The business protection market remains a small segment of overall business written. Exact figures on...
The business protection market remains a small segment of overall business written. Exact figures on market penetration are hard to come by due to reporting anomalies, but around 5%
is considered a reasonable estimate. How can IFAs tap in to this potentially lucrative area and what are the opportunities for them to add value for their clients?
Human asset protection is another way of looking at protecting the business. It is also about business survival. Most companies will have insurance to protect the buildings, contents, plant, machinery and so on. Many, however, forget the importance of insuring against the loss of the people upon whom the success of the business has been built. For smaller businesses the loss of a key individual can have disastrous consequences.
Indentifying key people
Who are these key people? Invariably they will have some or all of the following: specialist knowledge or expertise; key contacts; entrepreneurial spirit; vision; and above all, the ability to affect the bottom line, the profits of the company. While names such as Richard Branson spring to mind as central to the success of his businesses, one could argue that his empire is large enough to survive his absence in the long term. Smaller businesses do not have such a luxury, and the future viability of the operation could be seriously affected should a key person die or become seriously ill or disabled.
Business protection does not just mean key people; partnerships and shareholdings often display the same characteristics. Organisations which rely on the skills, judgement and talents of a few key people, are equally vulnerable if such a person dies or becomes seriously ill or disabled. Posing the question 'what happens to the business ifÉ?' should give the opportunity to discuss the issues of control of the business as well as making plans for its continued prosperity and really brings home the need for business protection.
Forward-thinking IFAs are skilled at the ongoing task of revising the needs of their client base. Key to the success of marketing business protection is an understanding of the risks facing such operations. The head in the sand attitude is all too common a hurdle to overcome. The table on the previous page shows the percentages of businesses where at least one partner/director will die before the age of 65. For example, for a business with four director's aged 40, there is a 48% chance that one of them will die before age 65.
A man has a one in four chance of surviving a critical illness before retirement age the figure for women is one in five. Clearly these scenarios can pose problems if they become a reality.
Risk assessment
How can an IFA spot firms that would benefit from business protection? One way is to gain an understanding of the business through a risk management appraisal. This involves understanding the future risks that could affect the business.
Once an understanding of how financially secure the business is and what contingency plans are in place to ensure the financial well-being for the future has been reached, it becomes easier to identify the need for cover. Much of this information is readily available in the report and accounts and the business plans and projections of the business. For example, the balance sheet will identify any loans secured against the business how much do these rely on the skills of the key person?
The assets and liabilities of the company will reveal how financially secure the company is how long could the company cope with a dip in orders or sales if the key person no longer contributed to the business?
The notes to the accounts can also be particularly revealing, since details on salary, pension contributions and any existing business protection policies will be noted a great opportunity to spot any gaps in protection.
Selecting cover
The most common form of cover for this situation is straightforward term assurance; a cheap and effective means of protecting the business. With increasing job mobility, there is an argument for recommending shorter-term contracts such as renewable cover. This gives the business an opportunity to reassess the situation at each renewal, with five-year and one-year terms being the most common.
Critical illness cover is also a growing area, particularly those contracts that pay out on either death or critical illness, whichever occurs first. Features and benefits of these contracts to watch out for include guaranteed insurability options, which allow increases in line with the value of the key person, the availability of either a lump sum or instalments over a short period of time (to help tax mitigation) and inflation protection.
Income protection is also an important consideration and specific products have been designed for the keyperson market. This pays out for a limited term and is usually based on either the person's salary or a percentage of the company's averaged profits.
The right amount and type of cover will naturally depend on the way the business is set up. The tax and trust considerations of partnerships and shareholdings demand different and careful planning to ensure the best arrangement for the business. This is a key area where IFAs can add value.
Tax issues
The tax issues surrounding the setting up of such arrangements can be complex; many areas of tax relief relate to businesses and a thorough investigation is essential. Ensuring the right money ends up in the right hands at the right time can be achieved by a carefully worded trust document. The following case study illustrates the point and benefits to the business.
A partner of an expanding software development partnership dies unexpectedly while on holiday. The deceased partner is widely known for his technical expertise and has been the backbone of the success to date of the partnership. The partnership has a few assets to liquidate to buy the share of the business from the deceased's family. The bank may not be so willing to make a loan to assist the remaining partner's finance of the buy-out as the key partner will be difficult if not impossible to replace. The family want to sell the interest in the partnership as soon as possible.
This poses a serious dilemma for all concerned. If the partnership cannot make a reasonable offer, the family may sell their interest to a third party. This could lead to a take over or merger. In addition, if the remaining partners and the family cannot resolve the sale to everyone's satisfaction, the business may be forced in to liquidation.
This scenario could be avoided by carefully written term assurance combined with a share purchase agreement. This would have ensured that on the partner's death, a lump sum would be available to the remaining partners to give them sufficient funds to buy out the family. The partners then have the cash to retain control of the business and the family have the cash to meet their needs.
Types of trust
There are a number of ways to write policies under trust flexible trusts, single option and double option agreements. Making sure the right arrangement is in place to reflect the intentions of the firm and the type of cover that is in place is important. For example, CI business protection plans are usually written in conjunction with a single option agreement. This gives the afflicted shareholder the right to trigger the agreement depending on how serious the critical illness is; if the illness is serious and a return to work is not expected, the other shareholders will be obliged to buy them out using the proceeds of the CI policy.
It is clear that those IFAs armed with a clear understanding of their clients' business are in the best position to advise and put forward workable solutions for the small business market. Those who are keen to develop and grow this area are likely to find it rewarding as average sums assured and premiums tend to be higher. While a common objection is that cover is too expensive, it can be argued that premiums for term assurance and CI have never been so reasonable with many cuts being made over the last year. Guaranteed premiums are also seen by many to represent good value for money and give advantage of fixed costs for the term of the cover. Using smart language such as profit protection rather than business protection can help drive the message home.
With over 96% of firms employing less than 20 staff this is clearly a market waiting to blossom. IFAs are in the ideal position to foster its growth.
Rosalind Pearson is personal finance research and planning manager at Swiss Life (UK)
