Small companies often insure their premises, equipment and professional risks, but the biggest financial risk may be the person who brings in most of the money.

For many owner-managed businesses, that person is the director.

A consultant, contractor, accountant or other professional may run a profitable limited company and still depend almost entirely on being fit enough to work. If illness or injury keeps them away from the business for six months, company income may fall at exactly the same time as their household still needs regular money coming in.

Executive income protection is designed for that situation.

Instead of the director buying a personal policy from their own taxed income, the company takes out the cover and pays the premium.

If the director becomes unable to work and the insurer accepts the claim, the benefit is normally paid to the company. The company can then use the money to continue paying the director.

Why directors can be particularly exposed

Employees in larger organisations may receive several months of sick pay or have access to group income protection through work.

Someone running their own limited company often has no equivalent unless they arrange it themselves.

The position can become more difficult where the director also generates most of the company’s turnover.

Take a consultant who normally needs £4,000 a month to meet household costs. Six months away from work could mean finding £24,000 before allowing for any wider effect on the business.

If most of the company’s revenue also depends on that person continuing to work, drawing the money from company reserves may not be as easy as it looks.

Executive income protection gives the company another source of funds during a longer period of illness or injury.

The company pays for the cover

The structure differs from ordinary personal income protection.

With a personal policy, the individual pays the premiums and receives the benefit directly.

With executive income protection, the limited company normally owns the policy, pays the premiums and receives any claim payments.

This can appeal to directors who would otherwise have to take additional money from the company, pay personal tax on it and then use what remains to pay for cover themselves.

The tax treatment needs to be considered properly when the policy is set up. Companies should not simply assume that every premium will automatically qualify for Corporation Tax relief, and payments made to the director following a claim will normally be dealt with through the company’s usual payroll arrangements.

A more detailed guide to income protection for limited company owners explains how company-funded cover works and the main tax points directors should consider.

Salary is only part of the picture for many directors

Owner-directors often do not receive all of their income through PAYE.

A relatively modest salary combined with dividends remains common, so the amount shown on a payslip may be well below the director’s actual annual income.

That matters when arranging cover.

Some executive income protection policies can take account of dividends when calculating the amount of benefit available, although insurers apply their own rules and may require evidence that the dividends are sustainable.

Depending on the policy, it may also be possible to include employer pension contributions or certain employment costs.

Directors should check exactly what the insurer will recognise rather than assuming that their normal monthly drawings will automatically be covered.

How long could the company keep paying you?

Most executive income protection policies include a deferred period.

This is the length of time the insured person must remain unable to work before payments start.

A company with strong cash reserves may be comfortable funding the first three or six months itself and choosing a longer deferred period.

A small consultancy where income falls quickly when the director stops working may want cover to start sooner.

Longer deferred periods will usually reduce the premium, but the saving only makes sense if the company can comfortably fund the gap.

The maximum claim period also deserves attention.

Some policies may pay for one or two years for each claim. Others can potentially continue until the director returns to work or reaches the selected policy end age.

Those are very different levels of protection, even where the monthly premiums look similar.

Check how the insurer defines incapacity

A policy only becomes useful when it pays a claim, so the definition of incapacity matters.

For many directors and professionals, an own-occupation definition is attractive because the insurer considers whether the person can carry out their actual job.

That can make a real difference for someone working in a specialist occupation.

A software consultant, for example, might still be physically capable of doing some forms of work while being unable to perform the role that normally produces their income.

Policy definitions vary, so directors should read the wording rather than relying on the product name alone.

Health, medical history and occupation will also affect the terms offered. An insurer may increase the premium, exclude a condition or decline cover depending on the circumstances.

Executive income protection and key person cover are not the same thing

The two are sometimes confused because both can involve insuring an important director or employee.

They solve different problems.

Key person insurance protects the business against the financial effect of losing someone important to the company, typically following death or serious illness.

Executive income protection focuses on continuing the insured person’s income when illness or injury prevents them from working.

A company may have a reason to arrange both.

One protects the business against the loss of an important person. The other helps the company keep paying that person during a period when they cannot work.

Start with the numbers

Before comparing policies, it is worth working out how much income the director actually needs each month and how long the company could maintain that level without fresh revenue.

A director who needs £4,000 a month and has enough reserves to cover six months faces a different problem from somebody who would struggle after eight weeks.

That calculation helps determine the level of cover, the deferred period and whether short-term or long-term benefits make more sense.

Income Protection Help has been created for directors and professionals looking at executive income protection, including how company-funded policies work and the points worth checking before arranging cover.

For many small companies, the director remains the main income-producing asset in the business. Protecting equipment and professional liabilities while leaving that income completely exposed can create a much larger financial gap than expected.