|
 In
many cases the amount of key person insurance requested is
dramatically higher than is available
from the life and disability insurance companies. For example,
just because a firm is borrowing $10,000,000 for a project
expansion doesn’t mean the insurance company will willingly
write $10,000,000 of key man life or disability insurance.
Specific details will be required by the insurance company
to justify the insurance amount requested. For more information
on how the insurance companies review financial needs of
businesses see, “Underwriting
Key Man Insurance.”
There are several valuation methods commonly used to determine
the proper amount of key person insurance needed from both
the business and insurance companies perspective. These valuation
methods include: the replacement cost method, the contribution
to earnings method and the multiples of income approach.
A brief explanation of each valuation method follows below.
Replacement cost method. The amount of key man insurance
needed is based upon what it would cost to replace the key
executive. The replacement cost of a key person is determined
by the salary and other ongoing expenses required in hiring,
training and completely replacing the key employee or executive.
Costs associated with decreased or lost revenue may also
be factored in when determining a key employee’s replacement
cost.
Contributions to earnings method. The contributions
to earnings method is calculated based on the percentage
contribution
the key employee makes to the company’s bottom line
profit. For example, a top salesperson in a small business
may contribute 50% or more of the sales of the company directly
resulting in half of the company’s profits. In this
case, the actual value of half of the company’s annual
profits would be multiplied by the number of years needed
to train an equivalent replacement.
Multiples of income method. The multiple of income method is the simplest most common
form of determining the value
of a key employee. Most insurance companies use a multiple
of 5-7 times current salary including benefits as a general
guideline. Of course, depending on the specifics of the
position, a higher or lower multiple may be justified. An
example of
the multiples of income approach would allow $1,000,000
of key man insurance on an executive making $200,000 in compensation
and benefits assuming a 5 times multiple.
The key man valuation
methods discussed above are not set in stone. Each case
merits specific consideration and therefore
should be reviewed based on their individual circumstances.
If you have questions regarding the amount of key man life
or key man disability insurance needed, please call MEG
Financial at (877) 583-3955 or complete a simple
online form now.
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