If you own a business, either solely or partly, have you considered what would happen to the business if you passed away or could no longer work due to disability or illness? Also, what impact would this have on your family?

There are three main business insurance concepts:

1.  Buy/sell purpose cover (also known as shareholder protection or share purchase insurance)
2.  Key personal capital purpose cover – includes business debt protection, guarantor protection, and loan account protection
3.  Key person revenue purpose cover

These three insurance concepts can be funded through lump sum insurances which includes:

• Life/Death insurance – pays out on death
• Total and Permanent Disability (TPD) insurance – pays out when you suffer an illness/disability that makes you unlikely to work again
• Trauma/Critical Illness insurance – pays out on diagnosis of a critical illness (e.g., cancer, heart attack, stroke)

Life cover generally has no upper limit, whereas TPD and Trauma insurances generally have limits of $5 million and $2 million respectively. Some insurers offer a ‘reserve’ TPD benefit which can provide up to $15 million of TPD insurance through a combination of Own Occupation, Any Occupation, and Activities of Daily Living (ADL) definitions. Similarly, some insurers also offer a reserve Trauma benefit which can provide a sum insured up to $10 million, with amounts over $2 million restricted to specific severe medical events and with additional exclusions.

Buy/sell insurance

This type of insurance is used where there are two or more business partners. It provides the funding mechanism to allow the surviving/able business partner to acquire the share of the business from the party who has passed away, become disabled, or suffered a critical illness. The buy/sell insurance plan should be supported by a legally enforceable agreement, which is why they’re often referred to as buy/sell agreements.

The sums insured should address and satisfy a few areas including:

• Providing enough funds to allow for an orderly transfer of business equity
• An allowance for any Capital Gains Tax (CGT) that may be payable on the transfer of the business equity from one owner to the other

Self-ownership of buy/sell agreements is generally considered the best ownership structure, as this allows the life insured to leave the business and maintain control of the policy. Furthermore, when insurance policies are self-owned, there is no CGT payable on the trigger of the policy. However, if there is an asset being disposed of, this may lead to a CGT event and subsequent CGT liability, hence why there should be an allowance got CGT in the sum insured.

Buy/sell agreements cannot be owned through superannuation as this contravenes the Superannuation Industry (Supervision) Act 1993.

Key Person Insurance

This type of insurance protects a business in the event of the loss of a person who makes a significant contribution to its profitability or stability. Key persons usually have a particular skill or ability that is integral to the success of the business and are therefore difficult and expensive to replace. Key person insurance is more important for small and medium businesses, as these would be impacted by the loss of a key person more than a larger business.

Key person capital purpose cover ensures the business’ ongoing survival after the loss of a key person by providing capital to maintain the capital value of a business.

This type of policy is best owned by the business as it is the business that needs to receive the benefit of the policy.

CGT usually isn’t payable on life insurance proceeds. However, it may be payable on any TPD or Trauma proceeds that are paid to the business.

Key person revenue purpose cover is the more common type of key person insurance and provides compensation to the business for the loss of an employee where their death or temporary/total permanent disability may have an adverse effect on the profit and revenue of the business.

Again, as it is the business that needs to receive the benefit, this type of policy is best owned by the business.

Any proceeds paid to the policy owner would be considered assessable income to the policy owner, however, the owner may be able to claim a tax deduction for the policy premiums.

The sum insured is generally based on the potential loss of profit and revenue that would normally have been generated by the key person. This is determined by how long it would take to replace them, the time taken by the new person to reach full capacity, and other costs of replacement such as recruitment and training costs. The sum insured should also include consideration for any tax which may have to be paid on the policy’s proceeds.

If you have any questions regarding personal or business insurance, please do not hesitate to contact the Risk & Insurance team at Hewison Private Wealth. You can submit your queries HERE.