Many shareholders and business owners spend years developing their business, pouring time, effort and money into a venture they truly believe in. But if one of the shareholders dies unexpectedly, everything can change. Whoever inherits the shareholder’s estate will inherit a stake in the business, along with all the decision power that goes with it. If the remaining shareholders can’t afford to buy back this influence, or if the family urgently needs access to capital, business equity could end up in the wrong hands.

Shareholder protection insurance can enable shareholders to map out a plan for their succession, should the unthinkable happen. It’s a way for companies to retain control following the untimely death of a shareholder and safeguard the business against competitors and unwelcome third parties.

This article guides you through shareholder protection insurance, covering the following sections:

• What is shareholder protection insurance?
• What is covered by shareholder protection insurance?
• Do I need shareholder protection insurance?
• How much cover do I need?
• How much does shareholder protection insurance cost?
• How to find a shareholder protection insurance provider
• Final thoughts & FAQs.

What is shareholder protection insurance?

Business shareholders each own a stake in a company, which translates to control over how the company is run. Should a major shareholder pass away, their stake would automatically pass to their estate. Ownership and control then pass on to the family members, who may have no interest in the company, or a completely different vision for the business’ future, based on little to no experience. Alternatively, they might sell the shareholding onto an outsider, who may care even less for maintaining the spirit of the firm. Shareholder protection insurance is designed to establish a clear succession plan and offer sufficient financial backing to realise the transfer of ownership to the surviving shareholders.

Typically, surviving owners want to purchase the remaining shares to retain control of the business and keep it on the same path. There may be two barriers to this: the first, is waiting for probate, and the second is being unable to raise sufficient funds to buy the shares. Shareholder protection insurance resolves this by establishing an agreement signed by key shareholders, which typically states that in the event one of them passing away, their shares will go to the surviving shareholders for a fair price agreed in the policy. The insurer then typically provides the funds as a payout to the survivors so that they can buy back the equity.

Not only is this type of insurance crucial for keeping the essence of a firm alive, but it is also designed to mitigate business disruption and uncertainty. Losing any member of staff is a challenge for a company, but losing a shareholder can put the breaks on any company decisions. Waiting for probate or the transfer of ownership to a new shareholder can cause a severe rupture in productivity, and can block the surviving shareholders from making important decisions. This type of policy is designed to facilitate business continuity and ensure the company can trade as normal.

A shareholder agreement can also guarantee protection for the family. Usually, all shareholders agree on a fair sum for their stake in the business before they sign the agreement. This typically ensures that the beneficiaries get a reasonable price for the shares, and can also alleviate stress for the family left behind by providing a pre-determined succession plan.

What is covered by shareholder protection insurance?

Should one of the major shareholders pass away, shareholder protection insurance typically pays out a sufficient cash lump sum to the surviving shareholders to enable them to purchase the business equity of the deceased. The exact terms of the legal agreement depend on the type of policy taken out. In the UK, there are three principal types of shareholder protection insurance.

Life of another

If there are only two shareholders in a business, they may take out a life of another plan. Each shareholder takes out a life insurance policy on the life of the other with an insured sum representing the amount they would need to buy their counterpart’s business equity. Each shareholder pays their own premiums individually. This option is typically tax-efficient, as the payouts tend to be tax-free.

Company share purchase insurance

Under this type of arrangement, the company takes out a policy for each individual shareholder. The sum insured under each policy matches the value of the individual’s share in the business, which is calculated and agreed when the policy is taken out. Should one of the insured shareholders pass away, the company becomes the beneficiary of the payout, which they can then use to purchase the shares.

Own life policy held under business trust

The final form of shareholder protection insurance involves each shareholder taking out an individual ‘own life’ policy, held under a business trust. If one of the shareholders pass away, the survivors can use the cash lump sum paid out by the policy to purchase the shares of the deceased, and the shares are divided equally among the surviving shareholders.

Life or life and critical illness

Within these three types of policy, you can arrange cover in two ways, which determines the type of claims that the policy can cover. These are:

• Life cover. This policy typically only pays out if an insured shareholder dies or receives a diagnosis for a terminal illness, with fewer than 12 months to live.
• Life and critical illness cover. This policy can pay out if an insured shareholder passes away, if they develop a serious illness or if they have an accident which leaves them unable to work.

Critical illness cover tends to be an optional add-on to widen the policy’s scope of protection to include more claims. However, the effect of a shareholder’s death or critical illness tends to have the same impact for a business. Serious ill-health which prevents them from returning to work may equate to the same loss of experience, skills and contacts as if they were no longer around. This may also translate into a barrier to making decisions to move the enterprise forward, should the shareholder be too unwell to approve the plans.

Policies differ as to which illnesses they can cover. Typically, a critical illness policy can provide a payout for the following types of health issue, either as standard or as optional add-ons:

• cancer (policies may specify particular types)
• heart attacks
• major organ transplants
• kidney failure
• strokes
• multiple sclerosis
• respiratory failure
• liver failure
• bacterial meningitis
• encephalitis
• total permanent paralysis or disability
• Parkinson’s disease.

Alongside the key claims typically covered by shareholder protection insurance, policies often come with additional benefits. These can include:

• a virtual GP service, generally available 24/7
• a second medical opinion service, offering employees a second opinion on their diagnosis from top medical specialists
• a counselling and stress helpline
• health programmes, such as nutrition or fitness schemes to encourage healthier lifestyles
• discounts, e.g. for gym membership.

Do I need shareholder protection insurance?

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

Not only could the business lose its essence under new ownership, but if the family of the deceased need to release money quickly, they may have no choice but to sell to the first interested buyer. There’s no way of knowing whether this buyer will have clashing objectives for the business. Worse, they could be a competitor. What’s more, even if the remaining shareholders would have the funds to buy the shares themselves, probate can be a lengthy process. While the shares are tied up in probate, the business may lose money, hampering productivity or even ceasing trade entirely.

Another consideration is what would happen to their family of the shareholders in the event of their untimely death. A shareholder agreement can offer business owners peace of mind, as it can ensure the family receive a pre-determined amount for the stake, without having to find a buyer or negotiate a price that may leave them short. If your family would struggle to cope financially without you around, shareholder protection insurance may be worth considering to help ensure they receive a fair sum.

Finally, small businesses, in particular, should seriously consider shareholder protection insurance. It may be even more difficult for shareholders of smaller firms to raise enough capital to buy the remaining shares, which puts them at greater risk of losing the reigns.

How much cover do I need?

The policy needs to cover a sufficient amount to enable the surviving shareholders to purchase the deceased shareholder’s portion of the business. Therefore, the sum insured should equal the value of the relevant owner’s shareholding. This is important to establish when taking out the policy to ensure that their family get a fair share price. Working out the value of each shareholder’s stake is a complex process, and the vast majority of companies work with an accountant to get an accurate estimation.

There are three primary ways that you can take out a shareholder protection insurance policy, which affect the valuation of business shares. The three methods used are:

• Open market value of the business. This ensures all parties receive a fair deal at the time, using a valuation based on how much the shares are currently trading at. However, it can be difficult to predict this value in advance, which may result in the sum insured not being sufficient to cover the current market value. The open market value must also be calculated following the death of the person insured, which could lead to significant delays in the completion of the sale, which is commonly one of the risks that businesses try to mitigate with shareholder protection in the first place.
• Fixed value for the share of the business. The company agrees on a method of valuing a shareholding when taking out the policy. The resulting value is written into the agreement.
• Fair value of the share of the business. This is a proportion of the company’s market value at the date of the shareholder’s death. An independent auditor or professional valuer will need to determine this value, appointed by the surviving owners and representatives of the deceased.

Typically, companies opt for an agreement based on a fixed value written into the contract. To work out this value, all parties in the agreement must agree on the valuation method used. A common method is to apply a multiple of profits. This takes past and present performance into account to create realistic projections of future profits.

There’s no single method for working out the amount of cover you need. The best way to achieve a valuation or determine an appropriate level of cover is to seek professional advice from a qualified adviser. To this end, you may have to provide extensive information on the company’s financial status. An adviser typically examines the following:

• business cashflow
• profits
• the company’s management
• the company’s asset value
• dividends paid
• liquidity
• the state of the economy
• the demand for shares
• articles of association
• the size of any individual shareholding.

The final element to consider when taking out a policy is how long a term you need. Insurance providers can tailor the term length to the needs of the business, depending on the shareholders’ age and how long they are likely to work at the company. If a shareholder is in their 60s, for example, and plans to retire at 65, then you may only need a term up to five years. For younger shareholders, you may want to take out a policy that lasts until their retirement age, some decades later. Most insurers can offer terms up to 40 years or more in length.

How much does shareholder protection insurance cost?

There are a range of factors which determine the price of a shareholder protection insurance policy. The first depends on the level of cover you choose. The likelihood of somebody developing a serious illness is far higher than somebody passing away suddenly. This raised probability increases the risk for the insurer, which is reflected in the price. According to the Online Money Advisor, policyholders can pay four times as much for a policy which includes critical illness cover than they would for a life-based plan.

Another factor determining price is the risk profile of the person insured. You have little control over these elements, as the insurer will use the following information to determine a suitable price:

• the age of the shareholder
• their state of health, including any underlying health conditions
• their smoker status
• their lifestyle habits, including alcohol consumption, level of activity
• family history, including whether any immediate families have suffered serious or hereditary illnesses.

The prices of the premium increase drastically with age. According to Drewberry Insurance, the average price of a shareholder protection premium was almost four times as much for a 55-year-old as it was for a 35-year-old, based on a ten-year policy.

How to find a shareholder protection insurance provider

Before you begin your search for a shareholder protection insurance provider, it’s essential to be clear on your search criteria. Many businesses choose to take out comprehensive business protection insurance, which can combine a shareholder protection insurance policy with other forms of life-related covers, such as key person insurance and business loan protection. Once you’ve established the features of cover you are looking for in a policy, there are three routes to finding a supplier that ticks the boxes.

Approaching insurers directly

One of the best ways to find out what’s on offer on the market is to approach insurers directly. Many providers have a team of expert advisers on hand to offer guidance with selecting a policy, as well as advice on a suitable type and extent of cover. Due to the complex nature of business protection insurance, many companies choose to take out a policy with a specialist life insurance provider. Indeed, many of the market leaders are specialist suppliers that exclusively sell life insurance-related products.

Going through a broker

Shareholder protection insurance is the most complicated business protection policy in the market, with three ways of taking out a policy and complicated tax rules applying to each. From working out the value of each shareholder’s equity to the extensive legal agreements that need to be put in place, a broker’s experience and industry knowledge can be invaluable to ensure your business gets the right level of cover for a reasonable price.

Brokers can also be helpful in the event of any claims disputes, as they can act a mediator between you and your insurer. With so many conditions and legal caveats to contend with, disputes of this kind are not uncommon.

Comparison websites

As with any insurance product, the breadth of the market can be overwhelming. A helpful starting point is to consult a comparison website, which can provide an easily digestible summary of cover for various products and suppliers on the market. Most comparison websites allow you to narrow your search by applying specific criteria.

However, shareholder protection insurance is a particularly bespoke product, and each insurer uses different methods to estimate a quote. It can, therefore, be difficult to generate accurate quotes and compare policies on a like-for-like basis through comparison sites.

Final thoughts & FAQs

The worst-case scenario is something nobody wants to think about, but it’s essential to business survival. If the unthinkable were to happen, a clear plan of succession and a financial safety net could ensure that a business remains on track, leaving survivors to focus on the things that matter.

Shareholder protection insurance can be crucial to safeguarding the essence and ethos of a business. It protects the company from unwelcome intervention and prevents the sale of shares to competitors. Overall, it’s a form of business protection insurance worth considering to maintain business stability and continuity in challenging times.

Still have questions on shareholder protection insurance? Check out answers to common queries, below.

Who pays for shareholder protection insurance?

It is usually the company which pays the premiums. In this case, the firm is also the beneficiary of the payout. If there are just two shareholders in a business and they have chosen to take out a life of another arrangement, the individuals would pay the premiums themselves and would also typically be the recipients of the cash payout.

Tax treatment of shareholder protection insurance

The way taxation works for shareholder protection insurance depends on what type of policy has been taken out. Under a company share purchase arrangement, the company is the owner of the plan and takes out a policy on the life of each shareholder. In this case, the premiums typically won’t be eligible for corporation tax relief as they are not generally considered an allowable business expense. However, they also usually won’t be taxable as a benefit in kind on the insured person, either. This is because the insurance is generally considered to benefit the company rather than the individual.

If the shareholders take out own life plans and if the company pays the premiums, these are generally seen as a business expense, making them tax-deductible. However, the premiums would usually constitute benefits in kind for the individuals, obliging the shareholders to pay tax on the premiums. The proceeds of a shareholder protection insurance policy tend to be exempt from corporation tax, as the payout is generally considered capital.

The most straightforward option when it comes to tax is a life of another policy. The premiums for the company tend to be tax-free. As it’s the individual who receives the payout rather than the company, there’s usually no tax implications for the business on the insured sum, either.

The taxation of shareholder protection insurance is complicated and varies significantly depending on certain factors. As always, it is important to seek tax information and advice from a qualified accountant or tax adviser or consult HMRC directly.

What is shareholder protection premium equalisation?

If all the shareholders take out individual policies under business trust, it tends to be more tax-efficient to equalise the shareholder protection insurance premiums. Otherwise, HMRC may view unequal premiums as a ‘gift’ or ‘transfer of wealth’ to those shareholders paying less, which has further tax implications. Again, you must seek advice from HMRC.

What other types of business protection are there?

Shareholder insurance protection is one of four principal types of business protection insurance, which all insure businesses against financial losses following the death or critical illness of someone related to the company.

Other types include key person insurance, which can offer a payout to cover company losses if a member of staff with a vital role, skills or contacts passes away. Another is business loan protection, which typically offers a payout for surviving shareholders to use to pay the outstanding debts of the deceased for which they now have liability. A final option is relevant life insurance, which can offer a payout to the family of a deceased employee.

What is a cross option agreement?

A cross option agreement is required for tax purposes between the shareholders and the business if they want to take out a company share purchase shareholder protection policy. The agreement typically states that the company has the option to purchase the shares and that the shareholder’s estate has the option to sell them, but there is no guarantee. Having no binding contract of sale in place can prevent the business from being liable to inheritance tax when purchasing the shares. With a cross option agreement, the payout is usually treated as a capital receipt and therefore is tax-free.

What is the difference between shareholder protection and partnership protection insurance?

Shareholder protection and partnership protection insurance are very similar policies. The difference comes down to the type of business in question. Share protection is for limited companies, where the insurance is taken out on the lives of the company’s shareholders. Partnership protection is for partnerships and limited liability partnerships, taken out on the lives of the business partners.