Business insurance is seen by many advisers as an area to steer well clear of, believing it is too complex and therefore best left to those who fully understand all the intricacies involved.
But who are those who fully understand all the intricacies? While legal agreements and taxation issues are an integral part of business insurance, financial advisers and financial services companies are best placed to understand how risk products can be used to protect businesses against personal events that may jeopardise the ongoing viability of a business.
This places them in a better position to initiate and implement the risk protection needs of a business than the other parties involved, namely solicitors and accountants.
An underdeveloped market
Both financial services companies and adviser groups see business insurance as a largely underdeveloped market, despite there being an abundance of good technical literature available on the vast use of insurance products to minimise business risk.
But is this underdeveloped market due to a:
n lack of understanding on how insurance products can be used in business insurance?;
n lack of confidence in managing the legal and taxation aspects?; or
n misunderstanding as to who should project manage the process of bringing business insurance to fruition?
The solution for getting advisers writing more business insurance would appear to lie in a number of approaches.
One is the need for greater recognition by financial services companies of the technical assistance required by advisers. This primarily relates to simplifying the process for advisers to write business insurance, such as the provision of legal assistance for the writing of contracts, samples of contracts relating to the different types of business insurance, justifications for financial cover, and templates for advisers listing the financial information required from accountants.
Another is recognition by advisers of their role as the main contributor to protecting companies against insurable risk factors and acceptance of their key role as project manager in bringing all parties together.
The key benefits
For both advisers and financial services companies, the advantages of writing business insurance is that in many instances (such as buy/sell agreements) the insurance contract is inseparable from the legal contract, thereby helping to keep the policy in force for a much longer period than is the case for ordinary retail policies.
Put simply, business insurance exists for the same reasons that any other form of insurance exists — to protect the financial risks faced by the business and its owners. The complexities that surround business insurance lie not with its purpose, but in recognising the personal financial risks that business people face and project managing the parties involved to bring the risk protection needs to fruition.
The risks facing a business are numerous and will vary according to the types and structures of the businesses involved. Finding solutions to these risks require a deep understanding of the business, the plans for its future and the financial aspirations of the owners. This is the role of the financial planning industry, not the legal or accounting professions.
Succession planning
In all businesses there comes a time when a person with a share in a business may wish to leave, is forced to leave through illness or injury, or dies. Unless there is a succession plan in place, the business could be put in a situation where it is forced to wind up and sell assets, often at less than their full value.
A succession plan involves a legal agreement between parties. It provides for a buyout at illness, death, retirement or disagreement. Its main purpose is to provide security to all parties so that they are financially protected and the business can continue.
For a partnership or company, there is often a dilemma when a partner or director wants to leave the business. How can they realise their share in the business and how can the other partner fund the purchase?
Planning for this occurrence is a major part of the long-term planning for the business. It requires a legal agreement that provides each party with the option of buying the other’s interest should either wish to leave. Funding for the purchase of the business may be done through a life policy, where the proceeds of the policy are used to buy the business, or a savings plan to which both parties contribute so that a lump sum is available to purchase the other party’s interest.
The business and the families of each director also need to be protected against the death or total disablement of another director. Without a succession agreement that caters for this occurrence, the deceased’s assets in the business will pass to their estate. An insurance policy needs to be in place that allows either partner to purchase the business from the proceeds of the policy upon the death or disablement of a partner.
Partners also require additional insurance cover to protect their family from loss of income through death or disablement.
Sole traders
A similar plan can also be drawn-up for a sole trader. This may be done by identifying and entering into a legal agreement with a key employee or through a family member providing them with the option to purchase the business should the owner leave.
An employee may be able to take out a life policy to cover the purchase price of the business should the owner die or become permanently disabled or retire. The insurance proceeds would then become available to buy the business.
Again, the sole trader requires insurance cover to protect their family for loss of income through death or disablement.
Key person insurance
In most businesses, there are key people whose drive and knowledge are essential to the profitability and future of the business. These can be directors, partners or employees.
A life policy which protects the business against the death, critical illness or disablement of a key person ensures that there are funds available to the business to cover lost revenue and the costs of bringing a key person into the business. Keyman policies can be arranged to allow the level of protection to grow as the value of the business grows.
Key person insurance is generally taken out to protect the revenue of the business and is therefore owned by the business.
It can also be taken out for capital purposes to protect the business’ financial position (guarantor insurance). In such situations, the guarantor or spouse usually owns the policy. For tax reasons, it is important that the purpose of the key person insurance is fully documented to support the intention of the business entity.
Guarantor insurance
Most businesses rely on loans and credit facilities to conduct their operations. These loans are often supported by guarantees against the personal assets of the partners or directors. The death of a guarantor triggers an automatic default in most loan agreements.
This means that the financial institution can proceed against a guarantor’s assets if it feels its loan is at risk. This can place the spouse in the unenviable position of having to realise family assets to repay the loan.
In the situation of a partnership or company, insurance taken out by the guarantors on their lives is used to cover the debt secured under personal guarantees. Other forms of insurance such as total and permanent disability (TPD) and trauma insurance can also be part of guarantor insurance.
Business overheads
The fixed expenses of running a business continue whether a business owner is there or not. Many of these expenses, depending on the policy, can be insured against, thereby reducing costs while a director is absent from the business through injury or illness.
For business owners, business expense protection complements a personal income protection policy to provide maximum protection during illness or injury.
Asset protection
In addition to policies such as fire and perils, business interruption, machinery breakdown and product liability, which may be required to protect the assets of a business against unforseen events, the protection of personal assets is also required.
Because of the liability business owners face for their actions and those of their partners or employees, it is important that personal assets are held in a trust. Also, life insurance policies and superannuation are protected from creditors up to reasonable benefit limits, making them a safe form of investment.
For companies, company and officers insurance protects company directors against personal liability for the company’s debts.
Opportunities for advisers
In summary, protecting the personal assets of business people is a major business opportunity for financial advisers. There are complexities that result from the need for legal agreements and the correct implementation of policies from a tax perspective. There is the difficulty of co-ordinating the different parties involved and managing the process.
However, the end result is the protection of the client’s personal assets and in many instances ensuring the continuity of a business. This is the role of the financial adviser. Policies are more likely to stay in place for long periods due to their being bound by legal agreements. Financial services companies need to make it as easy as possible for advisers to write this type of business.
The author would like to acknowledge the assistance received from ING , MLC , Tower , Genesys and Horrocks Financial Services in producing this article.
