Key Person Insurance - Protecting Your Greatest Assets

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Written by Commonwealth Bank

This article appeared in Issue 1#3 (Mar/Apr 2007)

of Business Franchise Australia & New Zealand

By Steward Creighton, National Manager Market Specialists, Commonwealth Bank of Australia

Have you considered what would happen to your business if you, or another key person, becomes sick, is injured or dies? For a business to continue to operate, a smart franchisee knows it’s essential to protect their investment with the right insurance cover.

Most businesses take out insurance cover for assets such as their plant, equipment, vehicles and buildings. But it is the people who use their initiative, drive, skill, specialist knowledge and ingenuity to turn capital and assets into profit.

It is essential for all franchisees and franchisors to consider the use of insurance to compensate the business for any financial loss suffered because an insured event has occurred with respect to a key person.

It’s also important to understand the taxation treatments for insurances.

What is a ‘key person’?

A ‘key person’ is someone whose continued association with a business provides that business with a significant and direct economic gain. Economic gain means more than just profits. It can, amongst other things, also include cost savings, capital injections, good will, access to credit and access to customers. A common example of a key person is a franchisee or an employee who is directly responsible for bringing in sales or who holds the key technical expertise on which a business relies.

How much key person insurance is needed?

Key person insurance can compensate the business for the loss of two different qualities:

business profitability (revenue purpose)
the capital value of the business (capital purpose).

Key person insurance proceeds can replace the lost profit or capital value that the key person would have generated. The funds can be used to stabilise the business until a suitable replacement person is employed who is capable of being trained to have the same key skills. Key person insurance proceeds can bridge the gap and enable the business to operate efficiently through, and after, the ordeal.

Key People Include

Franchisees are key people. Franchisors also employ a number of key people. While the following list is not exhaustive, a key person could also include a:

Managing director – whose expertise, ingenuity and ability enable the business to run smoothly, operate within budget and maintain a strong market presence;
Sales manager – whose unique contacts or business methods give the business a competitive edge;
Financial controller – who has set up a budgeting and reporting system that has saved the business money, and will continue to do so as the system evolves;
Operations director – who has established operational procedures that are important to the ongoing success of the business;
Working director – who does the work of two employees, but only draws a moderate salary, so that more money can go back into the business;
Silent partner – whose strong reputation with financiers allows the business to access more, or better, financing.

What insurance products can be used?

There are three policies which can all be applied:

Death;
Total and Permanent Disability (TPD); and
Trauma.

The sudden death, disability or traumatic illness of a franchisee has the most impact on the business if there has been no planning for the loss. Life insurance, TPD and trauma
insurance cover are the obvious solution.

What is the taxation treatment of key person insurance proceeds?

It is important to consider both the income tax and the capital gains tax (CGT) treatment of key person insurance. The income tax treatment of key person premiums and proceeds depends on the type of policy used and its purpose. Revenue purpose insurance premiums are tax deductible to the business, and the claim proceeds are assessable. Capital purpose insurance premiums are not tax deductible to the business and the claim proceeds are not assessable.

CommInsure is Australia’s largest life risk insurer, and has a solid track record for meeting claims payouts, treating every case with the best service and fairest assessment possible.

For more information contact the Commonwealth Bank franchising team on 02 8292 5611. The team can direct you to one of our insurance experts.

Financial Adviser: Brendan Krone

All franchisees need an adviser like Brendan Krone. As a Business Financial Adviser, Brendan supports franchisees by providing wealth protection options for their financial future.

“My role is to look after the franchisee by establishing a foundation of insurance,” said Brendan. The majority of clients take out Death, Total and Permanent Disability and Trauma cover. These products ensure a payout for practically all circumstances of death, sickness or injury. Stroke, cancer, heart attack, paraplegia, terminal illness, head trauma, mental disability preventing work, even severe depression preventing work, are just some of the trauma events covered under these policies.

“The actual cost to the client for this type of cover usually equates to less than one percent of the payout value. Yet, having this cover relieves the stress of meeting loan commitments should the unforeseen happen.

“It’s important for franchisees to ask themselves what would happen to their business, and to their family, if something unexpectedly happened to them, and they have no insurance in place. Would you need to sell the business? Would you lose your family home? Would you have to rely on borrowing heavily from friends and family? Insurance is the most simple and sure method of covering your exposure.

“Yes, you have to pay a premium, but this amount would be insignificant in the event of a claim. The fact is that males have a two in five chance of suffering a critical illness between the ages of 30 and 64, and the female statistic is one in four¹.

“Paying for general insurance cover is accepted as a fact of life. Most people accept that home and contents insurance, car insurance and even travel insurance are a necessary part of their budget. People realise that they can’t really afford not to have such insurances in place.

“The attitude towards Key Person and Life Insurance is not always the same. And yet, in reality it is your own skills and ability to generate income, as well as that of your key staff, which you should be insuring. For owner/managers, the inclusion of business loan protection (key person capital) insurance in your wealth protection portfolio is a logical safeguard.”

Brendan Krone is Manager Business Advice (Risk) at the Commonwealth Bank

¹ General Cologne Life Re Australia, 2002