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Posted by on Mar 9, 2015 in Uncategorized | 0 comments

How The Value Of Key Person Insurance Is Determined

Some organisations rely on one or more key individuals in order to function. Where this is the case and there is a risk to the business if that person were no longer present, then key person insurance is called for. How is this business insurance cover calculated?

Determining True Value

Underwriters will always want to know if the method chosen to place a value on the key person is in accordance with standard practice for the industry in question. They will also determine if the approach is in line with the purpose for which the coverage is asked. Fundamentally, the coverage level proposed must reflect the true value of the person to the organisation. Assessors will take one of three different approaches.

Present Value Method

In this method, the cost involved in replacing the particular employee will be calculated. Primarily the method looks at the salary needed to find an employee as a replacement until the time when that individual is of full economic value to the company. This is then added to the training costs associated, as well as any relocation costs.

Debt Cancellation Method

This method is used if the individual in question was a guarantor in some way or if their credit standing as a director or shareholder was primary in terms of attracting credits through the trade or bank loans. The corresponding estimates are based on the amount of any outstanding loans and the average of trade credits realised, while guaranteed by the director or shareholder.

Multiple Methods

A factor is used to determine the impact that the key person has on the organisation. In other words, how much does the business rely on the individual for its success? If there are only a small number of employees and a correspondingly large number of key people, this factor will be higher. However, if the organisation already has a range of employees with special skills, all of whom are contributing towards its success, then the factor will be lower.

Once the key factor has been determined, it can be applied to a variety of other metrics. For example, typically it can be multiplied by a figure representing three times the gross profit or multiplied against annual sales revenue. The factor can sometimes be applied to liabilities.

Here, much depends on the sector within which the key person worked. A calculation applied to a gross profit may be more appropriate for a key person who is in a general management position, while a key person factor applied to revenues may be more appropriate in the case of a sales executive.

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