How insurance plays a part in succession planning
It makes sense to mitigate your risks in succession planning. Richard Hopwood from PPS Mutual explains what insurance can do.
- Fewer than one in four accounting practices in Australia have formal succession arrangements in place.
- The life of the principal, the successor or both can be insured to mitigate financial risks.
- Having agreements over where the proceeds of an insurance policy are to be directed is also critical.
Succession planning is an exercise with many moving parts. But using insurance to mitigate the larger financial risks may help to ease worry and the financial burden.
The issue of succession planning is a perennial challenge, and fewer than one in four accounting practices have formal succession arrangements in place, according to Bstar’s latest 2020/21 Accounting Industry Insights Report.
But simply putting the planning off to another day is not really a plan. Is the risk of choosing the wrong person or persons holding us back? Perhaps it is the downside financial risk of investing time and money into succession that is also a limiting factor?
Being able to exit your business on your own terms is the ideal outcome. It requires patience and skill. For example, selecting and mentoring a junior employee or partner can take several years.
And once a suitable succession plan is worked out, what is the risk of failure? There can be many hazards; from the possibility of your chosen successor defaulting on a vendor loan, right through to more personal challenges such as an individual falling ill or having an untimely death.
At this point in a planning conversation, the obvious topic of insurance becomes useful.
Pictured: Some of the cast of HBO drama Succession.
The role of insurance in succession planning
Insuring the life of your employee to cover vendor finance loans or simply to cover key person risk to compensate the business should anything happen to their leader-in-waiting is a prudent move.
Junior partners are generally younger, meaning the cost of this ‘safety net’ is minimal relative to the cost of disruption to a business needing to go back to square one in its succession planning if the worst happened..
Insurance is also useful protection to all parties in the event of a “forced” exit from the business of the practice principal.
Insurance can be taken out on the life of the principal for the remaining amount of vendor finance. That means estate recipients can realise the value in the business if the principal unexpectedly exits due to disability or death. Insurance proceeds may be used to realise the value of the business instantly, before control is handed to the successor.
Premiums for this cover can be paid by the business, principal, successor or a combination of all three for an equitable outcome. Calculators help fairly spread the cost should there be multiple practice partners.
Key person cover
The life of the principal, the successor or both can also be insured. Any proceeds from key person cover protect the business rather than the individual, against unplanned costs of death, illness or permanent disablement. The funds can be used to recruit and train staff, or to provide financial relief from a revenue drop associated with the loss of a key income-producing employee.
Agreements over insurance proceeds are vital
It is important to realise that putting insurance policies in place is only a job half done. Without an agreement detailing where the proceeds of the policy should be directed, and what the funds should be used for (such as to fund a share transfer) then the results can be worse than if no insurance were in place. Having both insurance and agreements in place is critical when it comes to successfully protecting your business succession.
Using insurance to mitigate the larger financial risks associated with the death, serious illness or disablement of either practice principals or their key staff members is something that all accountants in practice should think about.
Essentially, business insurance has the same premise as other insurance cover: a safety net to mitigate risks and allow you to fund the right people at the right time.
Picture: Richard Hopwood.
“Essentially, business insurance has the same premise as other insurance cover: a safety net to mitigate risks and allow you to fund the right people at the right time.”
Succession planning guide for public practice
Provides a guide and checklists for practitioners to help plan long-term goals and have a documented succession plan.Get the checklist for your succession plan