Key Person Insurance Facts
- Most key person assurance in the corporate market is written for Small and medium sized companies.
- Care needs to be taken in arranging key person insurance contracts on major shareholders because their death may result in a large cash payment to the company and business property relief may be restricted because of the amount of cash in the company.
- Where the key person policy is being effected on a life of another basis, for the policy to be justified on the grounds of insurable interest, there must be a financial loss that will arise to the grantee (e.g. the company) on the death of the key person.
- The amount of cover provided by a Key Person policy should be determined by assessing the extent of the potential financial loss to the business on the death of the key person. In this context, the life office underwriting the risk will usually be concerned that the level of cover effected is roughly commensurate with the financial loss that would be suffered and there is no over-insurance.
- There is no hard and fast rule for accurately assessing the level of cover required in any particular case but two formulae often used in respect of non-business owning employees are Multiple of Salary (usually 5 x but could be up to 10) and Proportion of Profits formula.
Multiple of Salary approach to Key Person insurance
- The two drawbacks of the Multiple of Salary approach to Key Person insurance are:
- Salary does not necessarily show an individual’s true value to the business;
- Salary alone may not be a true reflection of the person’s total earnings. This can be overcome by using a total earnings formula.
- Salary alone may not be a true reflection of the person’s total earnings. Other benefits can increase the total remuneration package substantially such as pension contributions, share incentive schemes and bonuses.
- Even though Multiple of salary has significant drawbacks, it is the one most commonly quoted and favoured by insurers and reinsurers.
- The Multiple of salary does not allow for a time factor so a key person who is nearing retirement may be worth less to the company than an employee or director who is rather younger.
- The Proportion of Profits formula is regarded as being a more scientific approach for calculating Key Person protection.
- The general practice in dealing with insurance by employers on the lives of employees is to treat the premiums as admissible deductions, and any sums received under a policy as trading receipts if the sole relationship is that of employer and employee, the insurance is intended to meet loss of profit resulting from the loss of services of the employee and it is an annual or short-term insurance.
Key Person Insurance Tax Relief
- The tax treatment of Key Person policies depends on the facts of each case, and the practice of local tax offices can vary. Every company proposing to take out a key person policy should obtain guidance on the possible tax treatment of premiums and benefits from its own tax office before completing the arrangement. These are general rules that obtaining tax relief:
- It is given on most term assurance premiums.
- If tax relief is given on premiums, the benefits are generally taxed.
- It is not normally given on the premiums to any other type of policy. This is because they are treated as building up a capital sum.
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