How much cover do I need?
Depending on the type of cover being applied for, AIG’s approach is to use a simple formula based on either 100% or multiples of ten, five or seven.
When calculating cover for business loan or debt protection, the key is to first find out how much debt the business carries. You then need to consider how that loan/debt would be managed were the business owner/partner/shareholder to die prematurely or suffer a critical illness that removes them from the business.
It is highly unlikely that the business would be able to easily access further funds to allow the debt to be repaid. Cover that matches 100% of the debt should be considered to allow repayment on death or critical illness.
Multiples of ten and five
Two approaches can be used to assess the value of a key person in a business. Again this is a simple calculation:
- The first approach is to use a multiple of ten times the key person’s salary. However, it is important to note that this calculation may not reflect the individual’s true worth to the business, in which case the following approach may be more appropriate.
- A multiple of five times the business’s net profit (averaged over three years) could resolve the question of an individual’s ‘true value’ – but if there are a number of “key persons” then this figure should be split between the key individuals in the business, based on their contribution to net profits.
Multiple of seven
Valuing a business is the area of greatest concern. However, being able to do this is vital to calculating the right level of cover for shareholder or partnership protection. The key figure you will need is the average net profits from the last audited accounts.
There are various ways to calculate the value of a business – a multiple of seven times net profits will provide a ballpark business valuation which will then be pro-rated amongst all the shareholders/partners based on their ownership of the business.
The opinions expressed by third parties are their own are not necessarily shared by St. James’s Place Wealth Management.