How would your business cope if a key person fell ill?

More than 80 per cent of small businesses have no cover if an important employee is unable to work. Chiara Cavaglieri reports

Ill-health or a debilitating accident is bad enough news for an employee, but for business owners it can mean curtains.

New research by Scottish Widows has found that 81 per cent of small-business people who have key people in their businesses are not covered for the loss in profit or cost of replacing those people. This is despite the fact that four in five sole traders believe they have at least one person whose loss through death, critical illness or serious accident would undermine the survival of the business.

"Ultimately, key people are just that – key," says Ian Hudson from independent financial adviser (IFA) Hudson Green. "Without a key person, businesses cease to function as they did before and can often come to an end as they know it. Sometimes, a key person may be the driving force and life blood of a business, keeping the ship on an even keel."

Generally, the smaller the company the more vulnerable it is to the loss of key members of its workforce. But many small businesses are too concerned about cash flow and the effects of the recession right now to prepare properly for the unexpected loss of a crucial member of staff.

Essentially, protection policies such as life insurance and critical illness cover work in the same way for small businesses as they do for those offered to individuals. Most policies can be tailored to the needs of the company. Critical illness cover can be purchased alone or combined with life insurance and provides protection against an employee being diagnosed with a serious condition. Income protection policies pay out a regular income if the person is unable to work because of illness or injury. For a business this might mean that the money can be used to pay for any temporary replacement staff.

"The main difference is the way they are written and how they are applied for in the advice process. It is absolutely essential that a business receives advice before attempting to cover themselves against the loss of a key person, without which cover could be inappropriate and inadequate," says Mr Hudson.

Key person insurance falls under the umbrella of life insurance and is taken out by a company to cover someone who is considered to be vital to the business. The aim of key person insurance is to compensate for any shortfalls arising from the loss, temporary or permanent, of a particular person. This can be anyone associated with the business who is deemed to play a significant or unique role and would therefore leave the business struggling if they were incapacitated. More often than not, this is the director or founding partner of the company but a key project manager, for example, may also fit the bill.

The cheapest and most basic policies will pay out on death only, while the more comprehensive will have a critical illness element which typically pays out for serious conditions such as cancer and heart attacks. Cover can be used for the short term and for the long term. There may be a transient need for protection during a specific project, for example, in which case a term assurance policy can be taken out. More likely is that an owner of the business, or perhaps the face of a business, will play a key role throughout their working lives in which case a "whole of life" assurance policy should be taken out.

When it comes to calculating the level of cover needed, there are no steadfast rules. But two common ways to work it out are profit calculation, such as five times net profit the key person brings into the company, or two times gross profit, and also using a multiple of the key person's salary, such as up to 10 times gross income of that person. Various factors need to be considered including replacing the key person and recouping lost profits. There is the cost of recruiting and training a replacement as well as the potential fallout from lost sales and specialised skills.

This kind of protection insurance is complex so it is best to get independent financial advice. The usual factors that affect the premiums of any life or health insurance policy apply, so health, age, smoking and occupation will all have an impact. According to Lifesearch, for a 30-year-old non-smoking male to be covered with key-man life insurance for 20 years, for £250,000, would cost £11.75 per month with Aviva. For a 40-year-old covered for 10 years it would cost £17.75 per month, again with Aviva.

"The nature of the key person's role could also impact upon premiums," says Danny Cox from IFA Hargreaves Lansdown. "For example, a site manager who spends considerable amounts of time on site and at heights will command a higher premium than people who never leave their desks."

Another significant issue is the protection of shareholder or partnership interests. For any business that is a company, most key-person policies can be written on a life of another basis. In the event of a claim, the proceeds will be paid to the company and there is no need for a trust to be used.

However, in England, partnerships do not have the same legal status. A shareholder protection plan can be written on the life of a director shareholder and placed into trust. In the event of death or illness, the money can then stay in the business as the plan then pays out to the trustees.

"The money can then be used by the surviving shareholders to repurchase shares which may have passed to a beneficiary who does not have the experience to make a worthwhile contribution to the business," says Matt Morris from broker LifeSearch.

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Selby Jennings: VP/SVP Credit Quant- NY- Investment Bank

    Not specified: Selby Jennings: VP/SVP Credit Quant Top tier investment bank i...

    Selby Jennings: Quantitative Research | Equity | New York

    Not specified: Selby Jennings: Quantitative Research | Global Equity | New Yor...

    Selby Jennings: SVP Model Validation

    Not specified: Selby Jennings: SVP Model Validation This top tiered investment...

    Selby Jennings: Oil Operations

    Highly Competitive: Selby Jennings: Our client, a leading European Oil trading...

    Day In a Page

    A timely reminder of the bloody anniversary we all forgot

    A timely reminder of the bloody anniversary we all forgot

    Who remembers that this week we enter the 150th anniversary year of the end of the American Civil War, asks Robert Fisk
    Homeless Veterans appeal: Former soldiers pay their respects to a friend who also served

    Homeless Veterans appeal

    Former soldiers pay their respects to a friend who also served
    Downfall of Dustin 'Screech' Diamond, the 'Saved By The Bell' star charged with bar stabbing

    Scarred by the bell

    The downfall of the TV star charged with bar stabbing
    Why 2014 was a year of technological let-downs

    Why 2014 was a year of technological let-downs

    Security breaches and overhyped start-ups dominated a year in which very little changed (save the size of your phone)
    Cuba's golf revolution: But will the revolutionary nation take 'bourgeois' game to its heart?

    Will revolutionary Cuba take 'bourgeois' golf to its heart?

    Fidel Castro ridiculed the game – but now investment in leisure resort projects is welcome
    The Locked Room Mysteries: As a new collection of the genre’s best is published, its editor Otto Penzler explains the rules of engagement

    The Locked Room Mysteries

    As a new collection of the genre’s best is published, its editor explains the rules of engagement
    Amy Adams on playing painter Margaret Keane in Tim Burton's Big Eyes

    How I made myself Keane

    Amy Adams hadn’t wanted to take the role of artist Margaret Keane, because she’d had enough of playing victims. But then she had a daughter, and saw the painter in a new light
    Ed Richards: Parting view of Ofcom chief. . . we hate jokes on the disabled

    Parting view of Ofcom chief... we hate jokes on the disabled

    Bad language once got TV viewers irate, inciting calls to broadcasting switchboards. But now there is a worse offender, says retiring head of the media watchdog, Ed Richards
    A look back at fashion in 2014: Wear in review

    Wear in review

    A look back at fashion in 2014
    Ian Herbert: My 10 hopes for sport in 2015. Might just one of them happen?

    Ian Herbert: My 10 hopes for sport in 2015

    Might just one of them happen?
    War with Isis: The West needs more than a White Knight

    The West needs more than a White Knight

    Despite billions spent on weapons, the US has not been able to counter Isis's gruesome tactics, says Patrick Cockburn
    Return to Helmand: Private Davey Graham recalls the day he was shot by the Taliban

    'The day I was shot by the Taliban'

    Private Davey Graham was shot five times during an ambush in 2007 - it was the first, controversial photograph to show the dangers our soldiers faced in Helmand province
    Revealed: the best and worst airlines for delays

    Revealed: the best and worst airlines for delays

    Many flyers are failing to claim compensation to which they are entitled, a new survey has found
    The stories that defined 2014: From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions

    The stories that defined 2014

    From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions
    Stoke-on-Trent becomes first British city to be classified as 'disaster resilient' by the United Nations

    Disaster looming? Now you know where to head...

    Which British city has become the first to be awarded special 'resilience' status by the UN?