A Professional Key Employee Valuation Method for Business Life Insurance Purposes

A Professional Key Employee Valuation Method for Business Life Insurance Purposes

The figure above presents a key employee valuation worksheet that incorporates the principal elements of a complete and systematic method of valuation. The method estimates the difference between the key employee’s and a replacement employee’s contributions to the firm each year over a transition training period. The present value of the differences is an estimate of the amount of insurance required to carry the firm through the transition period.  The following factors are required inputs:…

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Basic Principles of Valuing Key Employees for Business Life Insurance Purposes

Basic Principles of Valuing Key Employees for Business Life Insurance Purposes

A conceptually sound approach to key employee valuation should measure the financial loss based on what the employee would have contributed to the future success of the firm and adjust the financial consequences for the timing of those lost contributions. It should also: account for trends in the employee’s contributions;  realize that, in every case, a key employee’s contribution to the firm will terminate at some point, either through death, disability, resignation, or retirement; and …

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Common Methods of Valuing Key Employees for Business Life Insurance Purposes

Common Methods of Valuing Key Employees for Business Life Insurance Purposes

Various ad hoc rules of thumb and approaches have been used to estimate the value of a key employee. These rules, although simple to apply, are conceptually limited. For example, estimating an employee’s value as some multiple of salary is entirely arbitrary. What multiple is appropriate? In addition, it takes no account of the timing of cash losses. The effect, in many cases, may not actually appear in revenues until future periods. Alternatively, a key…

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Life Insurance Needs of a Business

Life Insurance Needs of a Business

Life insurance is used in business applications to insure key employees, fund buy-sell agreements, and in various compensation arrangements, such as in death-benefit only plans, Section 162 plans, split-dollar arrangements, and in qualified pension and nonqualified deferred compensation plans. The insurance need in most of these cases depends on circumstances peculiar to each case, and is beyond the scope of the current discussion. However, the insurance need in most key employee situations is amenable to…

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The Needs Analysis Approach to Determining How Much Life Insurance to Buy

The Needs Analysis Approach to Determining How Much Life Insurance to Buy

In contrast with the income replacement approach, which is founded on the premise that the insurance need should be based on the income that would be lost if the insured dies, the needs approach estimates the insured’s family income needs directly. The typical needs of a family can be divided into two categories. The first category of needs consists of lump sum cash needs at death, typically including: administrative/final expenses; estate settlement costs; debt liquidation;…

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How Life Insurance Agents Should Determine Family Needs and Income Replacement

How Life Insurance Agents Should Determine Family Needs and Income Replacement

The chart above presents a worksheet that summarizes the nine basic steps in using the income replacement approach to determine insurance need.  For example, in the case of the Mike Fox family, the analysis would proceed as follows. Assume Mike’s after-income-and FICA tax take-home pay is $50,000. Assume also that Mike expects his income to grow at 4 percent [about 1 percent more than the rate of inflation, which is assumed to be 3 percent…

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Methods Life Insurance Agents Use to Determine Family Needs and Income Replacement

Methods Life Insurance Agents Use to Determine Family Needs and Income Replacement

Any method of determining a family’s insurance needs will be an estimate. Future circumstances will change in unexpected ways and basic assumptions about earnings, interest rates, inflation, and similar factors will never replicate actual experience. Consequently, every insurance program must be monitored and periodically updated to assure that the client’s needs are still being met.  Personal computers have made it possible to perform increasingly comprehensive and sophisticated analyses of insurance needs. The problem with this…

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The 3 Primary Needs For Life Insurance

The 3 Primary Needs For Life Insurance

Financial planning professionals apply diversified techniques to determine the life insurance needs of a family. Life insurance planning involves essentially three principal, but often overlapping needs areas:  Income replacement and family needs analysis  Business insurance needs analysis  Estate preservation and liquidity needs analysis  A comprehensive study of the client’s financial needs and concerns generally is the best way to conduct life insurance planning. The process of life insurance planning must begin and end with the…

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