07. Business Insurance

Question 1

1. What are the three basic business protection needs that typically apply?

Answer 1

• Business expense protection
• Asset and revenue protection
• Ownership protection

Question 2

2. What is the key financial problem (3 components) that business insurance aims to provide?

Answer 2

• the right amount of cash
• for the right person
• at the right time

Question 3

3. What is business expenses protection?

Answer 3

Insurance for loss due to sickness or injury for that proportion of their gross income that normally meets the business’s regular operating expenses.

Question 4

4. What is the benefit payment period for business expenses protection and what percentage does it indemnify for?

Answer 4

Up to 12 months. These can indemnify the business for up to 100% of actual regular normal expenses.

Question 5

5. What is asset and revenue protection?

Answer 5

Insurance to ensure that there is sufficient income for the business to meet its obligations in the event of disability, death or trauma of a key income-generating person

Question 6

6. What are the risks to the business if they do not have asset and revenue protection?

Answer 6

• Business could be forced to sell assets to maintain cash flow
• Losses may result while finding and training a suitable replacement

Question 7

7. What are the five ways that a business can raise cash to manage business expense risk?

Answer 7

1. Realising business assets
2. Borrowing cash
3. Creating a capital reserve
4. Absorbing the loss from current business profits, or
5. Transferring the risk to an insurer

Question 8

8. Which is the best of the five options for a business to raise cash to manage business expense risk?

Answer 8

• Insurance - it is the cheapest.

The other options pose risk, inefficient use of capital, removal of assets etc.

Question 9

9. What is ownership protection?

Answer 9

This insurance ensures the smooth succession of ownership between shareholders in the event of death, TPD or trauma of a partner in the business.

Question 10

10. Who does ownership protection benefit the most?

Answer 10

• Partnerships - Death of one partner automatically dissolves the partnership, and leaves two options - liquidate or reorganise.
• Proprietary companies - the death of a shareholder will transfer the shares to the heirs as an inactive interest.

Question 11

11. What will the ownership protection do, and why is this a benefit to partnerships and proprietary companies?

Answer 11

It sets up conditions and provides for the surviving owners to buy out the interest of the heirs of the deceased partner or shareholder. This enables the business to continue.

Question 12

12. What are five ways of funding the required purchase price of a business after the death of a partner or shareholder?

Answer 12

1) realising business assets
2) realising personal assets
3) borrowing cash
4) paying off the heirs gradually, or
5) utilising business protection (expense) insurance

Question 13

13. Describe the tax treatment of whole of life or endowment policies?

Answer 13

Premiums are not deductible and the proceeds are not assessable

Question 14

14. Describe the tax treatment for accident and term insurance policies?

Answer 14

Premiums are deductible and the proceeds are assessable if the purpose for effecting and maintaining the policy is of a revenue nature, otherwise premiums are not deductible and the proceeds not assessable.

Question 15

15. What are the further rulings the Tax Commissioner has made regarding the deductibility of revenue purpose insurance policies?

Answer 15

• Loss of the key person would result in a significant loss of profits
• Business would continue to operate while a replacement is sought and trained (not deductible if loss results in termination of business)
• The amount of insurance is baed on a reasonable estimate of the loss of profits likely to arise a the time the policy is entered into.

Question 16

16. Death claim proceeds are exempt from capital gains tax provided they are received by who?

Answer 16

• the original beneficial owner of the policy, or

* a person who did not acquire the rights or interest in the policy for consideration.

Question 17

17. TPD and critical illness claim proceeds are exempt from CGT if they are received by who?

Answer 17

• the insured person under the policy, or

* a spouse or relative of the person insured.

Question 18

18. Examples of key person indicators include what five factors?

Answer 18

• Significant remuneration
• Executive influence
• Significant facilitators
• Capital influence
• Creative influence

Question 19

19. What are the most immediate problems created for a business in the loss of a key person?

Answer 19

• profitability is adversely affected
• additional capital is required to recruit and replace
• business efficiency is lost,and/or
• goodwill is lost

Question 20

20. What are the benefits of having a policy of insurance on the life of a key person?

Answer 20

• cash to offset loss of profit
• cash to resource a successor
• cash to offset the cost of loss of goodwill
• cash to extinguish debts owed to the key person
• cash to facilitate business plans, and
• cash for working capital.

Question 21

21. What are the alternatives to key person insurance?

Answer 21

• Drawing on profits
• Establish a cash reserve by accumulating profits
• Borrow funds from lending institutions
• Sell business assets

Question 22

22. What are ways a business can minimise the need or amount of key person insurance?

Answer 22

• Spread its management responsibility among a number of individuals
• Have a well thought out management training program
• Have sufficient liquid surplus to meet emergencies, and
• can borrow money in its own name without the personal guarantee of any owners.

Question 23

23. Life insurance is often the foundation to many key person insurance solutions. These have add on features that may be useful when taking out life insurance for the purpose of mitigating key person risk. These add ons include (4)?

Answer 23

• Future insurability options
• Business loan cover options
• Partnership protection
• Protecting the business from additional life risks

Question 24

24. What is future insurability?

Answer 24

These provide for certain conditions where insurance may be changed including:

• when an increase can be exercised
• the types of events that may trigger a future insurability opportunity
• the amounts of each increase, and
• the maximum total value of all increases.

Question 25

25. What is a business loan cover option?

Answer 25

Provide a single benefit payment that may cover a number of lives that personally guarantee business loans.

Question 26

26. What is partnership protection?

Answer 26

It covers the business for multiple lives either for a single or multiple benefits to fund the consideration specified within a succession or buy-sell agreement between business partners.

Question 27

27. What options may be considered in a life policy to protect the business from additional life risks?

Answer 27

* TPD | * Critical illness etc.

Question 28

28. Who may be interested in taking out key person insurance?

Answer 28

* A Creditor / Investor * A partner * The company (for directors and key shareholders) * Beneficiaries or founders of a trust

Question 29

29. What are the ways to sell key person insurance?

Answer 29

* Identify clients that own businesses * Advertise for new prospects * Use centres of influence (eg accountants) * Provide information highlighting the risks

Question 30

30. With respect to key person insurance, what factors need to exist in order to achieve an insurable interest, which is required in order to take out the policy?

Answer 30

With respect to the key person they were: * a body corporate in the life of an officer or employee * an employer and employee in each other's life, or * a person likely to suffer pecuniary or economic loss from the death of another.

Question 31

31. When determining the value for key person insurance, what must be considered?

Answer 31

* debt that may need to be repaid if a key person leaves * any clients or contracts that will be lost * amounts payable to the key person or their estate * working capital required to continue operations * costs associated with location and training of a replacement * any loss of profits

Question 32

32. What are the three methods of determining the amount of insurance required for a key person loss?

Answer 32

* Present value method * Debt cancellation method - loans outstanding and trade credits * Multiple method

Question 33

33. What is the present value method of quantifying the amount required for key person insurance?

Answer 33

* salary and salary premium to attract new employee * expenses of training courses * expenses of locating / relocating a new employee

Question 34

34. What are the five basic rules to calculating the multiple method (to quantify the amount of insurance required for a key person)

Answer 34

* Revenue - sales rev x key person factor * Gross Profit - 3 x (gross profit x key person fact) * Net profit - 8 x (net profit x key person fact) * Liabilities - liabilities x key person factor * Remuneration - 10 x (total remuneration x key person fact)

Question 35

35. What are the two fundamental factors that an underwriter must consider in assessing the amount of insurance required?

Answer 35

* The method chosen to value the key person is in accordance with industry practice * The level of cover reflects the value of the key person in the business.

Question 36

36. What are the common problems with financial underwriting for key person insurance?

Answer 36

* evidence is needed (to prove the insurance wouldn't place the company in a better position) * Evidence is hard to substantiate * It is difficult to obtain evidence * Requests for further information can be unclear * Company may not agree with level underwriter will accept * multipurpose needs

Question 37

37. How is the tax deductibility of insurance for key persons generally determined?

Answer 37

* Whether the purpose is of capital or revenue nature. Paperwork is used to firm up this determination, and the absence of such paperwork will generally lead to a presumption that the life cover was not taken out for revenue purposes.

Question 38

38. What is the advantage of being able to claim a tax deduction on key person insurance?

Answer 38

Relative cost is reduced if a tax deduction is claimed

Question 39

39. What are the disadvantages of being able to claim a tax deduction on key person insurance?

Answer 39

* Higher premium payment/sum insured may lead to more stringent underwriting requirements * Tax deduction may not be available (due to income level or tax commissioner ruling) * Record keeping requirements are increased so may increase costs * Costs may be increased due to use of advisers and accountants * Higher initial cash flow is required to service the agreement.

Question 40

40. Permanent and temporary key person insurance can be considered. What are the main differences?

Answer 40

* Premium cost - permanent is higher * Cash value - is pid after a certain period for permanent * Taxation treatment - permanent are generally not available for tax deduction * accounting treatment - permanent policies should be shown in the balance sheet as an asset