In certain circumstances, protection policies may be arranged as part of a business arrangement.
There is two such arrangements: Partnership Insurance & Keyperson Insurance
Many small businesses are run by two or more individuals working together, either as:
- a partnership (i.e. two or more individuals carrying on business together with a view to making a profit), or
- as co-directors and shareholders of a private limited company.
In either structure (Partnership or limited company) the sudden death of a partner can cause immediate financial problems for the surviving partners Partnership Insurance is an arrangement designed to meet the needs outlined above.
There are two key components to the structure of a Partnership Insurance arrangement:
There is a legal agreement, often called a Buy/Sell Agreement, between the partners, under which on the death of a partner the deceased partner’s next of kin are bound to sell, and the surviving partners bound to buy, the share of the deceased partner. Hence the term Buy/Sell Agreement, i.e. it is an agreement to buy and sell a partner’s share of the business on death.
To ensure that the surviving partners are in a financial position to complete the transaction, each partner’s life would be insured for a sum assured equal to the estimated value of their share of the business, in order to provide sufficient liquid capital on death for the surviving partners.
A company is a separate legal entity from its shareholders and employees. Therefore the death of a shareholder or employee does not directly cause the ‘death’ of the company. However the death of a “key” shareholder or employee could, in certain circumstances, lead to a financial loss to the company, due to the loss of the particular expertise, reputation, experience and contacts the individual had.
Keyperson Insurance seeks to financially protect the shareholders of the company against this potential loss. Keyperson Insurance is therefore a term used to describe life assurance effected by a company on the life of one of its key employees or directors with a view to compensating the company for an anticipated financial loss of profits following the death of that individual.
The death of a key employee or director, could cause a financial loss to the company in two different ways:
Loans to the company could become repayable, particularly any loans from banks or any other institutions for which the individual had given a personal guarantee or indeed any loans made by the individual himself to the company which would now be repayable to his or her estate.
Loss of profits caused by the loss of the individual’s expertise, experience, contacts and knowledge of the business.
Quantifying the loans that may need to be repaid is easy. It is much more difficult to quantify the loss of profits. A Keyperson Insurance policy is a life of another policy, with the company as the proposer and policyholder, and the key employee as the life assured. Normally the directors would pass a Special Resolution to authorise the company to effect the policy and to clarify that the policy is being effected for the benefit of the company and NOT for the benefit of the individual’s estate.