Think HBR

Do you have a key person risk in your business?

Gavin Fernando
Prosperity Advisers Group
Managing risk is a key component of the ongoing management of any enterprise. There are many risks involved in business including competitive threats, obsolescence of products or services, insolvency of the business or a key individual, and the death or prolonged incapacity of a business partner or key team member.
Competitive threats can be identified through SWOT or similar analysis and strategies developed in consultation with business advisers to minimise risk through diversification of product/service lines or differentiation. Insolvency risks can be mitigated through sensible financial structuring such as the use of companies and/or trusts to reduce the personal risk to owners and their personal assets. An area many business owners are reluctant to think about is financial risk in relation to death or prolonged illness. It’s a hard topic to discuss around the dinner table yet it’s something which can have a real and lasting impact on many small and medium businesses. When looking at this we usually consider the risk in relation to the business or the individual’s capacity to:
• Bear the loss
• Manage the loss
• Avoid the loss
• Insure against the loss.
Here are some things for you to consider when looking at how you might insure against the loss in your business which might come from the death or prolonged poor health of a significant individual.
There are four main groups of life insurance that can be taken on an individual’s life:
1. Death cover – a lump sum payable to the nominated beneficiary/s or the deceased Estate upon the insured’s death.
2. Total & Permanent Disablement (TPD) Cover – a lump sum payable in the event that the individual is no longer able to work due to illness or injury.
3. Trauma or Crisis cover – a lump sum payable in the event of diagnosis with a specified illness or injury.
4. Income Protection cover – a regular sum (usually monthly) payable to the insured if they are unable to work due to illness or injury.
Death and TPD cover is useful in a business sense to fund Buy/Sell agreements. In the event of the death or permanent incapacity of a partner, the insurance is triggered and the life insurance payment can be used by the surviving partner/s to payout the deceased or ill partner’s equity.
This type of cover is sometimes held through a Trust specifically setup for this purpose. Premiums can be funded by the business.
This type of cover can also be held by the individual to satisfy the payment of personal liabilities and/or the funding of lifestyle or education costs for his or her surviving beneficiaries. A common way to assess the appropriate level of cover is to consider the likely ongoing requirements of the beneficiaries, their life expectancies and insure for an amount that will fund the regular expenditures over the beneficiaries’ lifetime. Any debt or one-off capital requirement can be added to the calculated amount.
Trauma or Crisis cover is a relatively new insurance type. It pays upon the diagnosis of a specified condition or injury. The main triggers are heart attack, stroke and cancer. The lump sum is payable assuming the insured survives the condition for a specified period. This cover was designed in recognition of the advancement of medical treatments that meant the severe illnesses that were terminal for our parents and grandparents can frequently, with early intervention, be treatable these days. The ensuing recovery period is, however long – hence the Trauma cover to cater for expenses through the recuperation period.
Income Protection is arguably the most important of the insurances. Just as most businesses are valued as a multiple of their earnings or profit, the most significant asset an individual owns is typically their ability to generate an income. This can be worth millions of dollars over a lifetime. In the event of an illness or injury, the regular payment kicks in for (a) an amount no greater than the sum insured; after (b) the specified waiting period in the policy; and (c) for a period covering the absence from work or the benefit payment period (whichever is the lesser). Sums insured are no more than 75% of pre-disability earnings.
The four insurances are usually “packaged” to cover the likely costs that may occur in the short-term, long-term or death. Determining the appropriate levels of cover, the right insurer (for a particular person or occupation), and the correct structure within which to hold insurances, is the subject of good insurance advice. If you are considering how you can manage risk in your business then speaking with a suitably qualified and authorised financial planner is a good idea.
For further information contact Prosperity Advisers on 02) 4907 7222, email or visit
Gavin Fernando is an Authorised representative of Prosperity Wealth Advisers Pty Ltd (ABN 32 141 396 376), part of the Prosperity Advisers Group and an Authorised representative of Hillross Financial Services Limited, Australian Financial Services Licensee 232705.
This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider you financial situation and needs before making any decisions based on this information.
Gavin Fernando2 Gavin Fernando
is a Financial Adviser and Director of Prosperity’s Financial Services Division. Gavin has over 30 years’ experience in the financial services industry. He focuses on bringing clarity and simplicity to financial matters, working to accelerate financial success and bringing that extra measure of freedom that financial advice and wealth building delivers.