Key Person Insurance

1. 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.

2. Contributions to earnings method.The contributions to earnings method are 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.

3. 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 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.