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What is Profit Protection Insurance

(a subset of Keyman Insurance)

And why all businesses should consider it

Page Summary:

Keyman insurance and in turn Profit Protection falls under the umbrella of Business Protection Insurance.

Find out on this page what it is and how it works, as well as its advantages and disadvantages.

What is Profit Protection insurance

Important explanation

Keyman insurance falls under the main insurance umbrella of Business Protection insurance and there are 3 different policies available -

  1. Profit Protection which is discussed on this page
  2. Loan protection, and
  3. Ownership Protection

You also might like to read The introduction to Keyman Insurance page

What is Profit Protection insurance - How does it work

A profit protection Keyman insurance policy pays out a cash sum to the business if a key worker dies or is unable to work due to a critical illness. The money can be used by the company in a myriad of ways, perhaps helping to shore up profits, cover an overdraft, recruitment or security in cash reserves.

Who it is designed for

Some or all the following are usually deemed as key workers -

  • Managing Director/CEO or Executive Chairman etc
  • Head of sales/Marketing
  • Star salesmen
  • IT and Finance Directors
How to work out the level of cover needed

Use the following formula to get an indication of the amount of cover needed. Then go into more detail with your insurance broker.

A worked example

  • The Keyman insurance is for the managing director who is paid £50k pa
  • The company's total payroll is £250k pa
  • Average gross profit over the last 2 years was £200k
  • Assume the company would take 3 years to recover from the MD's death or if he's unable to work due to a critical illness

(£50k/£250k) x £200k x 3 years = £120,000 of Profit Protection cover

Another formula to use

Another way to easily calculate the amount of cover needed it to use the rough and ready rule of:

3-10 times an employees salary

Use it to get a quick estimation of the kind of cover needed for different types of key employees. For example, although a Finance Director of any company is important they're often not the driving force and vision behind the firm. So using the 3-4 times their salary might be appropriate.

However, for a key mover and shaker in the firm use 5+ annual salary and maybe even up to 10 times should they be absolutely critical to the ongoing success of the firm.

Who pays the premiums and are they tax deductible

The company will pay the premiums of a profit protection plan.

How the premiums are treated in relation to tax is usually tricky and clouded in uncertainty. The Inland Revenue will normally grant tax-relief but then if the policy pays out the cash lump sum will often be treated as income, and therefore taxed.

Use a staggered payment schedule to reduce tax

When setting up a policy it's normally possible to agree to any payments being spread over 2-5 years. This will in turn reduce any corporation tax obligations.

However, as indicated throughout these pages it's imperative to seek proper tax guidance from your company's Finance Director plus directly from the Inland Revenue.

Advantages To Profit Protection insurance
  • It's sensible future planning - A well run and successful company is as much about preparing for the future as it is running the everyday operations

  • Shore up profits - Studies have shown that nearly 50% of smaller business owners expect their company to fold within 12 months of a key person either passing away or suffering a critical illness. A higher percentage expect their companies to serious struggle

  • Money to be used to train and recruit new staff - Recruiting well qualified staff is usually expensive and can take considerable time and yes it's a business cliché but time is money

  • Peace of mind for the company's bankers and backers - It's only common sense to reassure your banks and bankers that in the event of the death of a Keyman the company will have the problem covered

  • Cost - Many view Keyman insurance as money well spent, not because of its actual cost, rather the real cost to the company if a Keyman dies and in turn the turmoil that might cause
Disadvantages
  • Often bundled with a corporate loan - Watch out for this as some banks will try to add on protection insurance with any loan or credit they grant. The better strategy is to shop around and buy this insurance independently

  • Thought is needed to get the right policy - Each business is different, each has different aims, obligations and of course different key people. For this reason a business protection plan is not so hard to setup but a lot of thought has to go into what cover is needed, who needs to be covered and in turn to what degree. For example, a CEO who is the driving force behind the company will probably need more cover than the Finance Director

  • Specialised insurance - Business protection insurance is obviously not as popular as car or home insurance. It's far more specialised and so it can take time to set up and organise the right policy
Do you need Profit Protection insurance
A good way to determine if you or your business needs a Keyman insurance policy is by asking the following questions -
  • Do you have at least 1 key person in your firm?

  • If a key member of your company dies or suffers from a critical illness and is out of action for a long period of time would the business still be operating in 12 months?

  • And if still in operation after 12 months would the profits be serious affected?

  • If your fellow executives or partners have a substantial shareholding in the firm, who would these shares be transferred to in the case of their death? If it's a child or spouse that might cause the business problems especially as they would be unlikely to have commercial experience.

  • Is your company's debt and loan obligations insured? And if not what would happen if a key person, especially a major profit generator, dies or suffers from a critical illness?

  • Is there a risk of any personal guarantees being called in by your banker's if a key person passes away or suffers a critical illness?

  • If one or more of your top sales team were lost would your company's sales take a serious hit? Also, do your salesmen have invaluable contacts?

  • How many employees does your firm have? As a rule of thumb the less employees the more the firm will rely on 1-2 key employees
Why not half insure

One idea to consider concerning all forms of Keyman insurance including Profit Protection is to half insure a sum of money. For example, if the company's profits are around £100,000 a year why not consider insuring £50k or maybe even £30k?

The premiums will obviously be cheaper and if the policy pays out it will go a long way to both helping the company and reassuring its bankers and backers.

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