2.2.12 Key Employee Insurance
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Most businesses have two essential resources - the physical assets
such as plant and machinery, and the people who manage and operate
the business.
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More often than not, the former is fully insured, the latter, in
terms of the value to the company, hardly ever.
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Of particular value to the company amongst the human resource are
those who add significantly to the value and profitability of the
business through their work as individuals, rather than as a team
member.
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Of the key employees who would fit the above description, not all
are necessarily directors or senior executives.
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Who will be classified as a key employee will depend on the industry
and the size of the business. The smaller the business, the greater
the likelihood of there being a key person and of identifying the
individual.
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The larger the organisation, with the greater potential for back-up
and safety nets, the less likely that the loss of any individual
would have a significant impact on the company, either its operation
or its final profits.
Identifying the key employee may be a simple matter of pointing to
the sole designer or salesperson. On the other hand, it may be necessary
to ask a few questions, such as:
- Who would you pay to keep.
- Who was head hunted into their post.
- Who deals with the important business connections.
- Who would you least like to leave.
- Who would be most difficult to replace.
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For loss through death, the company might perhaps consider:
- Term Assurance.
- Whole of Life.
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As key employee insurance is essentially a type of loss of profits
insurance, it should be taken into consideration that key employee
status is likely to disappear at some stage, and the potential for
lost profits become negligible.
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Consequently, a short-term policy is perhaps more relevant, particularly
if it can be renewed, escalated or indexed. Additionally, of course,
it may be the cheapest option, and may be more easily understood
by the client.
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Modern unit-linked whole of life policies may be an acceptable
alternative with their wide spread of sums assured and flexibility
to keep up with changing requirements.
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For loss through disability, the company might consider:
- Income protection insurance.
- Critical Illness.
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Short-term IPI policies may be useful for temporary replacement
of an element of cash flow, but do not really add value if the illness
is prolonged. This is because such policies are usually payable
for three to five years at the most, out of a policy period of perhaps
ten years.
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Critical Illness cover might be an alternative or an additional
route, perhaps best combined with either term assurance or whole
of life to provide a wider degree of cover.
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Generally, most short term assurances will qualify for relief on
premiums, but the company will be liable to tax on receipt of the
policy proceeds.
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Other policies such as whole life are treated as capital items,
and so may not enjoy relief on the premiums.
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The treatment does depend on the circumstances, however, and the
wise course would be to obtain guidance on the tax position from
the local tax inspector, as practice can vary from inspector to
inspector.
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It is not possible for a company to forego relief on premiums as
a way of escaping tax liability on payout. Relief must always depend
on 'allowability' as a trading expense, and so claiming an expense
or not is irrelevant. It follows, then, that the policy proceeds
are also not affected.
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Premium payments will generally attract tax relief provided it
can be shown that:
- The sole relationship is that of employee and employer, so major
shareholders who are insured may find that relief is not permitted
on their policy. This is because the benefit would be partly for
their personal benefit as a shareholder, and so would fail the 'wholly
and exclusively... for the purposes of trade' qualification for
expenses.
- The purpose of the policy is to meet loss of profits resulting
from loss of employee input. Consequently, any policy where part
of the premium goes towards investment content rather than protection
would not qualify for relief because again it would fail the 'wholly
and exclusively' test. This might also be taken to apply to convertible
term policies, because the conversion option means the possibility
of change over to an 'investment' policy. If the purpose of the
policy is to secure a loan, this would be seen as part of the cost
of raising capital and so would not be allowed.
- The policy is short-term, this generally being interpreted as
no more than 5 years, and excluding single premium policies.
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This means that the 'non-qualifying' rule means that any profit
or gains made on a policy would be treated as company income and
subject to corporation tax. Where the claim is on death, any profit
calculation is based on the surrender value immediately prior to
the death, not the pay out. Any gain, therefore, could be fairly
insignificant, especially in the early years.
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Generally, the rules for life assurance policies regarding taxation
of premium and policy proceeds apply to IPI policies.
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Critical illness policies are generally treated as term assurance
policies where the base policy does not have investment content
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