Business Insurance
Business insurance considers the continuity of your business if it is ever hit by an unforeseen event, such as the illness or death of an owner or the impact of losing a key employee or a business partner.
For business owners, ensuring their business continues to operate in the event of a key person's illness and protecting the ownership and succession of their business should they die unexpectedly is often considered too complex or is often overlooked.
Unexpected events can and do occur in business life, as in daily life. Business owners can be temporarily or permanently disabled by sickness, accident, major health trauma, or even premature death.
Business interruption can be short-term, prolonged, or permanent. If a business cannot continue even for a few days, stakeholders, including suppliers, staff, clients, creditors, and family, can be severely impacted. Business owners should be concerned about business continuity.
When considering mitigating the negative impact of unexpected events, the simplest and most effective solution is implementing a business insurance strategy. These strategies can protect you as a business owner, your family as potential estate recipients, your business itself, your business partner and your clients.
Every owner has a unique set of requirements and potential challenges to consider. Business insurance needs to be carefully crafted to ensure the right strategy and the right level of coverage. As a guide, business owners should consider:
- Life Insurance (covering both asset and loan protection cover)
- Total & Permanent Disablement Insurance (covering both asset and loan protection cover)
- Trauma (Critical Illness) Insurance (covering both asset and loan protection cover)
- Income Protection Insurance
- Business Expenses Insurance
- together with buy/sell agreements and
- group insurance.
Key Person & Buy-Sell
A business can insure its key employees so that if they die or become disabled, the business receives a lump sum of cash to fund the financial losses it may incur. This could be due to the loss of customers or know-how that the key person delivered. It can also be used to repay debts or train a replacement so the business can continue to thrive.
Business partners can also insure each other to ensure a smooth transfer of ownership to the surviving partner if one partner should die prematurely.
Business insurance as part of a business succession plan
Whether your business is structured through a partnership, company or trust, few have effective mechanisms in place for the transfer of equity and/or control if one of the owners is lost to the business due to death, disablement or a critical illness. In many cases, the loss of a business owner from one of these events results in the demise of an otherwise healthy business simply because there was no succession plan and funding agreement in place. A business succession plan incorporating insurance funding protects your investment. It ensures the survival of your business should one of the business owners or a key person die, become disabled or suffer a critical illness.
Who is a key person?
Most businesses have one or more key persons whose skill, knowledge, experience and leadership ensure the
success of the business. A key person in any business may generally be defined as one whose death, disablement or early retirement may have an adverse economic effect on the business.
It is important to identify these key people and to quantify the adverse affect that is likely to be suffered by the business in the event of death, disablement or illness. There are three basic protection needs that typically apply to businesses:
• Asset Protection
• Revenue Protection, and
• Ownership Protection
Asset Protection
The most important asset to a business is not the obvious physical assets but the key person or persons.
In the event of a key person’s death or disablement, a business may be forced to sell assets to maintain cash flow – particularly if creditors press for payment or debtors hold back payment. Similarly, customers and suppliers may not feel confident in the trading capacity of the business and its credit rating could fall if lenders are not prepared to extend credit. Outstanding loans owed by the business to the owners (or their beneficiaries) may also be called up for immediate repayment.
What is Asset Protection?
Asset Protection can provide your business with enough cash to preserve its asset base so it can repay debts, free up cash flow and maintain its credit standing if a business owner or loan guarantor dies or becomes disabled. It can also release personal guarantees secured by the business owner’s assets (such as the family home).
Tax treatment of insurance premiums and proceeds
Asset Protection (or capital purpose debt protection) poses a complex set of taxation issues. In addition to the Capital Gain Tax (CGT) provisions that apply to all life and disability cover, the commercial debt forgiveness rules and the taxation of company profits as dividends must also be considered.
Generally, whilst the CGT provisions and the taxation of company profits favour individual beneficial ownership of cover, the commercial debt forgiveness rules tend to favour ownership of cover by the debtor (often the business).
As the priorities for various business principals will vary, Asset Protection ownership solutions for each business
is also likely to vary.
Revenue Protection
A drop in revenue is often inevitable when a key person is no longer there. Losses may also result from demand that can’t be met while finding and training a suitable replacement, errors of judgement by a less experienced replacement or through the reduced morale of employees. If there isn’t a suitable replacement within the business, it may take substantial time and financial inducement to find and train a successor.
What is Revenue Protection?
Revenue Protection can provide your business with cash to compensate for the loss of revenue and costs of replacing a key employee or business owner should they die or become disabled.
Tax treatment of insurance
premiums and proceeds Policies that are taken up for the purpose of protecting revenue are tax-deductible to the business, and the proceeds on payment are assessable income. Deductibility of revenue protection
premiums is contingent upon the purpose for cover and how the sum insured was calculated being clearly documented at the time the cover was taken out and at every review.
It is, therefore, prudent for you to prepare minutes that explain the purpose of the policy (i.e. to protect revenue) and the treatment of premiums and proceeds. This is required for auditing and taxation purposes.
Business Expenses Insurance
A complement to income protection insurance is business expense insurance. This type of cover ensures the portion of your business expenses for which you are responsible can be met should you be temporarily unable to work due to injury or illness.
Business Expenses insurance generally reimburses you for certain regular business expenses such as rent, utilities, lease costs and depreciation. It is important to note not all expenses will be covered. This can help cover your fixed business costs and keep your business afloat while you are recuperating. Generally, this type of insurance can cover up to 100% of eligible expenses up to the chosen benefit amount. The maximum benefit payment is for one year’s expenses. The reason is if you are disabled for longer than one year, the business would be disposed of or restructured in some way.
Ownership Protection
The death of a business owner can result in the demise of an otherwise successful business simply because of a lack of business succession planning. While business owners are alive, they may negotiate a buy-out amongst themselves, for example, on an owner’s retirement. But what if one of them dies? The remaining owners must now
negotiate with the deceased owner’s legal representative, who may be more concerned about the needs of the estate than the needs of the business.
Many business owners mistakenly believe this contingency has been catered for in the business’ constitutional documentation but often, there is no buy-out provision or
if there is, it’s often ineffectually drawn up and inadequately funded.
Similar issues arise when an owner is disabled and cannot (or no longer wishes to) be involved in the business.
What is Ownership Protection?
Ownership Protection can provide the continuing owners or their nominees with sufficient cash to transfer the outgoing owner’s equity to the continuing owners should a business owner die, become disabled, or suffer a critical illness.
Tax treatment of insurance premiums and proceeds
The premiums payable on non-superannuation policies, which are taken for the purpose of protecting ownership, are considered as being nontax deductible to the business owners. The proceeds are tax-free when the beneficial owner of the policy is the life insured or a relative of the life insured. The premiums on policies owned by the business owners and paid for by the business will generally be tax-deductible to the business but subject to Fringe Benefits Tax (FBT). This will lead to an increase in the effective cost of the insurance.
The premiums on policies owned by the business owners’ superannuation funds are tax-deductible to the trustee of the fund. This deduction is usually returned to the member’s account (being the business owner). Furthermore, the business owner may choose to arrange additional contributions to be made to the superannuation fund, which will generally either be tax deductible to their business entity or themselves. The proceeds of superannuation death benefits paid to most beneficiaries will be tax-free. However, benefits paid to certain beneficiaries – such as children who are financially independent – will attract some tax.
Similarly, Total Permanent Disability (TPD) benefits paid to business owners under age 60 as a lump sum will attract some tax. Where superannuation benefits paid to a member or their beneficiaries attract tax, the amount of insurance recommended
can be grossed up, so a desired net amount will be paid. While the additional insurance means a higher premium, the deduction received by the business entity or business owner for paying the premium will mean the cost of insurance will generally be less than if the insurance was arranged outside superannuation.
Business Succession Planning
What would happen to your business if you were to die or be unable to work due to illness or injury? Would your business partners want to buy out your share? Do you want your family burdened with business issues? How would the business afford to restructure by buying out the affected partner’s share?
By implementing a Buy/Sell agreement as part of an overall business succession plan, you can ensure a smooth transition of ownership and help keep the business running without upheaval.
We can apply our experience in setting up such structures to help take the worry out of the business succession. We work with accounting and legal advisers to get the valuation and documentation set up correctly, and we can show you how to fund the agreement efficiently to allow the succession plan to be implemented.
As you can see, Business insurance and business succession planning is a complex area and will need the involvement of a Financial Adviser and your accountant.
To speak to our team about your Business Succession Planning and business insurance needs, click here