Key person insurance 2007/2008

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Key person insurance

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Important Information

This guide has been published by MLC Limited (ABN 90 000 000 402, AFSL 230694) 105-153 Miller Street, North Sydney, NSW 2060. The guide is solely for the use of authorised financial advisers and is not intended for distribution to investors. It has been published as an information service without assuming a duty of care, and the information in it is effective from 1 February 2008.

This guide is intended to provide general information only and should not be used as the basis for any investment, financial or other decision. It has been prepared without taking into account any particular person’s objectives, financial situation or needs. Advisers should, before advising a client, consider the appropriateness of this information having regard to their client’s personal objectives, financial situation and needs.

The product information contained in this flyer must be read in conjunction with the current version of the Product Disclosure Statements (PDS) for MLC Personal Protection Portfolio and MLC Life Cover Super as terms, conditions and exclusions apply. Applications for MLC Personal Protection Portfolio and MLC Life Cover Super, which are subject to acceptance by MLC, must be made on the Application Form contained in the relevant PDS.

Persons should obtain a copy of the relevant PDS and consider it before making any decision about whether to acquire or hold the product. A copy of the PDS is available upon request by phoning MLC on 132 652 or by visiting our website at mlc.com.au

MLC Limited, a member of the National Australia Group of companies, is the issuer of MLC Personal Protection Portfolio. An MLC Personal Protection Portfolio policy does not represent a deposit with, or a liability of, National Australia Bank Limited (ABN 12 004 044 937) or any other member of the National Australia Group of companies (other than a liability of MLC Limited as insurer). Neither National Australia Bank Limited, nor any other member of the National Australia Group of companies (other than MLC Limited as insurer) guarantees or accepts liability in respect of MLC Personal

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The most valuable asset in any business – whether a milk bar or a multi-national corporation – is the key people who run the business.

The loss of the managerial skills, expertise and leadership of a key person can have a substantial impact on revenue and profitability. Considerable costs can be incurred in recruiting and training a suitable replacement. There may also be an adverse impact on the business’s goodwill and its ability to repay debts or other expenses.

In this guide, we outline the tax and technical implications of using insurance to protect a business in the event of the death, disablement or critical illness of a key person. The information in this guide is based on MLC’s understanding of current legislation and ATO practice as at 1 December 2007. If you have any further questions, contact your MLC Representative.

Introduction

MLC Super Buy Sell facility

2007/2008

When providing insurance advice to business owners, there may also be circumstances where a Buy Sell agreement is appropriate. To find out more about MLC’s solution – the MLC Super Buy Sell facility – go to mlc.com.au or contact your MLC Representative.

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Overview of key person insurance

How can the loss of a key person impact a business?

While material assets such as plant and equipment can be replaced relatively easily, this is not the case with human assets. When a person dies, is totally and permanently disabled or suffers a critical illness, they can be lost to the business forever and this can create one or more of the following problems:

• Profitability may be adversely affected. There are many businesses operating today at a profit after several years of loss, simply because of the efforts of one person. There are also many well known organisations that have attained success and a reputation, mainly if not solely, through the vision, drive and ability of a key person.

• Considerable time and money can be spent recruiting and training a replacement. These costs can escalate if there are no suitable candidates available within the organisation and an external person has to be recruited. The business may even incur expenses to relocate a suitable person from interstate or overseas.

• The momentum and efficient management of the business can be adversely impacted. This can be an even greater issue if the business is in the middle of, or about to embark on, a major expansion program.

• The goodwill and credit rating of the business may be threatened, as creditors may press for debts to be repaid.

To indemnify the business against these (and other) losses, the business should consider using key person insurance.

Note: Two interactive calculators are available in the Adviser Planning Tools/Calculators page in the adviser section of mlc.com.au that can be used to demonstrate the importance of key person insurance.

• The Death and TPD calculator enables you to illustrate the probability of at least one business owner dying or suffering a total and permanent disability prior to age 65.

• The Critical Illness calculator enables you to illustrate the probability of a client developing a critical illness before age 75.

What is key person insurance?

Key person insurance is an insurance policy that is generally taken out and owned by a company, trust, partners in a partnership or sole proprietor on the life of a key person in the business. The purpose of the policy is to protect the financial position of the business by providing a lump sum payment to offset the estimated losses that would arise upon the death, total and permanent disablement (TPD) or critical illness of that key person.

The tax treatment of the premiums and the insurance benefit payable will depend on whether the insurance is taken out for a revenue or capital purpose (see pages 6 and 7).

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How do you identify a key person?

A key person in any business may generally be defined as one whose death, disablement or critical illness may have an adverse economic impact on the business.

Common examples include: • company owners and directors, • management,

• financial controllers, • IT developers, • sales staff, and

• business development and relationship managers.

When attempting to identify the key people in a business, the characteristics to look out for are many and varied.

One objective test is the level of a person’s remuneration. Although taken by itself, a high level of remuneration does not ensure key person status, in most businesses it is an indication that management believes this person to be a valuable asset.

Another important factor is the decision making powers of the individual. If a person’s position allows them either to make important managerial decisions, or to exert substantial influence over management, they are generally instrumental to the success of the business.

In addition to the ‘planners’, the ‘doers’ (ie those employees who bear direct responsibility for carrying out management directives in the areas of production, sales or otherwise), will often fit the definition of key persons.

A person, whose presence in the business represents a source of capital, either directly or through their rapport with borrowing sources, may be a key person. Where such sources consistently request a particular person to co-sign business loans, their departure will have an adverse effect on the sources of capital available.

An individual may also be classified as a key person because they possess a unique talent which could be difficult and costly to replace.

Note: While virtually anyone that meets one or more of these characteristics could be considered a key person, not everyone will meet the ATO’s definition of key person for premium deduction purposes (see page 7).

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What are the alternatives to key person insurance?

While there are other options that can be used to protect the financial stability of a business, each has its own shortcomings and problems.

If a business decides to cover the loss with current year profits, how would the owners feel about the reduction in distributed profits that may result? Also, what if the business doesn’t earn enough in that year to absorb the losses?

The business could accumulate a reserve. However, it could take many years to build up enough funds and, because the money needs to be readily available, it has to be invested in conservative (lower return) assets. Most businesses generally prefer to put capital to a more efficient use, earning higher returns and generating greater value for shareholders.

Another option is to borrow the money. But many financial institutions can be reluctant to lend to a business that has just lost the services of a key person.

Finally, while a business could sell existing assets, they may not get fair value if forced to sell. Also, the sale could deprive the business of the necessary plant and equipment to ensure it continues as a viable operation.

When it comes to providing an injection of cash to cover the loss of a key person, insurance is usually considered the most cost-effective funding solution. This is because the annual expense is only around 0.5% to 5.0% of the sum insured, depending on the key person’s age and the type(s) of cover taken out.

With other options, the cost of funding each dollar of loss is generally a dollar plus an opportunity cost and any other relevant outlays, such as loan interest. In this context, the opportunity cost is the rate of return that could have been earned if the funds were used by the business for a profitable purpose.

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Tax implications of key person

insurance

Overview of tax implications

The table below summarises the tax implications where a company, trust, partners in a partnership or sole proprietor owns insurance on the life of a key person in the business.

This tax summary is based on MLC’s understanding of current legislation and ATO practice as at 1 December 2007. The comments are general in nature and the tax implications may vary depending on your client’s individual circumstances. You should recommend that your clients obtain professional taxation advice before taking out any particular insurance policy.

Note: In Income Tax Ruling 155, the ATO has made it clear that the tax implications will depend on whether the key person insurance policy is used for revenue or capital purposes (see page 7).

Scenario Are the premiums

tax deductible? Are the insurance benefits assessable? Are the insurance benefits subject to Capital Gains Tax (CGT)?

Life cover For a revenue purpose1

Yes – the premiums are deductible to the company, trust, partnership or sole proprietor (IT155) provided the policy is term life insurance.

Yes – the benefits are assessable to the company, trust, partnership or sole proprietor at the applicable tax rate (IT155).

No, unless the recipient is not the original beneficial owner and they acquired the interest for consideration.2

For a capital purpose3

No (IT155). No (IT155). No – as above. TPD and Critical Illness

For a revenue purpose1

Yes – the premiums are deductible to the company, trust, partnership or sole proprietor (IT155).

Yes – the benefits are assessable to the company, trust, partnership or sole proprietor at the applicable tax rate (IT155).

Yes – if the recipient is not the life insured or a defined relative4

of the life insured (s118-37 ITAA 1997). The capital gain is, however, reduced by the amount included in assessable income.5

For a capital purpose3 _{No (IT155).} _{No (IT155).} _{Yes – if the recipient}

is not the life insured or a defined relative4

of the life insured.

1 Insured can generally be an employee or partner in a partnership.

2 Consideration may be monetary or otherwise, but does not include premiums paid on the policy.

3 Insured can generally be an employee, partner in a partnership or sole proprietor. 4 A defined relative includes a spouse

(married or de facto), parent, grandparent, brother, sister, uncle, aunt, nephew, niece, child (including adopted or step) or a spouse of these people.

5 It’s generally unlikely for a capital gain to be higher than the amount otherwise assessable as income, particularly if the capital gain is a discount capital gain.

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What is a revenue purpose?

Key person insurance may be considered to have a revenue purpose if the reason for the policy is to protect the business against an adverse impact on the profit and loss account resulting from the death, disability or critical illness of a key person. This includes, but is not limited to:

• compensation for a reduction in revenue or profits,

• covering the expenses associated with recruiting and training a replacement, or • meeting other continuing expenses of the business, such as outstanding projects and

general overheads.

Note: Taking out key person insurance to protect a business against a loss of revenue is sometimes referred to as providing ‘Revenue Protection’.

What is a capital purpose?

Key person insurance may be considered to have a capital purpose if the reason for the policy is to protect the business against an adverse impact on the balance sheet resulting from the death, disability or critical illness of a key person. This includes, but is not limited to:

• providing funds for the repayment of debts to a key person, their estate or a financial institution, • reimbursing the business for a loss of goodwill, or

• protecting the credit rating and capital structure of the business.

Note: Taking out key person insurance to protect assets used as security for business borrowings or shareholder loans is sometimes referred to as providing ‘Asset Protection’.

What is the definition of key person for tax

deductibility purposes?

Where a business wants to claim a tax deduction for premiums under a key person revenue purpose policy, consideration should be given to the ATO’s definitions of ‘key person’ as outlined in Tax Ruling IT 2434.

In this regard, an employee may be accepted as a key person where the loss of that employee would result in a significant loss of profits being derived by the employer during the continuation of business operations subsequent to that loss. This would be a situation where there is a continuing business and the resulting loss of profits is a matter that would be expected to be overcome as another employee or a new employee is trained to replace the expertise lost with the former employee.

A key person is not seen to exist in a situation where the loss of an employee, such as the owner/manager of a one-person incorporated business, could be expected to result in the termination of the business. In other words, the ATO does not recognise an employee as a key person for revenue purposes if their death or disablement will most likely result in the closure of the business.

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Why does the business need to substantiate the

insurance purpose?

Given the different tax implications, it’s important that the business owners or partners declare the purpose for the insurance and the basis of the valuation. Appropriate records should also be kept, including minutes and book entries.

Where a tax deduction is sought for premiums in relation to key person revenue needs, the level of cover should bear a close relationship to the loss in profits that would be experienced upon the death, disablement or critical illness of the key person.

Yearly reviews should be conducted to establish, where applicable, that the premium was paid for a revenue purpose. Supporting documentation will be crucial in showing how the level of cover was determined and how regularly it has been reviewed.

It is also important to note that needs and purposes can change over time and the Commissioner of Taxation will generally consider all the surrounding circumstances, including:

• the minutes and book entries,

• the use to which the proceeds are actually put, and

• advance declarations of the intended purposes contained in the relevant correspondence. As a result, proceeds that were anticipated to be non-taxable could be considered taxable at the time of payment, even where no premium deduction has been claimed. Where both revenue and capital purpose key person insurance is required, it is generally better for administrative and record keeping purposes to take out two separate policies.

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How is a key person insurance policy treated for

accounting purposes?

Since a term policy does not have a cash value, it will generally not be recorded on the business’s Statement of Financial Position (Balance Sheet) as an asset, although it is quite often referred to in the notes accompanying the accounts.

Whenever term key person insurance is used, the annual premiums will be reflected as an expense in the Statement of Financial Performance (Profit and Loss Statement). Whether or not the expense is deductible for tax purposes will depend on the purpose for the key person insurance (ie capital or revenue) – see page 7.

In the event of a death, TPD or critical illness claim, the proceeds will be reflected as a gain on the Statement of Financial Performance and the tax treatment will depend on the purpose of the insurance.

Under the PAYG system, a taxpayer may choose to vary their instalment rate from the one calculated by the ATO, which appears on the quarterly BAS returns. If that taxpayer subsequently receives an assessable insurance benefit that was not factored into the calculation for the varied instalment rate, underpaid PAYG instalment(s) may result. The ATO may also levy penalty interest on those underpayments.

This situation is not unique to key person policies and could occur in a number of situations, such as a taxpayer receiving a court settlement or winning a new business tender. One solution is to not vary the ATO instalment rate, as penalties will not apply if the ATO rate has been used. However, if the rate has been varied and the taxpayer calculates that an underpayment will occur, a voluntary PAYG payment can be made to limit the interest penalty.

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Is the 50% CGT discount available?

Where CGT is payable on the proceeds of a key person insurance policy (see page 6), the 50% discount (which would normally be available to an individual or certain beneficiaries of a trust if an asset has been owned for more than 12 months) is unlikely to apply. This is because:

• The policy owner's entitlement to the insurance proceeds (ie the date the asset is acquired for CGT purposes) will usually be either the date the trigger event occurs (eg death or the diagnosis of a disability or illness) or the date the claim is lodged or accepted, and

• These dates are unlikely to be more than 12 months before the claim is paid (ie the date the asset is disposed of for CGT purposes).

Note: Companies are not eligible for discount capital gains.

Can key person insurance be held in super?

The SIS legislation requires that a benefit from a super fund is paid to:

• the member’s estate or their dependants for super purposes in the event of death, or • the member in the event of total and permanent disability.

This prevents a business from receiving a death or disability benefit (including insurance proceeds). The exception is where key person insurance is used for asset protection purposes in family-held proprietary limited companies, where business debts are often secured by personal guarantees from the directors. In this situation, husband and wife directors could take out life or TPD insurance in super (eg through MLC Life Cover Super).

In the event of death, the benefit could be paid tax-free to the surviving spouse, as they are a dependant for both tax and superannuation purposes. The surviving spouse could then lend the proceeds to the company so that it can repay the debt and extinguish the personal guarantee. In the event of disability, the benefit will be paid to the insured key person, who could then lend the proceeds to the company so that it can repay the debt and remove the personal guarantee. The advantage of insuring through super is that, unlike key person insurance policies taken outside super for capital purposes, the super contributions paid to fund the premiums will generally be tax-deductible to the contributor. Furthermore, CGT will not apply to the proceeds.

Before arranging key person insurance in super, your clients should seek tax advice. For example, adverse tax consequences could arise when a loan taken out by a family company is repaid using proceeds from an estate.

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Other FAQs

Who can be the life insured?

The table below provides examples of who may be the life insured under a key person revenue and capital purpose policy.

Revenue purpose policy Capital purpose policy Sole proprietorships • key employees, so long as the

business would continue on the employee’s death or disablement.6

• the sole proprietor • key employees • creditors of the business. Partnerships • either or all of the partners

• key employees.

• either or all of the partners • key employees

• creditors of the business. Single shareholder

proprietary limited structure

• key employees, so long as the business would continue on the employee’s death or disablement.6

• the sole shareholder • key employees

• creditors of the business. Proprietary limited

or public company structure with multiple shareholders

• company directors (only if the money is not intended to be used to repay a debt owing to the director or directors estate) • key employees.

• company directors • key employees. • creditors of the business. Family discretionary

trust (carrying on a business)

• directors of the trustee • key employees of the trustee • the principal controller of

the trustee.

• directors or shareholders of the trustee

• key employees of the trustee

• the founder and principal controller of the trustee • particular beneficiaries • creditors of the business. Unit trust (carrying on

a business)

• directors of the trustee • key employees of the trustee.

• directors or shareholders of the trustee

• key employees of the trustee • unit holders

• creditors of the business.

6 As outlined on page 7, a sole proprietor and owner/manager of a single shareholder company generally cannot be the life insured on a revenue purpose policy, as it is likely that their death or disability will result in the termination of the business.

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Who would usually own the policy?

Sole proprietorships

Where key person insurance is available (see table above), the policy must be owned by the sole proprietor in their own name, as the business is not a legal entity and does not own assets. Partnerships

The partners will generally own the key person insurance policy in joint names, not in the name of the partnership. Like a sole proprietorship, a partnership is not a legal entity and does not own assets. Assets in a partnership are owned jointly by the partners, usually as tenants in common. However, in partnerships where membership changes are frequent, it may be more appropriate for an administration company (or the trustee of a trust) to own the policies, to reduce the risk of potential CGT problems.

This is because, if a key person policy is owned jointly by the partners and one of the partners leaves, there has to be an assignment of the exiting partner’s share of the policy to the incoming partner or remaining partners (if no new partner is admitted). Furthermore, if this assignment is done for consideration (eg as part of the purchase price of the incoming partner’s share of the partnership) then CGT will generally be payable on the proceeds from a key person life insurance policy (see page 6).

If the key person policy is owned by an administration company (or trustee of a trust) the policy will not need to be assigned on partnership changes. As a result, CGT should not be payable on the proceeds from a key person life insurance policy in the event of death. However, the trade-off is that the premiums for revenue purpose key person insurance policies will generally not be deductible to the administration company (or trustee of a trust) because these entities do not employ the key person. Also, tax could be payable on the insurance proceeds when paid from the administration company to one or more of the partners.

Note: An administration company is often established by professional partnerships, such as accountants and lawyers. Single shareholder proprietary limited structure

Where a tax deduction is sought for the premiums of revenue purpose policies, the policy should be owned by the company, as the company employs the key person. Alternatively, where the policy is for capital purposes, the single shareholder could choose to be the owner.

Proprietary limited or public company structure with multiple shareholders

The owner of the key person insurance policy should be the legal entity that employs the key person (ie the company).

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Family discretionary or unit trust structures

The owner of the key person insurance policy could be the trustee (which could either be a company or a natural person). However, most family discretionary trust or unit trust structures do not exist in their own right, but in conjunction with other structures. If a deduction is sought for revenue purpose premiums, the structure that owns the business and employs the key person should own the policy.

ExamplE a

Family Trust A Family Trust B

Unit Trust Company Business

In this example, two family trusts are the unit-holders of a unit trust. The unit trust in turn owns the company which runs the business. In this scenario, it may be most appropriate for the company to own the key person policies, not the trustees of the unit trust or trustees of the family trusts.

ExamplE B

Unit Holder A Unit Holder B

Unit Trust Business

In this example, the unit trust is used to run the business and employs the key person. The unit trust is owned by two unit holders. In this scenario, it may be most appropriate for the trustee of the unit trust to own the key person policies.

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How do you determine the sum insured?

The objective of key person insurance is to provide a sufficient amount to offset the estimated loss to a business which would be caused by the death, disablement or critical illness of a key person. In effect, this requires the business to place a value on a human asset.

In undertaking such a valuation the business should consider the following factors:

• whether a particular borrowing, or other finance facility, may need to be repaid or replaced, • the amount of loan accounts and other amounts that would need to be paid by the business to

the key person or their estate,

• whether a particular contract or client will be lost to the business,

• the amount of working capital required by the business to continue operations until a suitable replacement is found,

• the direct and indirect costs associated with locating, training and establishing a suitable replacement, and

• the likely loss of profits, particularly in the short term, which could occur as a result of the disruption and reorganisation of the business.

Below, we have outlined some methods that can be used to estimate the amount of key person insurance required. These methods are only suggestions and the final choice will depend on your client’s circumstances.

When determining the sum insured, you should take into account any tax (including CGT) that may be payable on the insurance proceeds – see page 6. It is also important that the amount of cover can be verified and substantiated to MLC’s underwriters.

When assessing key person insurance applications, MLC’s underwriters will need to be satisfied that the method chosen to value the key person is in accordance with the usual practice for the industry in which the business operates and the purpose for which the insurance is sought. The level of cover proposed will also need to reflect the value of the key person to the business. See page 19 for more information on MLC’s underwriting requirements.

Present value method

This method can be used to quantify the cost of replacing a particular employee. Estimates should be based on the sum of the:

• salary (and salary premium) needed to attract a new employee for the period until they can be of economic value to the business, plus

• training costs, plus • relocation costs.

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Debt cancellation method

This method can be used to quantify the cost of replacing a shareholder or director whose credit standing and guarantee has enabled the business to source loans and trade credits. Estimates should be based on the value of the loans outstanding and average trade credits guaranteed by the shareholder or director.

Multiple method

This method uses a key person ‘factor’ (or multiple) to assess the impact a key person has on the business. For example, in a business with two key people and a small number of employees, each key person may be regarded as having a key person factor of 50%, as they are responsible for 50% of the success of the business. If, on the other hand, there were a larger number of employees with specialist skills contributing towards the success of the company, the key person factor may be reduced to say 33% or 25%.

There are five basic rules of thumb which can be used as a starting point when using this method. 1. Revenue: Sales Revenue x Key Person Factor.

2. Gross Profit: 2 to 3 x Gross Profit x Key Person Factor. 3. Net Profit: 5 to 8 x Net Profit x Key Person Factor.

4. Liabilities: Liabilities x Key Person Factor (sometimes adjusted for assets). 5. Remuneration: 5 to 10 x Total Remuneration x Key Person Factor.

The appropriate rule of thumb will depend on the nature of the key person and their contribution to the business. For example, the sales revenue multiple is probably more appropriate for a sales manager, whereas a gross profit or net profit multiple may be more appropriate for a general manager.

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Why should the business also insure for TPD

and critical illness?

While it’s easy to appreciate why life insurance should be used to protect the business against the economic loss that could arise upon the death of a key person, the impact could be just as significant if a key person is forced into early retirement due to TPD or critical illness. Therefore, the business should also consider including both TPD and critical illness as trigger events in a key person insurance policy.

Another key issue to keep in mind is that for a TPD benefit to be paid, the disability must generally have existed continuously for at least six months. So, by including TPD and critical illness in the policy:

• the critical illness benefit could be used to cover the business’s needs within the six month TPD waiting period, and

• the TPD benefit could be used to cover the business from six months onwards.

You should note, however, that payment of a Critical Illness claim would not necessarily lead to the payment of a TPD claim, as events which lead to a successful claim are defined differently under each insurance.

For more information on the TPD definitions available through MLC, see page 18.

How often should key person insurance be reviewed?

Once established, key person insurances should be reviewed on a regular (eg annual) basis. If applicable, the sum insured should be amended to take into account things like changes in the value of business loans and value of the key person(s) to the business.

If the level of insurance required is likely to increase in the future, you should consider future insurability options. Using such an option, your clients may increase their level of insurance in future years without having to supply medical evidence for the increase. All that MLC requires is financial evidence of the need (eg an increase in a business loan or value of a key person). Future insurability options can speed up the increase process because otherwise-required medical tests do not have to be performed. In addition, a future insurability option can guard against any adverse change in the health of the insured key person which could make them uninsurable or insurable only with a premium loading. MLC has two options available – see the current Product Disclosure Statement for details and conditions.

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Why does MLC require an insurable interest?

While the legal requirement for an insurable interest to exist was repealed by the Life Insurance Act 1995, MLC’s underwriters still require an insurable interest to be shown from a moral hazards point of view, especially given the generally large sums insured with key person insurance. For this purpose, MLC’s underwriters refer to the former Section 19 of the Life Insurance Act 1945, which sets out various relationships where an insurable interest was deemed to exist. With respect to key person insurance they are:

• a body corporate in the life of an officer or employee; • an employer and employee in each other’s life; or

• a person likely to suffer pecuniary or economic loss from the death of another.

From a legal viewpoint, there is no upper band on the indemnity to the policy owner. However, MLC would follow a normal underwriting practice against moral hazards and affordability of premiums. Where a company or a partnership has an insurable interest in the key person, each shareholder or partner may also have an insurable interest in that key person in proportion to their ownership interest in the business.

As such, if the operators of the business do not wish the business itself to propose and maintain key person insurance coverage, it may be possible for individual shareholders and/or partners to propose and maintain the insurance cover.

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What TPD definitions does MLC offer?

With MLC’s TPD insurance, a business may choose to insure key people using either an ‘any occupation’ or ‘own occupation’ (for certain professional occupations) TPD definition. Under the ‘any occupation’ TPD definition, a life insured is totally and permanently disabled if: • they have a disability caused by injury or sickness, and

• as a result of their disability they are completely unable to work at their usual occupation or any other occupation they are reasonably suited to by education, experience or training, and they will never be able to do so again, and

• these circumstances have existed continuously over at least six months.

Under the ‘own occupation’ TPD definition, a life insured is totally and permanently disabled if: • they have a disability caused by injury or sickness, and

• as a result of their disability, they are completely unable to work at their own occupation and they will never be able to do so again, and

• these circumstances have existed, and they have not been working in any occupation, continuously over at least six months.

By the very definition of ‘any occupation’ TPD, a key person will be lost to the business where a TPD benefit is payable. This may not necessarily be the case where an ‘own occupation’ definition is used, as the key person may still be able to perform certain roles within the business. It is important to consider each business’s needs and the possible scenarios that may arise for each key person, when deciding how to structure TPD insurance.

Note: If key person insurance is taken out in a super fund (see page 10) and the ‘own occupation’ TPD definition is chosen, there is some risk the Trustee will not be able to release the benefit in the event of a TPD claim. This is because the ‘own occupation’ TPD definition is not consistent with the definition of ‘permanent incapacity’ under superannuation legislation.

What premium options are available through MLC?

While both level and stepped premium options are available through MLC, the level premium option can be more attractive for two reasons:

1. Long-term savings. Over the long-term (typically seven years or more), the level premium option is generally less expensive. The MLC Windows-based premium quotation software (Adviser Switchboard) allows you to demonstrate these long-term savings to your clients in both a tabular and graphical format.

2. Easier budgeting. Although not a guaranteed rate, your clients will be able to budget more easily with a level premium, as opposed to the generally increasing costs under a stepped premium structure.

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What are MLC’s underwriting requirements?

Insurance up to $1.5 million can usually be considered without additional financial evidence providing the reason for the insurance is clear. A supporting statement from the adviser outlining the methodology used to calculate the sum insured is always helpful in this regard.

Insurance in excess of $1.5 million must always be supported by completion of MLC’s Financial Questionnaire and, for insurance beyond $2 million, the last two years’ business accounts must also be provided (as well as MLC’s Financial Questionnaire).

In these situations, it is vitally important the MLC Financial Questionnaire is completed and signed by the principal(s). The MLC Financial Questionnaire (form number 01063) can be ordered from Post Logistics or by contacting your MLC Representative.

Please note that further financial evidence may be required for cases below $1.5 million if the need for the insurance is not evident from the proposal and supporting documentation. Larger cases (ie above $2 million) may also require individual financial underwriting requirements to satisfy evidence of the valuation.

If you have any questions about the underwriting requirements, call MLC’s toll-free Underwriting Hotline on 1800 811 861. More information on the financial underwriting requirements (as well as the standard medical underwriting requirements) may be found in the ‘Underwriting Requirements’ section of the MLC Personal Protection Portfolio Adviser Guide.

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Glossary

Assessable income – Income (including capital gains) received before deductions.

Capital purpose – Key person insurance taken out to protect the business against an adverse impact on the balance sheet resulting from the death, disability or critical illness of a key person (see page 7).

Death benefit – A payment made from a super fund in the event of a member’s death. Includes, where applicable, the proceeds from a life insurance policy and the member’s investment balance. Dependant for superannuation purposes – Those people eligible to receive a death benefit directly from a super fund. Includes a spouse (legally married or de facto, but not same sex), a child of any age, a financial dependant (such as dependant children) and a person in an interdependency relationship with the deceased (such as a same sex partner).

Dependant for tax purposes – Those people eligible to receive tax-free lump sum death benefits from a super fund. Includes a spouse (legally married or de facto, but not same sex), minor children, a financial dependant (such as dependant children) and a person in an interdependency relationship with the deceased (such as a same sex partner).

Fringe benefit – A benefit provided to an employee by an employer in respect of the employee’s employment.

Fringe Benefits Tax (FBT) – A tax payable by an employer on the taxable value of certain fringe benefits received as an employee. The current rate of tax is 46.5%.

Interdependency relationship – Generally two people can be considered to be in an interdependency relationship if:

• they have a close personal relationship, and • they live together, and

• one or each of them provides the other with financial support, and

• one or each of them provides the other with domestic support and personal care.

Revenue purpose – Key person insurance taken out to protect the business against an adverse impact on the profit and loss account resulting from the death, disability or critical illness of a key person (see page 7).

SIS legislation – Superannuation (Industry) Supervision Act, 1993 and Superannuation (Industry) Supervision Regulations, 1994.

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51830

MLC

02/08

MLC Service Centre

For more information call

MLC Service Centre from anywhere

in Australia on 132 652,

or contact your financial adviser.

mlc.com.au

MLC Limited PO Box 200 North Sydney NSW 2059

Key person insurance 2007/2008