Shareholder protection insurance

What is Shareholder Protection Insurance and How Does it Work?

| 4 minutes read

Shareholders and business entrepreneurs spend years developing their business, pouring time, effort, and money into a venture they genuinely believe in. But if one of the shareholders becomes ills or dies, everything starts changing. Whoever inherits the shareholder’s estate will inherit a particular stake in the business/company, along with all the decision power within the organization. 

Shareholder protection insurance provides shareholders to map out a plan for their succession. It’s a way for companies/businesses to retain control following in case of death of a shareholder and protect the business against competitors and unwelcome third parties.

What is shareholder protection insurance?

The sudden death of a shareholder is a loss that can not be fulfilled because the business suffers the most because maximum things get to change. Shareholders are often critical decision-makers within an organization, and their death can have severe consequences for any surviving shareholders. The loss of a colleague and leader within your business is already a distressing and traumatic time. Shareholder protection insurance helps alleviate some stress during an already difficult period and provides peace of mind that the company can continue with minimal interruption.

What is covered by shareholder protection insurance?

Should one of the significant shareholders pass away, shareholder protection insurance generally pays out enough cash lump sum to the existing shareholders to access them to purchase the business/company equity of the deceased. The actual terms of the legal agreement depend on the type of policy taken out. 

How does shareholder protection insurance work?

One of the simplest ways to think of shareholder protection cover is to imagine life insurance for your business. In case of a shareholder’s death, it provides an actual sum payout for one or multiple named beneficiaries, so they have enough cash to purchase some of all of the shares from the deceased’s family.

Shareholder protection insurance could be complicated to set up and ensure all the proper agreements are in one place. Premiums are calculated using a particular formula. An expert will ensure that the correct amount of cover and trusts are in place to avoid paying inheritance tax and a legal agreement for the sale/purchase of a director’s (died) shares.

Do I need shareholder protection insurance?

Businesses of any size should consider the potential impact of a shareholder’s death or inability to work. There are two things considered: firstly, whether the existing shareholders could afford to purchase the stake of the deceased director, and if not, the effect that could have on the business’s future. Suppose the remaining existing owners could not afford to buy back the shares. In that case, the company must be prepared for a new direction from a new stakeholder whose interests and values may not align with those of the existing survivors.

Not only could the business lose its original essence/the culture under new ownership if the family of the deceased needed to release the money, but they also have no choice left to sell to the first interested buyer. There’s no way of knowing whether this particular buyer will have clashing objectives/goals for the business/company. Worse, they could be competitors and may lead the business in the wrong direction. While the stakes are tied up in probate, the business may lose money, hampering productivity or even ceasing trade entirely.

Another consideration is what would happen to the family of the shareholders in the event of their unexpected death. A shareholder agreement can offer business owners/founders peace of mind. It can ensure the family receives a pre-determined amount for the stake without finding a buyer or negotiating a price that may leave them short. If your family struggles financially without you around, shareholder protection insurance may be worth considering to help ensure they receive a fair sum.

Finally, in particular, small businesses should consider shareholder protection insurance. It may be difficult for shareholders of smaller firms/startups to raise ample capital to buy the remaining shares, which puts them at higher risk of losing the reigns.

How much does shareholder protection insurance cost?

A range of factors determines the price of a shareholder protection insurance policy. Firstly it depends on the level of cover you choose. The likelihood of somebody developing severe illness is far higher than somebody passing away unexpectedly. This raised probability increases the risk for the insurer, which is also reflected in the price. According to the reports, policyholders can pay four times as much for a policy that includes critical illness cover as they would for a life-based plan.

You have little control over these elements, as the insurer will use the following information to figure out the right price:

  • the age of the shareholder as per government id proof
  • their state of health, including any underlying health conditions
  • their lifestyle habits, including alcohol consumption, level of activity
  • family history, including whether any immediate families have suffered hereditary illnesses.

The prices of the premium increase with age. For example, according to Drewberry Insurance, the average cost of a shareholder protection premium was almost five times as much for a 55-year-old as it was for a 35-year-old, based on a ten-year policy.

What are other covers available?

Another type of cover to consider is a “relevant life plan.” These policies provide an actual sum benefit on the death of a director outside of a registered group life scheme, with premiums paid by the company.

Relevant life plans are ideal for:

  • High-earning employees who have significant pension investments and want to avoid their death-in-service benefits making up part of their lifetime allowance
  • Small businesses (MSMEs) where there are too few employees to enable a group life assurance scheme
  • SME Directors who need a value for money way of providing life assurance

These policies are tax-effective as the premiums are not subject to income tax. They are not assessable as a benefit in kind to the director/employee. They can be treated as an allowable expense for the company in calculating their tax liability, potentially reducing tax on business profits. In addition, in most cases, the benefits are paid free of inheritance tax – provided they are delivered via a discretionary trust.

The benefit is separate from any pension in place – payments don’t count towards an employee’s annual pension allowance and won’t form part of their lifetime pension allowance.

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