A lender often makes it a condition of a loan that some of the directors and key employees have life insurance cover. In fact, the lender may not advance the money until the cover is in place.
Who needs it and why?
As well as loans from recognised lenders, a business may have a loan from one or more of its directors. This might be an actual unsecured loan, or the directors may leave some or all of their salary, bonus or dividends with the business in the form of a loan. Directors often act as guarantors of loans to the business from lenders, and may be personally liable if the business defaults on the loan, or the lender calls it in.
Who does it cover?
The company is usually the policyholder, and the key employee is the life assured. Depending on the type of cover chosen, if the employee dies or has one of the named critical illnesses, the company receives a cash sum which, depending on the level of cover chosen, can be used to repay part or all of the outstanding loan.
Unless the lender specifies the type of cover and term, the company can choose the best combination to meet its particular needs. For example, cover could be for life only or combined critical illness and life cover, and for a fixed term or whole of life.
How long should it last?
Typically, the life/critical illness policy should run for at least the possible duration of the loan.
Who pays the premiums?
If the company owns the policy then typically the company will pay the premiums. Note that typically the company will retain ownership even if another person (eg a director) pays the premiums unless the policy is assigned (see below).
What are the key considerations when setting up the cover?
Your client will need to consider:
- How much cover is needed now.
- Whether it will need to increase in the future.
- How the loan will be repaid and over what period.
- Whether any directors or partners have given personal guarantees for the loan.
- Whose death or absence through ill-health might affect repayment of the loan.
- Whether an immediate cover facility is needed to avoid delays in receiving the advance.
The process for setting up loan cover is the same as for key employee cover.
Assigning a policy to a key person
When a key person leaves the company or retires, it may be possible to assign the policy to them so the cover can continue for their personal benefit. There may be a tax implication on both the company and the employee of the assignment but this could be outweighed by the benefits afforded to the individual.
In these circumstances, if the policy is not assigned the company will remain the owner of the policy, even if the individual pays the premiums.