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CPD Questions

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1. Joint and several liability means that when signing a mortgage contract with others:

a) The non-earning party is granted relief from their share of the loan b) Each party is only responsible for their share of the loan c) The highest-earning party agrees to pay off the whole debt if the others do not pay d) Each party agrees to pay off the whole debt if the others do not pay

2. Insurance for joint and several debts in business partnerships:

a) Allows each member to only insure their share of, not the total, debt b) Allows each member to completely insure a debt, not just their share c) Is a type of specialised general insurance d) Is capped using a sliding scale

3. What does the author recommend for those considering a co-borrower loan?

a) Nominate to use a mediator if necessary b) List what is discussed and agreed upon c) Use a signed legal agreement to act in all parties’ best and fair interests d) All of the above

4. In the context of joint and several mortgage debt, the life insurance industry:

a) Precludes cover for taking time off for home improvement work b) Applies a base rate of $2 million for mortgage insurance c) Has difficulty recognising the value a homemaker brings to a relationship d) None of the above

5. Co-owning a property with a mortgage can impact future borrowing capacity.

a) True b) False

6. If a default happens on your loan because of a coborrower’s actions, it is not listed on your credit file.

a) True b) False

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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Volume 16 Issue 01 I 2021

The bottom line is that any joint debts mean joint responsibility and liability.

The Australian Securities and Investments Commission (ASIC) Moneysmart website has a useful factsheet titled ‘Love and loans’ about this issue.

How do you protect family borrowers from a joint and several mortgage debt?

So how do you protect the joint borrowers in a family, especially if one of them does not work?

The life insurance industry traditionally had a difficult time recognising the value a homemaker brings to a relationship and limited the amount of life insurance a homemaker (though not working by choice) could apply for to $1.5 million life insurance.

This creates potential problems for a typical two-parent household with two kids and a $2 million mortgage if one of the adults is a fulltime homemaker.

This can create a problem for partners doing extensive renovations on a property where one adult is not working but managing the renovation full-time, while their partner continues to work.

If the debt is a joint and several mortgage, both working and nonworking borrowers are still liable for the entire debt of $2 million.

The solution might be a specialised life insurance policy designed to recognise and insure joint and several liability mortgages debt on the family home.

This is where the total amount of the mortgage can be insured, regardless of the working status of the adults in the family.

How do you protect business owners and partnerships from a joint and several debt?

This speciality life insurance is also available to business partnerships.

A four-partner accounting firm may have a debt of $4 million and needs each partner to completely insure the entire debt, not just onequarter of it. A joint and several life insurance policy allows each of the four-partner business to completely insure the entire $4 million debt, not just traditionally one-quarter of the debt.

Conclusion

Borrowing with others can increase your opportunity to get ahead, but can also increase your risks to manage. Therefore, make sure everyone knows what is at stake when co-borrowing. fs

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Insurance:

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46 Insurance advice for business clients

By Crissy Demanuele, BT

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Insurance

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CPD

Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD.

Worth a read because:

If a key person is unable to work in a business due to health reasons, the impact may be significant. This paper examines key person insurance for revenue versus capital purposes, outlines taxation considerations for various forms of cover, and discusses the pros and cons of associated policies.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Insurance advice for business clients

Crissy Demanuele R unning a business means taking all sorts of risks, many of which can be difficult to control: economic ups and downs, increased competition and changing consumer behaviour, to name a few. However, one type of risk a business can have a degree of control over is people risk. That is, the financial impact to a business if a key person dies, becomes temporarily or permanently disabled or suffers a specific medical condition.

To protect itself against the temporary or permanent loss of a key person, a business can use what is commonly known as ‘key person’ insurance. When insurance is used for this purpose, it is to assist with protecting the business as an ongoing entity.

Life can be risky, for instance, the prevalence of cardiovascular disease and cancer in Australia. Insurance can be used as a means of protecting against the financial implications of such risks. Key person insurance may include lump sum cover for revenue and capital purposes and key person income cover for temporary incapacity. Businesses may also hold business overheads insurance to cover specific expenses of the business such as electricity bills and rental costs.

Who is a key person?

A key person is someone who is critical to the financial wellbeing of a business through their continued association. A key person may be someone who plays an important role in generating the revenue for the business. They may provide a loan to the business, or make it possible for the business to obtain loans.

A key person can include: • a director, managing director or CEO • a partner in a partnership • an employee with a unique skill or technical expertise • a senior sales manager.

There may also be occasions when an external supplier is considered a key person to a business.

Revenue or capital purpose

If a key person is disabled or passes away, and can no longer work in the business, either temporarily or permanently, their absence from this business may impact either the revenue or the capital of the business, or both. Therefore, it is important to understand the difference between taking out the insurance for revenue purposes or for capital purposes.

Key person lump sum cover—revenue purpose

The death or disablement of a key person could have a significant impact on the revenue of a business and therefore its ability to meet day-to-day expenses. This could occur, for example, where that person has a unique skill or has particular knowledge relevant to the business or has relationships with key clients.

If this happens, a business could consider replacing lost revenue by:

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• using existing cash reserves, if it has any • drawing down from existing loan facilities • selling some of the business assets • weathering a period of reduced profit.

For many businesses, these options are sometimes simply not possible or too expensive. For these reasons, insurance cover often represents the only commercially viable solution.

Key person cover for revenue purposes provides a lump sum to the business for the replacement of the revenue lost in the months following the exit of the key person. It is normally established in the form of a term life, total and permanent disability (TPD) and/or trauma insurance policy.

Structure and taxation of key person revenue cover

Insurance policies that cover a key person for the purpose of protecting the business against a fall in revenue or sales are generally owned by the business entity or, for more complex arrangements, a trust (with the business entity as one of the beneficiaries of the trust). Business ownership is often the simplest method of ownership. Where a trust is used, the policy will normally serve a number of business needs, including debt reduction and even buy/sell funding.

With regard to taxation, the purpose of the cover will determine whether the premiums are tax deductible and how the proceeds are taxed. As a general rule, where the purpose of insurance is to protect the revenue of the business, through replacement of lost sales or provision for increased expenses, the premiums will be tax deductible and the proceeds will be assessed as income.

In circumstances where the business is expected to cease on the exit of the key person, an insurance policy is not considered to have a revenue replacement purpose and is therefore not generally tax deductible (see Taxation Ruling IT 2434 Income tax :split dollar insurance arrangements). This would commonly be seen in sole trader or one-person incorporated businesses.

If a business needs to insure the same person for a capital purpose (for instance, for debt reduction), it could either establish a separate policy, or cover both needs with the same policy. By using a single policy, there can be greater flexibility when revenue and debt reduction needs fluctuate. However, only that portion of the premium which relates to revenue protection cover would be tax deductible. Where this approach is taken, appropriate records should be kept for tax auditing purposes. This approach can be cumbersome.

Many advisers therefore find it simpler to establish separate policies where both revenue and debt reduction needs exist. Depending on the policy features, the business may be able to increase the sum insured when revenue or debt reduction needs change, within certain limits but without additional underwriting. Key person income cover

Traditionally, key person insurance cover in Australia has involved the use of lump sum insurance products, such as term life and TPD. Unfortunately, these policies do not typically address the risk of temporary disablement.

This is an important gap to acknowledge because a temporary disability is statistically more likely to occur than a permanent disability or death. The key person may also be more likely to qualify for payment, as the definition under key person income cover may be more generous than the definition under TPD or death cover.

The absence of a key person due to temporary disablement can place a business under the same significant stress that occurs in the event of death or permanent disablement. Often there is uncertainty as to when (or if) the key person will return. This makes it difficult for the business to make decisions about whether to hire and train a replacement, how to handle certain client relationships, and general business planning.

Key person income policies differ from the traditional business overheads policies in a number of important ways. Business overheads policies generally only provide cover for certain business expenses incurred during the period of disability. Key person income policies, on the other hand, can provide a monthly benefit which can be used not only for fixed business expenses, but also to cover lost revenue.

Crissy Demanuele, BT

Crissy Demanuele is BT’s senior product manager, life insurance, and a member of the product team within the company’s life insurance business. Her areas of expertise are insurance, taxation, superannuation and SMSFs, social security, estate planning and aged care.