Keyman Insurance Sought
Sydney Morning Herald
Wednesday March 18, 1992
QUESTION:
I am a computer consultant working in partnership with two others. I have heard people talk about keyman insurance providing protection for a business should a senior employee or business partner die.
Is it relevant for a partnership such as ours and how much would it cost?
ANSWER:
One of the purposes of this type of insurance is to help ensure that a business doesn't suffer as a result of the death of one of its principals or a senior executive.
Another is to protect the interests of the deceased's estate.
Most partnerships and professional businesses tend to be highly geared while the personal assets of the principals are often pledged as collateral security.
It is likely your death or disablement would result in a disrupted cash flow for your business. There would be a review of credit facilities by your bank and considerable expense incurred while the business is revalued and restructured.
A valuation of the business will reflect the disrupted state and your equity will be devalued, reducing the amount your family may expect to receive as part of the restructure process.
Your business partners, however, may be unable or unwilling to raise sufficient capital to buy out your share even at the reduced value, and it is possible a new partner will be sought. In my experience your family would receive an offer to sell your share on less than attractive terms involving a reduced valuation and payment over an extended period.
Specific "buy-sell" arrangements may be established which ensure equitable treatment for all concerned. The agreement will provide for the transfer of equity at a fair and reasonable value and will also provide the basis for the business to continue in a viable form.
Such agreements usually specify that life insurance policies be established to ensure that cash funds are available when required. The amount of insurance cover will be sufficient to facilitate the transfer of equity and may also include amounts allocated to reduce loans outstanding and replace lost income. The nature of the business and the ownership structure will determine how the life insurance policies are established.
There are various types of insurance policies promoted as being suitable for keyman and buy-sell arrangements and you should take care to ensure that the policy offered is appropriate to your circumstances. Term insurance offers value coverage (a 35-year-old man may be insured for $1 million for less than$1,000 per annum) while whole-of-life and endowment insurance policies involve higher premiums but may offer other benefits when packaged correctly.
In a series of taxation rulings clear guidelines regarding these arrangements have been established but many insurance agents continue to promote concepts which are in conflict with those guidelines. Consult your taxation adviser when considering such arrangements.
© 1992 Sydney Morning Herald