Valuing a Key Employee
It can be hard to put an exact monetary value on how important a key person is to a given business. The goal when valuing a key person for life and disability insurance is to get the correct amount of coverage based on the specific needs of the business, but that also corresponds to the realistic loss associated with the death or disability of the key employee from the insurance company’s viewpoint.
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.
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.