Updated 30 November 2018
Many small businesses still don’t have key person insurance in place – and are putting their future in jeopardy as a result. Neil Adams of Drewberry Wealth Management explains why it’s increasingly a must-have.
There are 5.4 million companies in the UK, with more than 90 per cent of these employing fewer than ten people. That’s a lot of companies where success or failure rests on very few shoulders and which would likely face significant financial hardship or maybe collapse if just one of these people were unable to work due to illness or injury, or even if the worst happened and they passed away.
It’s also worth noting that the average age for critical illness claims in the UK is only 47 and a man has a 1 in 5 chance of suffering a long-term, career-ending illness (women fair slightly better, with a 1 in 6 chance).
On the death or illness of a key person at a small business, one of biggest consequences would be the loss of the ambition, drive and grit that got the company off the ground and kept it running. Small businesses are often all about that special someone who is both chief, cook and bottle washer – the leader and all-rounder whose sudden absence would leave a gaping hole. In this unforeseen scenario (and it is usually unforeseen) it can take a significant amount of capital to steady the ship.
Key person insurance is a type of protection designed to cover loss of profits or other business continuity problems, either or both of which may happen as a result of a key employee becoming critically ill or dying. The insurance provides a capital injection to limit the immediate financial ramifications, to buy the business time so it can get back into its stride.
Small businesses in particular may find this kind of insurance to be essential. Cash-rich larger companies with many employees can usually meet the costs of temporary cover to replace a key person, or else spread their duties among other senior members of staff. If the key person is unable to return, then a large company is also more likely to be able to begin recruiting a replacement immediately, limiting the time that the business is rudderless. By contrast, a small business with few staff and limited cash in the bank will be left in a much trickier predicament.
Companies also have to factor in the very real risk of a key person dying. Even when this risk is small, the consequence can be so severe that it is important to factor it into your business plan. This key person life expectancy calculator from Drewberry Insurance has been built using data from the Office of National Statistics, and can be used to get ballpark estimates for the risks of key person death within a set period of time.
Victoria Slade, business protection adviser at Drewberry Insurance, said, ‘The real value in any small business is the people who run it: the ones with the vision, direction and expertise to make it a successful enterprise. Without these people, a company can quickly falter. This explains why lenders and investors alike increasingly require key person cover to protect their interests.’
Even if you believe your company can in fact manage well enough without a key person, don’t expect your creditors to share your faith. Credit lines are frequently a lifeline for a small company, especially if that company is a startup. A director has to ask the question: what would happen to those loans if she or another senior person were to be suddenly absent due to serious illness or death?
It’s something that keeps lenders up at night as well. Although the death of a key person in a large business is unlikely to make the bank or investors overly jittery, for a small business it could lead to them calling in the loan or pulling their investment. Suppliers too may be similarly nervous in the absence of a key person, wondering if their next invoice will be paid.
Many investors and lenders are now demanding to see key person Insurance in place, to safeguard their investment if the worst should happen. For a business, having a policy can minimise disruptions resulting from nervous suppliers and lenders, and ensure survival at a particularly difficult time.
Key person insurance isn’t just about risk management – it’s also about legacy planning. It provides the means for your company to continue trading after the loss of a key person or, if you wish, to be wound down in an orderly fashion. It can also take care of employees left behind by the sudden absence of a key person. For some business owners, the biggest attraction is the assurance that their business will live on after they’ve gone.
It’s a natural step for a family to take out personal policies to take care of their loved ones if the worst should happen. The same prudent approach should apply to businesses. If you ever find yourself asking, ‘Where would we be without X?’ and you really don’t like the answer, then a key person insurance policy should be top of your to-do list.
About the author
Neil Adams is financial adviser with Drewberry Wealth Management, a firm of specialist pension and investment advisers. Neil has a Diploma in Financial Planning (DipPFS) undertaken with The Chartered Insurance Institute (CII) and has also passed the advanced G60 Pensions examination.
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