Life assurance planning process - 5 steps in order
calculating life cover formula
Should be based on five steps;
- identify need for life assurance
- quantify amount of income and capital a client needs. Should distinguish between capital needs (debt) and long and short term needs (spouse & child income)
- determine term
- take into account other assets and cover
- recommend appropriate type of cover
Calculating life cover;
Lump sum for capital needs + short term + long term = x - existing lump sum cover
Extra life assurance needs - needs not taken into account in expenditure based calc (7)
Needs not taken into account in the expenditure based calc;
- Inflation
- Additional benefits for family
- Flexibility (convertible/renewal)
- WOP
- timescale (unsure on term)
- existing cover (may be app not to take some into account)
- impact on state bens (cover can reduce entitlement)
How are IP & CIC complimentary to each other - coverage, subjective payout, earnings, bridge, lump sum and retirement
- IP pays out for many policies not covered by CIC
- IP may not pay out or pay reduced benefit on subjective assessment where CIC pays out on diagnosis
- IP benefits low if did not have significant earnings whereas CIC not related to earnings
- CIC can help bridge financial gap from IP paying out less income
- may help recovery if use lump sum to relieve of debt and make life adjust
- CIC can provide fund for retirement income, taking over when IP ends
IFA product selection - should consider (3)
Underwriting requirements - limits include (sum assured, medical and reassurance)
Premium rates - considerations and aggregate rates
Quality of service - process
Financial strength - what should be considered and more relevant for what types of policies? IFAs should looks more into (company x2, opened, liquid and expansion)
Should consider;
- scope of cover - definitions for illnesses and incapacity, exclusions and territorial limitations
- underwriting requirements - different limits include;
- level of sum assured whereby GP Report is required
- level above which medical examination required
- level beyond which reassurance is required
- premium rates must be considered along with potential ratings. Some providers provide aggregate rates which means rates do not vary for smokers.
- quality of service - admin and underwriting process should be smooth
- financial strength of provider - free asset ration should be considered but is not always accurate. FAR more relevant for with-profits policies.
- IFAs should look more into;
- parent company, foreign parent company risk, when established,liquidity concerns and is life office expanding?
Key person insurance - what is it and how written
Need for KP;
- replacement costs - what does this mean
- business interruptions - how may it be interrupted (4)
- financial implications - how? (Profits, creditors, loans, finance, liabilities, repayment, refinanced when and target hitting with funding
- business uses normal life assurance to protect from financial loss suffered on death or key person
- should be written under life of another
Need for key person insurance;
- replacement costs - replacing key person can be costly and can take some time for newby to perform at old persons level
- business interruptions - future projects may be delayed, contacts and contract may be lost, deadlines may be difficult to meet and staff morale may suffer
- financial implications - profits may fall, creditors may not offer same facilities during period of instability, overdraft/Ioans may need to be repaid, finance less available, more difficult to meet existing liabilities, may have to repay loan key person has made, loans refinanced where KP was guarantor and funding may depend on target hitting which may be down to KP
Identifying a KP - depends on (type, esta, transacted and projects)
Where are KP particularly essential;
- new what x2, buyouts, manufacturing, tech, trading and size
Death of. Major shareholder may result in…
Key people will depend on;
- type of business & size, if new or well-established, kind of business transacted and special projects with time limit
Key persons are particularly essential in areas such as;
- new businesses, new markets, management buyouts, manufacturing companies (specialist equip op), high technology, trading companies and size of business (smaller = more key people)
Care needs to be taken when arranging cover for major shareholders as death may result in large cash sum to company and could therefore create inheritance tax.
Calculating amount of cover - when assessing net loss on KP death should consider;
- present, profits, effect, recruiting & delay, project, loans and savings
Financial underwriting - what is it and docs used for evidence (4)
When assessing net loss on KP death should consider;
- present cash position
- recent profits and projected profits
- effect if key person dies or illness
- cost of recruiting and replacing + delay to profits caused when settling in
- loss if KP working on specific project on death
- loans that may be recalled
- should also factor in savings that will be made
Financial underwriting - insurance company need to be convinced that sum assured is set a correct level and not over insured. Documents that should be sent as evidence are;
- accounts, business plan, loan agreements and supplementary q
Main approaches to calculating KP cover - multiple of salary - usual multiple, package, true value and why, time factor, this approach not appropriate for what
Multiple of salary - usually multiplied by factor of 5 up to 10
- should use total package such as pension contributions
- this method does not necessarily show true value to the business, however, as director can set own renumeration and/or may be paid in dividends
- salary does not allow for time factor (near retirement = less valuable)
- purely salary based approach not appropriate for determining level of cover required to meet loss of profits.
Main approaches to calculating KP cover - proportion of profits - formula
Requires caution as;
- profit fig can be…, net profit good or what but does not include what and why is gross profit better
- if taxable, what should be used to calc sum assured
- same difficulties as what (can list some as well)
- time factor
- if showing a loss?
Key persons salaryprofit for last yearno. Of years to replace/total salary bill
Requires caution;
- profit figure can be pre or post tax - net profit good reflection of performance but may be low for tax reasons. Does not include for fixed expenditure still paid post KP death. Gross profit better reflects business profit loss on death.
- if proceeds of policy taxable, gross profits should be used to calc sum assured
- involves same difficulties as multiple salary basis
- difficult to determine time factor
- if formula showing a loss (many new companies do), formula no use
Tax position of KP - rules for obtaining tax relief - most, TR on prems, why not given on other policies (CIC etc), each case, tax relief not available on premiums for who (4)
Rules for obtaining tax relief;
- given on most term assurance policies
- if tax relief given on premiums, benefits usually taxed
- tax relief not given on prems for other policies as treated as building up cash sum.
- depends on each case
- tax relief not available on premiums for shareholding director/employee, partner, LLP member, sole trader.
Conditions for tax relief on premiums (KP) -
- sole relationship - what is it and limit for shareholding’s
Loss of profit - purpose, record, sum assured, surrender value
Wholly & exclusively - no tax relief when
Short term assurance - term must be, single premium pols and max term should be what
Sole relationship - must be employer to employee. If have shareholding above 5%, cant get tax relief.
Loss of profits - purpose of cover to meet profits lost due to KP death
- should keep record of why this was taken out as may be requested by HMRC
- sum assured reasonable in relation to probable loss of profits
- if surrender value, doesn’t qualify
- no relief on convertible term policies
Wholly and exclusively - as described - may not be given when life assured has significant shareholding due to partly being for life assureds own benefit.
- no tax relief if insured a KP in subsidiary.
Short term assurance - policy must be annual or short term assurance. Single premium pols, unless one year only, would not qualify. Max term should be estimate on how long employee will be useful to company.
KP - suitable policies - term assurance - what suitable for (3), disadvantages (inflation, increase options, promotions and CIC)
Flexible WOL - when can be taken out (period and contribution) and increases
Term assurance;
- suitable for short-term project, expandinly rapidly, new company + mor
- disadvantages include - may not protect against inflation, not all incorp increase options and cant deal with promotions and CIC may be provided sep so more expensive.
Flexible WOL;
- person is likely to be important to bus over longer period and KP is expecting to make significant contribution during working life.
- has more facility to increase sum assured
KP - IP - how ben amount worked out;
- multiple of salary - good for what, how worked out and personal IP
- proportion of profits - only used when
Why is IP cover needed usually lower than life;
- advisory, return and creditors, incentive, term and other
IP;
multiple of salary;
- good for temp replacement but not for profit loss
- usually x2 salary
- if already has personal IP, then can limit amount of group IP company will get.
Proportion of profits;
- only used confidently if profit figures show regular pattern.
Amount of cover needed for IP lower than life cover as;
- if KP unable to perform can still have advisory role
- KP could return to work t4 events may not occur such as creditors losing confidence
- company should have incentive to return to work or get replacement
- term of benefit payments may be shortened
- other restrictions imposed such a deferral period or max term
Share protection - what is it and intended for who, objective to (shares x2), problems include (find and funds), taxation (if company pays premium)
Provides funds to buy the company shares if a shareholder dies or ill. intended for private LTD companies where small amount of shareholders. Objective to;
- ensure funds are available to buy the shares from SH or estate
- ensure funds are paid to those people who want to buy the shares
Problems;
- may struggle to find buyer of shares
- may not have funds to buy shares
Taxation;
- if company pays premiums, these would be subject to income tax on the shareholder as well as NICs
Partnership protection - similar to what but for who
Buy & sell agreement - what is it, sum assured should be, IHT and BPT
Cross option agreement - what is it, how should life policy be unwritten and term, BPR
Similar to shareholder protection but for partners.
Buy & sell agreement - estate has to sell whilst partners must purchase
- sum assured on policy should be enough to cover partners shares
- deceased shares form part of estate and therefore subject to IHT
- buy & sell does not qualify for business property relief.
Cross option agreement - option to buy and sell
- life assurance policy should be written under trust with other partners as beneficiaries and should have term up to retirement
- does not affect BPR on IHT
Partnership protection - automatic accrual - shares pass to who, policy represents what, life policy pays out to who and difference
Under automatic accrual, it is agreed that;
- deceased partners shares will pass to surviving partners
- life policy taken out that represents value of their shares
- life policy pays out to family in lieu of shares and if sum assured lower than value then other partners pay difference
