Valuation of Key Person in a Business - By Ayush Baheti, CFA, CMA

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, and
the multiples of the 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.

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.