What Is Business Succession Life Insurance?
When two or more people work together in a business, there needs to be serious consideration of the disposal of each person’s share of the business in all circumstances. This is sometimes referred to as a succession plan or business will which can be governed by a legal agreement that can cover a wide range of important situations such as a deadlock over a business decision, a divorce or relationship breakdown of a principal, a principal’s loss of professional licence, a permanent breakdown in the relationship between principals, the resignation of a principal, the retirement of a principal or a sabbatical of a principal.
A succession plan may include the provision for one of the owner’s interests to be bought out by another owner based on certain events. This can be referred to as a “buy/sell” arrangement. Such arrangements involve the principals of the business discussing, negotiating and agreeing on buy and sell trigger events, on how the business interests will be valued, and on the respective buy and sell obligations of the principals – including the funding methods for the transfer of ownership – should a trigger event occur. The agreements usually contain :
- A Legal agreement that sets out the terms and conditions of the business transfer including business valuation method, trigger events and procedures to follow.
- A Funding mechanism to provide the money to facilitate the sale. Funding could be provided by selling assets, taking out a loan, gradual buy-out, insurance or a combination of options.
These agreements could cover both asset transfer and liability release (e.g. guarantees). There are many benefits with the agreements such as :
- Ensuring business continuity and avoids disputes.
- Preventing unwanted involvement from family members or external parties.
- Providing financial security and peace of mind for all stakeholders.
Some of the trigger events could include events related to the health of the principal, including serious illness, injury or death. For these events, the funding method could be fully or partly via life insurance such as life cover and/or Total and Permanent Disability (TPD) cover and trauma insurance. Business succession insurance, also known as Buy/Sell Insurance, is a method of funding the consideration for the transfer of an asset from one person or entity to another in the case of death, temporary disablement, permanent disability, terminal illness as well as the occurrence of a major medical event.
Considerations For Buy/Sell Insurance
The insurance funding for the transfer of the business interest from the departing business proprietor (or their estate) based on health related events, to the continuing proprietors should correspond to the terms of the buy/sell agreement, which ideally should be the value of the proprietor’s interest plus any tax liability, such as income tax, CGT, legal fees, stamp duty or GST, connected with the transfer of the business interest.
The agreement should provide a mechanism whereby the departing proprietor (individual or owning entity) can easily sell its business interest to the continuing proprietor(s)and the continuing proprietor can purchase the departing proprietor’s business interest.
The acquisition of life and disability insurance for this purpose may be a viable consideration. But it may not be possible or may be limited due to insurers’ product limits, underwriting issues due to the business principal’s age or health, due to affordability or unnecessary because the principal has other financial reserves to draw on.
The choice of insurance solution depends on which trigger events are being provided for. Death and TPD can usually be readily insured against, by way of life insurance (with appropriate riders as required). Trauma insurance can also be used in a buy/sell agreement but some issues must be considered.
Industry Terms for Buy/Sell Insurance Cover
- Buy/Sell Insurance Agreements
- Business Insurance Will
- Business Succession Insurance Agreements
- Business Insurance Trust Agreement
- Buy/Sell Purpose Insurance Cover
- Equity Transfer Insurance
- Insurance-Funded Buy/Sell Agreement
- Succession Planning Insurance
Ownership Considerations For The Buy/Sell Insurance Cover
There are many options for policy ownership such as :
- Self ownership by each principal. Each principal owns a policy on their own life which can be simple, portable and possibly CGT-exempt. This does require a written agreement to avoid disputes.
- Cross-ownership – the policy owner changes with changes in business ownership which may create problems for CGT on death payments. CGT may be payable on TPD and trauma payments
- Insurance trust ownership. Here a Trustee owns policies on behalf of principals and this could potentially offer CGT exemptions and flexibility.
- Ownership by the operating entity of the business. There could be adverse tax consequences of this option to consider further.
Ownership by a superannuation fund trustee may not be possible and is generally not considered.
Care must be taken to understand the advantages and disadvantages of each option
Premium Considerations For The Buy/Sell Insurance Cover
- Considerations are needed on who pays the premium and how the cost is shared, if at all.
- Mechanisms should also be put in place to avoid policy lapses for non-payment.
- If the business entity pays the premium then it could be a non deductible or FBT expense. If paid by a company the payment may be deemed to be a dividend or could be deducted from the owners’ loan accounts.
- All business owners could agree on a mechanism to combine premiums and each pay a portion of the total cost based on their share of business ownership.
- Care must be taken to understand the advantages and disadvantages of each option.
Who to involve ?
- The Company Solicitor
- The Company Accountant
- For any life insurance to be arranged, an insurance broker like Experien Insurance Services
Want to read more about buy sell insurance ?
- Click here to read an article on this important topic for some businesses
Information on our website is general in nature and does not take into account your personal circumstances. You should consider personal advice that allows for your own goals and situation and always read the Product Disclosure Statement (PDS) issued by an insurer before considering buying cover.
