If correctly structured, insurance policies can be used effectively to protect your business against future risks. If death, disability, or critical illness strikes a key person or shareholder of a business, the profitability and future sustainability of a company can be jeopardised, and in such circumstances, long-term insurance can play an important role in mitigating risk.
If the key person dies, becomes disabled, or suffers from a critical illness, the proceeds of the policy will be paid directly to the business. The proceeds effectively provide the company with cash flow to enable the business to continue operations until a replacement is found. Note, however, that if the insured’s life is covered in respect of disability as well as death, it is important that the definition of disability as it stands in the policy matches the definition of disability as set out in the buy & sell agreement.
The reality is that many shareholder’s agreements or Memorandums of Incorporation do not deal with the practical details of ownership transfer to new parties. As such, a buy & sell agreement is designed to set out the details of what will happen with a partner’s share in the business should they die or become disabled. A properly drafted agreement should ensure business continuity in the event of tragedy, together with a timeframe in which the transfer should take place.
In respect of a typical, non-conforming business assurance policy, the premiums are not tax deductible. However, the proceeds paid from the policy will then not be taxed, and the buyer will have access to the full amount required to purchase the shares. As insurance policies are considered deemed property in the estate of the deceased shareholder for estate duty purposes, it is important that the buy & sell policy is correctly structured in order to avoid unintended estate taxes.