How do you develop a formula to establish a dollar value on the financial impact of a key employee’s death? As difficult as it may be, you need to come up with a figure as a guide to how much insurance coverage to buy.

Look at the employee’s responsibilities and value how important they are to you annually. If, for example, the employee is responsible for a certain volume of sales, the loss is the profit derived from the person’s sales, less the profit that could be expected from a replacement.

Additional costs might include replacing the employee with the same or similar income, and the costs associated with hiring the replacement: HR expenses, moving costs, possibly a higher salary.

So what are key decision-makers really worth? Unfortunately, there is no tried and true formula that transcends industries and business cycles.

Step 1: Examine each department and define all the required tasks and their value to your organization. This will give you a basis for benchmarking compensation against industry standards.

Figure out which positions have the most impact on overall performance, based on a variety of financial metrics–sales, earnings, return on capital and the like. Be sure to consider how certain positions affect others–poor performance in one area could be the result of problems in another. Then, rank each job in order of importance, based on these factors.

Step 2: Canvass the competition. Try to establish a fact base for the role you’re hiring. Look at industry data. Remember that pay scales for certain roles vary considerably by industry, geography and company size.

According to Salary.com , top executives in the finance, insurance and real estate industries do better on average, while construction and health care execs– UnitedHealth ex-chief William McGuire notwithstanding–go wanting. As for geography, companies in the northeast United States, for example, tend to compensate key executives at higher rates than companies elsewhere in the country. Finally (and not surprisingly) size does matter: Overall, larger companies pay 20% to 70% more for key players across all executive positions than do businesses on the whole.

Salary-benchmarking surveys from major human resources consulting firms like Mercer can cost up to $5,000, but you don’t need to pay that much. Comparison sites PayScale.com and Salary.com sell compensation reports for as little as $20 a pop. The Bureau of Labor Statistics provides salary data by industry for free online. Yet another data option: Look at Securities and Exchange Commission filings by smaller, publicly held companies in your industry.

In Pictures: How To Figure Out What That Key Guy Is Worth

Term insurance is usually used when the only purpose is to compensate for losses caused by the key employee’s death. Policies that accumulate cash value are appropriate in some circumstances. You need to discuss the options with your life insurance agent.

Usually, your organization owns the policy, pays the premium and is the beneficiary. Alternatively, your business and a key employee may agree to split the premium payments, cash surrender and death benefit value.

The employee must agree to the company’s purchase of this insurance. The insurer may also require a resolution from your board of directors stating the policy’s purpose.

Key employee disability income insurance is less well known than key employee life insurance. Nevertheless, the risk of a key employee experiencing partial, total or permanent disability is actually much greater than the risk the person will die. Should a key employee suffer permanent total disability, the loss to your business will be just the same as if the person had died. Key employee disability income insurance protects the business from this loss exposure by paying you anywhere from 40 to 70 percent of the disabled employee’s earned income.

If the disabled person is a partner or sole proprietor, a business overhead expense disability policy provides some protection. This pays, up to the policy limit, office expenses including rent, utilities, salaries and depreciation that continue when a partner or sole proprietor is disabled.

Protect Your Company From A Catastrophic Loss

Just to clarify, a key employee is someone without whose knowledge and skills would negatively impact your business income and, according to a survey of small businesses by the National Association of Insurance Commissioners, 71 percent of the firms surveyed said they were very dependent on one or two key people for their success. The disturbing fact, however, is that only 22 percent of respondents had key person life insurance in place.

Key Employee Insurance Life or disability income insurance can compensate your business when certain key employees die or become disabled. These coverages cushion some of the adverse financial impact that results from losing a key employee’s participation.

The policy works by paying the business in the event of the death or disability of a person who is so important to the business that their loss could destroy the business. The policy is a cheaper option than standard life or disability policies because the policy can be purchased with a “first to die” provision and cover multiple key employees.

For example:

A company founded by three individuals could take out a key policy on all three of the founders with a “first to die” provision. Upon the death or disability of one of these founders, the policy would pay benefits to the company. The policy would no longer apply to the two remaining founders. The policy payment would be used to replace the efforts of the first founder (hiring personnel, covering loss of sales, etc).

The good news is that insurance purchased in this manner would be much cheaper than three individual life policies and three individual disability policies.

The cost of this coverage can often be defrayed as a business expense on company taxes (see your tax professional). The cost is often cheaper because it is sold as a term product usually for fifteen to twenty years and often corresponding to the most productive work years of the employee or officer. Your company may not need this coverage, but even engaging in the analysis of whether this coverage is necessary is often helpful. Do the analysis and consider what you would if Employee X was not able to work tomorrow.

How do you develop a formula to establish a dollar value on the financial impact of a key employee’s death? As difficult as it may be, you need to come up with a figure as a guide to how much insurance coverage to buy.

Look at the employee’s responsibilities and value how important they are to you annually. If, for example, the employee is responsible for a certain volume of sales, the loss is the profit derived from the person’s sales, less the profit that could be expected from a replacement.

Additional costs might include replacing the employee with the same or similar income, and the costs associated with hiring the replacement: HR expenses, moving costs, possibly a higher salary.

So what are key decision-makers really worth? Unfortunately, there is no tried and true formula that transcends industries and business cycles.

Step 1: Examine each department and define all the required tasks and their value to your organization. This will give you a basis for benchmarking compensation against industry standards.

Figure out which positions have the most impact on overall performance, based on a variety of financial metrics–sales, earnings, return on capital and the like. Be sure to consider how certain positions affect others–poor performance in one area could be the result of problems in another. Then, rank each job in order of importance, based on these factors.

Step 2: Canvass the competition. Try to establish a fact base for the role you’re hiring. Look at industry data. Remember that pay scales for certain roles vary considerably by industry, geography and company size.

According to Salary.com , top executives in the finance, insurance and real estate industries do better on average, while construction and health care execs– UnitedHealth ex-chief William McGuire notwithstanding–go wanting. As for geography, companies in the northeast United States, for example, tend to compensate key executives at higher rates than companies elsewhere in the country. Finally (and not surprisingly) size does matter: Overall, larger companies pay 20% to 70% more for key players across all executive positions than do businesses on the whole.

Salary-benchmarking surveys from major human resources consulting firms like Mercer can cost up to $5,000, but you don’t need to pay that much. Comparison sites PayScale.com and Salary.com sell compensation reports for as little as $20 a pop. The Bureau of Labor Statistics provides salary data by industry for free online. Yet another data option: Look at Securities and Exchange Commission filings by smaller, publicly held companies in your industry.

In Pictures: How To Figure Out What That Key Guy Is Worth

Term insurance is usually used when the only purpose is to compensate for losses caused by the key employee’s death. Policies that accumulate cash value are appropriate in some circumstances. You need to discuss the options with your life insurance agent.

Usually, your organization owns the policy, pays the premium and is the beneficiary. Alternatively, your business and a key employee may agree to split the premium payments, cash surrender and death benefit value.

The employee must agree to the company’s purchase of this insurance. The insurer may also require a resolution from your board of directors stating the policy’s purpose.

Key employee disability income insurance is less well known than key employee life insurance. Nevertheless, the risk of a key employee experiencing partial, total or permanent disability is actually much greater than the risk the person will die. Should a key employee suffer permanent total disability, the loss to your business will be just the same as if the person had died. Key employee disability income insurance protects the business from this loss exposure by paying you anywhere from 40 to 70 percent of the disabled employee’s earned income.

If the disabled person is a partner or sole proprietor, a business overhead expense disability policy provides some protection. This pays, up to the policy limit, office expenses including rent, utilities, salaries and depreciation that continue when a partner or sole proprietor is disabled.

© Copyright 2014 intouch Business, Inc. All rights reserved. Certain names and articles used with permission of owners. Trade names mentioned herein are owned by third parties.

Protect Your Company From A Catastrophic Loss

Just to clarify, a key employee is someone without whose knowledge and skills would negatively impact your business income and, according to a survey of small businesses by the National Association of Insurance Commissioners, 71 percent of the firms surveyed said they were very dependent on one or two key people for their success. The disturbing fact, however, is that only 22 percent of respondents had key person life insurance in place.

Key Employee Insurance Life or disability income insurance can compensate your business when certain key employees die or become disabled. These coverages cushion some of the adverse financial impact that results from losing a key employee’s participation.

The policy works by paying the business in the event of the death or disability of a person who is so important to the business that their loss could destroy the business. The policy is a cheaper option than standard life or disability policies because the policy can be purchased with a “first to die” provision and cover multiple key employees.

For example:

A company founded by three individuals could take out a key policy on all three of the founders with a “first to die” provision. Upon the death or disability of one of these founders, the policy would pay benefits to the company. The policy would no longer apply to the two remaining founders. The policy payment would be used to replace the efforts of the first founder (hiring personnel, covering loss of sales, etc).

The good news is that insurance purchased in this manner would be much cheaper than three individual life policies and three individual disability policies.

The cost of this coverage can often be defrayed as a business expense on company taxes (see your tax professional). The cost is often cheaper because it is sold as a term product usually for fifteen to twenty years and often corresponding to the most productive work years of the employee or officer. Your company may not need this coverage, but even engaging in the analysis of whether this coverage is necessary is often helpful. Do the analysis and consider what you would if Employee X was not able to work tomorrow.

© Copyright 2014 intouch Business, Inc. All rights reserved. Certain names and articles used with permission of owners. Trade names mentioned herein are owned by third parties.