There are several different methods to use when calculating cover, however, where the cover is taken out to cover a loan, the cover for each person is usually equal to the amount borrowed.
Apportionment method
This uses an average of the last three years’ pre-tax profits, less any exceptional or extraordinary items. Normally, someone inside the company will be able to allocate the profits between the key personnel, based on their individual contribution to the business.
The advantage of this method is that it can be simple, and related to the company’s profits. However, the disadvantage is that it uses a subjective assessment of the key employee’s contribution to the company’s profits.
Salary method
This method uses a straight multiple of the key person’s full salary package, including their pension, company car and any other benefits in kind. This method can be simple to work out and understand but does not take loss of profits into account.
Example:
| Total salary package |
£50,000 a year |
| Chosen multiple |
the normal multiples are:
up to 10 for life cover
up to 5 for critical illness cover |
| So the cover needed is |
£50,000 x 10 = £500,000 (or (£50,000 x 5 = £250,000) |
Loss of profits method
This method uses a straight multiple of the business’s profits. This can be based on either the net or gross profits. It is simple, but does not take fixed costs into account.
Payroll method
The total salary package is divided by the business’s total payroll, multiplied by the yearly gross profit and the number of years the business believes it will take to recover from the loss of the key employee.
It can reflect the true situation more accurately, but the key employee’s total salary package must be shown to be reasonable within the marketplace.
Example:
| Total salary package |
£50,000 a year |
| Total payroll |
£2 million a year |
| Gross profit |
£10 million a year |
| Number of years to replace key employee |
3 years |
| So the cover needed is |
£50,000/£2,000,000 x 3 x £10,000,000 = £750,000 |
Financial underwriting
In most circumstances there will not be a need for any further financial information than that on the application form. However, for sums assured above a certain amount, say £600,000, you may need to provide more information before a case can be underwritten.
In certain cases, for high sums assured, additional medical evidence may be required.