Keyman

Keyman insurance is not easy to calculate. After all, there is no simple mathematical formula to determine the worth of a keyman. However, over the years, business owners have used the following methods to estimate the worth of a keyman to their company—and to appreciate the value of keyman insurance to protect against loss.

• "Multiple of compensation"
  This method assumes that the value of a keyman is accurately reflected in his or her total compensation package. The multiple that is used (for example: 2 X annual compensation) will depend on the type of business and the estimated difficulty in finding a qualified replacement keyman. This method is perhaps the easiest way to estimate potential loss to the firm and determine the appropriate level of keyman insurance.
  
  
• "Contribution to profits"
  This method estimates the impact that a keyman has on the company's net profit. The firm first calculates the expected profit from a normal return on capital (e.g., the net book value of assets). Profit in excess of this normal return is assumed to result from the efforts of the keyman employees. An estimate is made of the percentage of profit attributable to each keyman. This percentage is then multiplied by total excess profit, to determine the dollar amount of excess profit from each keyman. This sum is then multiplied three times the number of years needed to find and train a competent replacement for the keyman. The amount of keyman insurance is determined accordingly.
  
  
• "Cost of replacement"
  This method totals the direct, out-of-pocket costs involved in finding, hiring, and training a replacement keyman, as well as the estimated loss-of-opportunity costs. This total is used as the guide for purchasing keyman insurance coverage.

Many factors determine which method would be right for you, including (1) your type of business, (2) your industry, and (3) the age of your firm. It is critically important to bring in an accountant or financial advisor that specializes in business valuation to determine the value of your own keyman personnel.

In general terms, a keyman is considered to represent 15-20% of the value of a business, if the firm can find a competent successor keyman in a reasonable amount of time. However, if the business is likely to fail or be placed in serious jeopardy upon the loss of a keyman, then the factor rises to 20-45%. Keyman insurance protection becomes a clear concern, in this light.

Please consult with a qualified professional to protect against the loss of your keyman employees.

About the Author

Steven H. Kobrin, LUTCF, specializes in helping "high risk" clients obtain free life insurance prequalification. If you would like Steve to request prequalified life insurance quotes on your behalf, simply send him an email or call him toll-free at 1 (866) 633-1818.

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