Your business don't risk it
SME owners may be overlooking significant risks when they fail to take out insurance tailored to their specific business needs and activities. Christine Long reports.
Damage to buildings, plant and stock caused by fire or storm damage can be an easily perceived risk, but business owners also need to protect their business from the loss of income and additional costs they may face in keeping their business running after an insurable loss. The Insurance Council of Australia found 20% of small businesses are not insured at all for such events and about half are either severely or significantly underinsured.
Similarly, research released by the Investment and Financial Services Association (IFSA) in August 2006 found that 69% of people in small business did not have income protection insurance at all and only one in four could maintain their lifestyle for more than six months if they suffered serious illness or disablement.
Richard Gilbert, Chief Executive Officer of IFSA, says the results show many small businesses are failing to adequately protect their assets and that could be placing more than their business in jeopardy.
"For many people, their business is often part of their superannuation strategy, which could also be at risk without adequate protection."
Protecting your income
Evan Goode, Business Protection Specialist at NAB says the mistake many business owners make when assessing their insurance needs is to assume that the business will continue to pay them if they suffer from a serious illness or disablement and are unable to continue to work.
"If that's been going on for some time the business owners that are actually putting in the hours get sick of paying that person."
To avoid that situation Goode suggests all partners in a business should take out income protection insurance, an expense that is usually tax deductible and can be funded through salary sacrificing.^ Similarly, business owners need to be aware of the impact the sudden death or disablement of a key employee can have on the future profitability of the business. The cost can go well beyond recruitment and replacement costs.
Even if a replacement is found quickly, there can still be a prolonged impact on profitability.
"It can be difficult to find someone in the industry who has the same working knowledge and it may be that they have an extended network of contacts that enables them to do their job much more efficiently," says Goode.
Key person insurance
The loss of a key person can also create a need to clear some of the debts carried by the business, particularly where there may be loan guarantees in place. "The banking institution may be unwilling to renegotiate the guarantees so the deceased estate has this issue where assets are frozen and it can go on for years and years," says Goode.
Key person insurance can cover the business against such risks, either by insuring against the loss of revenue or the loss of capital caused by the sudden death or disablement of a key person in the business.
That key person may be anyone who is responsible for a major portion of the revenue of that company, not just the business owners.
Succession or ownership cover
Another area of risk that is often neglected is how to handle some of the issues that arise by a change in ownership of the business. "As the business grows the owners are so consumed by the day-to-day running of the business they neglect to insure the real risk of one of them not being there the next day and having to be bought out," says Goode.
Without adequate insurance they could be setting themselves up for massive struggles if the surviving spouse has no skill to contribute to the business or no interest in maintaining a stake in the business.
Goode says such situations can place enormous strain on the remaining business partners, not only because they need to come up with the cash to buy out the surviving spouse, but because they may place different values on the business.
"It would be a different situation if they had agreed on a price of the business by a market valuation and then insured each of the business partners for that amount. Then the deceased's family would have sufficient cash to clear personal debts and have an income stream from other assets."
He advises business owners to revisit their level of succession or ownership cover at least every 12 months to ensure it keeps pace with the growth in the value of the business.
Tailor insurance to suit your needs
While it is vital businesses are adequately insured against such risks, they do need to weigh up which cover will provide the best protection for their particular needs. For example, a business owned by three couples may not need succession insurance if all are equally involved in running the business and would bequeath their share to a surviving spouse or partner in the event of their death. Or it may be a question of prioritising the level and type of cover. A profitable business might agree to pay each of the partners an income even if they are unable to work.
"What they might be able to negotiate between them is an extended waiting period for income protection cover to lower the overall premiums," suggests Goode. "It's always going to be about weighing up the cost and making an informed choice."
Financial advisers are able to help business owners assess how to adequately insure their personal risks using income protection, critical illness, life and total and permanent disablement products. But there can be a need to consult a specialist business protection adviser, particularly to help guard against unintended tax consequences.
And business owners should be wary of selecting insurance cover solely on price. When choosing a provider it is just as important to consider the definitions in the insurance contract and the stability of the financial institution.
"Choose a reputable insurer with expertise in your industry," concludes Goode.
Christine Long is a finance writer who contributes to The Sydney Morning Herald and Australian Financial Review