­tary value to ev­ery­thing. Con­cepts like in­vestor con­fi­dence and losses that can­not be defini­tively linked to the loss, can’t be cov­ered,” he cau­tions. “We do have some chal­lenges in the area be­cause, in many cases, the direc­tor of a small to medium sized com­pany is also some­what older, which im­pacts the cost of pre­mi­ums,” Kil­foil states. He points to one ex­am­ple where a busi­ness run by a client in his seven­ties faced ex­tremely high pre­mi­ums. There is, un­for­tu­nately, no way around this and the only al­ter­na­tive is to put a suc­ces­sion plan in place that will al­low for the seam­less trans­fer­ence of the busi­ness. This does not how­ever solve the prob­lem of ap­ply­ing for loans. It is im­por­tant to re­mem­ber that key person cover is meant to cover busi­ness costs and Kil­foil points out that many ad­vis­ers and clients alike of­ten con­fuse buy- back in­sur­ance with key person cover. “Buy- back in­sur­ance is life cover that part­ners in a busi­ness take out on one another in order to buy the other’s shares in the event of death. In those cases, there needs to be a pro­vi­sion in the part­ners’ con­tract with each other and sep­a­rate life poli­cies on the life of each part­ner. Busi­nesses of­ten en­counter prob­lems down the line when they treat key person and buy- back as syn­ony­mous,” he con­cludes. Key person cover is un­likely to change much in the com­ing years and, ac­cord­ing to Frone­man, will al­ways be a vi­tal part of a busi­ness.

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