Oftentimes, people don’t always know what they’re shopping for when it comes to life insurance. How much is enough and for how long a term should I carry coverage? The best advice is to ask questions and be upfront with your expectations. Every adviser, financial columnist, and relative has their own formula that they consider to be the best.
This article is aimed at presenting various methods used and the pros and cons of each. Since life insurance deal’s with how to value one’s life, this is a very complex process.
The method that makes the most sense to you is probably the one that will work the best. But remember, no method is perfect.
Life brings many new changes, which could alter your insurance needs. The more assumptions you make, the more complex you’ll make your planning, and the more chances there are that something will not work as planned.
This does not mean that you should only use the simplest method. It’s to give you a concept of why it’s important to actively participate in all of your planning, fully understand it, and constantly monitor it. After all, it is your money.
Remarkably, the simplest formulas can often be the best.
All of the issues discussed with this question, will have an impact on the amount of life insurance needed. Often the desired goals may not be financially feasible. These issues are not only financially based; they can also be extremely emotional.
Another thought to keep in mind is that as your other assets grow, such as retirement plans and investments, your need for life insurance will decrease.
Here are the most common approaches:
Multiple of Income
Multiple of Income, also known as the “human capitalization value”, is one of the oldest, best-known methods, but also the easiest. This method uses the approach of a multiple of your annual income – typically ranging from five to eight times your annual income.
While simple, this method misses a range of important factors. For example, household demographics, past savings, Social Security offsets, housing expenses, taxes, etc.
It also ignores expected life changes and individual preferences about sustaining the living standards of survivors.
It is simply a “best guess.”
Cover Your Debts
This is a method of buying only enough life insurance to cover debts, such as mortgage, student loan bills, or outstanding car notes. This has similar issues as the previous method, as it misses a whole range of factors.
This method is also too simplistic to provide any real value.
Human Life Value Concept
The human life value concept deals with human capital, which is a person’s income potential. We all have a human life value. In wrongful death litigation, human life value is measured daily in court. However, the litigation value tends to be significantly different.
Insuring human life value is the primary purpose of life insurance, and this method does beyond numbers and figure. It considers the entire impact when a human life is lost.
Here are some questions to give you a start:
– If you were killed in a car accident last week, and someone else was responsible for your death, how much would your family sue the responsible party?
– If you were killed in a car accident last week, and you were responsible, how much money would you want your family to receive?
– If you died last week from cancer, how much money would you like to leave your family?
– How much are your tomorrows worth?
– What is your Potential Earning Power (PEP)?
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Steuer, author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, has more than 25 years of experience and holds the Department of Insurance Analyst License (LA) as well as the Charted Life Underwriter (CLU) designation. Tony holds various leadership positions and has authored three books on the topic of life insurance.
Steuer’s work has been awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy for his The Questions and Answers on Disability Insurance Workbook and The Questions and Answers on Insurance Planner. Forbes named Questions and Answers on Life Insurance: The Life Insurance Toolbook as one of their top nine great investment books.
He’s also the founder of the Insurance Literacy Institute and creator of The Insurance Bill of Rights designed to empower consumers and to identify members of the Insurance Industry dedicated to strong professional standards.