What is profit protection?
The easiest way to explain the meaning of profit protection is with a hypothetical example.
Alan Taylor is the Managing Director of a private limited company. The company is recognised as one of the foremost design agencies in Scotland. Sales revenues are increasing and much of this is down to the tireless enthusiasm of Donald Sime, the Sales Director. His skills have meant many accounts have been snatched away from larger established agencies. Indeed, his most recent successful pitch has netted a contract that will guarantee expansion for the next five years.
Alan is confident that, with the help of recently agreed finance from a bank, the company can look forward to a rewarding and profitable future.
Then everything changed, Alan was greeted with the tragic news Donald had been killed in a traffic accident. After the initial shock, Alan’s thoughts turned to Donald’s family. How must they be feeling? Will they be okay financially?
But then he began to think about the implications of Donald’s death on the future of the business. What if an important contract is now in danger without Donald’s expertise and enthusiasm to manage the account? To many people Donald is the company - will his death mean loss of sales and loss of new accounts? Loss of sales will have a detrimental effect on cash flow, profits and turnover. What happens if the bank loses confidence in the company and decides to call in the recent loan?
Donald was a key employee. Alan has to face the reality that Donald’s death could also be the death of the business.
A cash injection from a life assurance product on Donald’s life could replace lost revenue, pay off outstanding loans, or even cover the cost of recruiting a replacement. Most importantly, it could give Alan’s company the financial breathing space it needs to reassess its strategy and refocus its remaining resources. Any cover should be placed in the correct trust to ensure payment is made correctly and tax efficiently.
Understanding the need for keyperson cover
In many ways, businesses already acknowledge the problems they may face if a key individual leaves. All job adverts for key positions describe the excellent salary the successful applicant will earn. They also regularly describe the company car, potential bonus, health care and pension scheme.
Despite this irrefutable logic, many companies do not have any form of keyperson cover. Why should this be? The main reason is usually lack of awareness.
These packages are designed not only to attract the best qualified staff but also to ensure those people remain in the position. If one of these executives received a better offer from a competitor, it is likely they would be offered a financial incentive to stay. So, the business is effectively insuring itself from a key individual leaving of their own free will. It would be prudent to pay a similar financial amount to protect a company against the financial consequences of a person leaving through critical illness or death.
Keyperson insurance is a form of profit protection.
Coverage
One of the first things to do is conduct a comprehensive analysis of who is actually a key person to the business. Identifying prospects requires a certain amount of knowledge about how businesses are structured. This requires a discussion to understand the impact of each key employee and the impact if anything were to happen to them. Sometimes key people are not the most obvious ones and therefore it is important to take a thorough approach.
Potential tax savings
Most premiums will be eligible for corporation tax relief if set up correctly, significantly reducing the upfront cost for the business.
Summary
Keyperson cover is often an overlooked area of risk management in business and even when it is taken it, it is not always sufficient. Far too often business critical individuals are missed off of the insurance or costs are overestimated due to a lack of knowledge surrounding tax reliefs. When it comes to keyperson cover, for many it would be prudent to reflect on the well-known business maxim “hope for the best, but prepare for the worst.”
Author
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Financial PlannerApprover Quilter Financial Services Limited & Quilter Mortgage Planning Limited 29/12/2023
All references to clients’ examples in this article are fictitious.
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