How much key person cover do you need?
There are two common ways to work out how much key person insurance your business needs: a multiple of what the individual earns, or a share of the profit they generate spread over the time it would take the business to recover. The one difference that decides which you use is whether you are measuring what it costs to replace the person, or what it costs to lose what they produce.
The short answer
Takes the individual’s total earnings, usually salary plus dividends, bonuses and benefits in kind, and applies a multiple. Up to ten times earnings is a common ceiling for life cover and up to five times for critical illness cover. It is a proxy for replacement cost: what it would take to recruit someone of similar calibre, pay them while they get up to speed, and absorb the recruitment fees and lost output along the way.
Works out the share of profit attributable to the person and multiplies it by a recovery period, meaning the time the business would realistically need to get back to where it was. The formulas most commonly used are up to two times the proportion of gross profit directly attributable to the key person, up to five times the proportion of net profit directly attributable to them, or the key person’s salary divided by total payroll, multiplied by gross profit, multiplied by a recovery period of up to five years. An average of the last two years of profit figures is routinely used rather than a single year.
The two can produce figures that differ greatly on the same person, and where they diverge sharply it is usually the profit figure that is telling you something useful. Insurers will usually want the number evidenced either way, and larger sums assured are more likely to be cross-checked against your profits and turnover. Cover is subject to underwriting and acceptance.
IGotCover is a business protection specialist, and we work with businesses of different sizes and structures. We can help you work through both methods and arrive at a figure you can evidence to an underwriter.
Which is right for you?
- Your business is young and does not yet have two years of stable profit figures to average
- You are insuring an employee rather than an owner, and their pay broadly reflects their market value
- The role is well defined, so replacement cost is a reasonable proxy for the loss
- You want a working figure quickly, ahead of a fuller review with an adviser
- Your accounts are in flux after a merger, a pivot or an unusually good or bad year
- You need to sanity check a profit-based figure that looks surprisingly high or low
- You are insuring an owner or founder who takes a small salary and the rest in dividends, so pay understates what they are worth
- You have at least two years of accounts to average and profit has been reasonably stable
- A large share of your revenue or gross profit traces back to one person’s client relationships or technical knowledge
- The sum assured you have in mind is large enough that an underwriter is likely to ask you to justify it
- The role would take a year or more to fill and get productive, so a recovery period genuinely matters
- An earnings-based figure has come out looking obviously too low for what the person actually contributes
Side-by-side comparison
| Comparison | Multiple of earnings method | Profit contribution method |
|---|---|---|
| What it measures | The cost of replacing the person. | The cost of losing their output while you recover. |
| Inputs you need | Total earnings including salary, dividends, bonus and benefits. | Gross or net profit, total payroll, and an estimated share attributable to the individual. |
| Typical formula | Up to 10 times earnings for life cover, up to 5 times for critical illness cover, varying by insurer. | Up to 2 times attributable gross profit, or up to 5 times attributable net profit, or salary divided by payroll, multiplied by gross profit, multiplied by a recovery period. |
| Time to produce a figure | Minutes.Faster | Usually needs the last two years of accounts to hand. |
| Works for a new business | Yes, even with limited trading history.Works without a profit record | Poorly, because it needs a profit record to average. |
| Works where earnings are not representative | Poorly, a low salary understates a high contributor. | Yes, it measures output rather than pay.Better for founders |
| Reflects client concentration | No. | Yes, through the attributable share.Reflects concentration |
| Builds in a recovery period | Only implicitly. | Yes, explicitly, and it can be varied by role.Explicit recovery period |
| Evidence insurers usually want | Payslips, dividend vouchers, accountant’s confirmation of remuneration.Lighter evidence | Two years of accounts and a reasoned basis for the attributable percentage. |
| Risk of overstating cover | Higher for well paid employees in easily replaced roles. | Lower, since it is anchored to profit.Less likely to overstate |
| Risk of understating cover | Higher for founders on small salaries. | Lower, though a conservative recovery period can still understate.Less likely to understate |
| Handles critical illness sizing | Yes, through the lower multiple.Simpler for critical illness | Less directly, the recovery period usually has to be shortened by hand. |
| Best used for | A fast first estimate, or a sense check on the other method. | The figure you put in front of an underwriter. |
The multiples and formulas above are commonly used market starting points. They are not guarantees of what any insurer will offer, and the figure an underwriter accepts depends on your circumstances.
Real-world scenarios
Illustrative examples showing how the decision tends to play out. Names, businesses and figures are invented for illustration only, and are not quotes or a guarantee of cover.
Ellen, a two-year-old software business with a new sales director
Ellen owns a software business that is two years old with volatile profits and has just recruited Tim, a sales director on £75,000. There is no meaningful profit history to average and no track record to attribute revenue to him yet.
Read the full scenario
Ten times earnings gives an indicative £750,000 for life cover and five times gives £375,000 for critical illness cover.
The profit method would produce a figure that says more about a young company’s accounts than about his value.
- Earnings£75,000
- Life cover£750,000
- Critical illness£375,000
Pete, a specialist manufacturer with a technical lead behind most of the margin
Pete, a director of a specialist manufacturing firm, has a technical lead on £55,000 who designed and maintains the process behind roughly 40 per cent of the firm’s £1,000,000 gross profit.
Read the full scenario
Ten times earnings gives £550,000. The gross profit basis gives 40 per cent of £1,000,000, doubled, which is £800,000.
His pay reflects a modest salary in a rural location rather than his value to the business, and replacing his knowledge would realistically take two years.
- Earnings basis£550,000
- Gross profit basis£800,000
- Recovery period2 years
The rule of thumb
Where the two are miles apart, the profit figure is usually the one telling you the truth, and it is the one an underwriter will want to see.
Frequently asked questions
How much key person insurance do I need?
Should I use salary or profit to work out the cover?
Why is critical illness cover set lower than life cover?
How many employees should I insure?
Do dividends count as earnings for the calculation?
How often should I review the amount of cover?
Related decision guides
Not sure which method fits your business?
If you are unsure which method fits your situation, a business protection specialist at IGotCover can talk you through both and help you size the cover. Free, and with no obligation.
Get a Free Quote →Important information: This guide is for general information purposes only and does not constitute financial, legal, or tax advice. Tax treatment depends on individual circumstances and may change in the future. All figures and scenarios are illustrative only and do not represent a guarantee of cover, premium, or payout. Eligibility for cover is subject to insurer underwriting criteria and acceptance. You should seek advice from a qualified financial adviser and, where relevant, a solicitor or tax adviser before taking out any policy or entering into a legal agreement. Insurance provider benefits are subject to change. IGotCover is a trading name of Caspian Assured Ltd, authorised and regulated by the Financial Conduct Authority (FCA reference [FRN]).
