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From the 19th addition of the Florida Life, Health, and Variable Annuity Study Manual FAIFA
There are many uses for life insurance, some of which are easily recognized, others of which are not so apparent. A family’s desire to provide protection against the loss of it’s breadwinner (or breadwinners) is certainly understood to involve life insurance. A small business’s needs to protect itself against death of a key employee is also easily solved with life insurance. But how many recognize whole life insurance as a means of saving for retirement or a child’s education? The uses of life insurance extend far beyond the realm of “death benefits”.
How much Life Insurance is enough?
Determining the proper amount of life insurance depends on a number of factors.
The ability of the policy holder to comfortably afford the premium payments is, of course an important consideration. But you must ask yourself some simple questions.
What are the planned uses for the insurance?
What are my long range goals and can life insurance help me to reach these goals?
Where do I see myself and my dependants in 10 years, 15 years, 20 years or more?
How can I do everything I can to insure that I protect these goals?
There are two basic approaches used today to help insurance buyers determine the proper amount of insurance. The older method,
known as the human life value approach, has been largely replaced by the more practical needs approach - but both methods can
be effective in answering the primary question “ How much life insurance do I need?”
Human Life Value Approach (Life)
The concept was formulated by the late Dr. Solomon S. Heubner in 1924 as a philosophical framework for understanding the services that can be performed by life and health insurance, for people both in and out of the insurance business. The result of Dr. Heubner’s work is that everyone can have a better idea of how an insurance plan can be tailor made to meet specific objectives.
Dr. Heubner pointed out that the value of a human life can and should be expressed as
a dollar valuation; that is , determining the economic value of a person by discounting estimated future net earnings used for family purposes at a reasonable rate of interest.
A relatively simple method of accomplishing this is to:
1: estimate an individual’s average annual future earnings after deducting taxes and personal living costs;
2: estimate the number of years the individual expects to work until retirement;
3: select a reasonable rate of interest (compared to current rates paid on insurance
proceeds held by insurers) at which future earnings should be discounted;
4: multiply the present value of one dollar payable annually for the number of years until
expected retirement, using the selected interest rate, by the estimated average future
annual earnings
The result is a reasonably accurate estimate of the individual’s economic value to his or her family.
Needs Approach
Fundamentally, the needs approach for analyzing the family’s (or business‘s) financial needs and objectives should the breadwinner (or business person) die or become disabled.
Then those needs are weighed against the ability of the family ( or business) to meet them out of current or anticipated assets.
For example: the death of a family breadwinner (or businessperson) will necessitate a new source of funds to replace the earnings that are now lost.
The obvious answer is Life Insurance.
However the amount of life insurance required must take into account the amount of monthly benefits the family will be receiving
from Social Security, the deceased’s pension plan, from personal savings, and any other source. The difference between what is
now owned (or what will be ultimately available) and what will be needed in terms of funds will help to determine an insurance
program involving the use of term insurance, whole life insurance, annuities or a combination of all three.
The needs approach is not limited to fulfilling objectives in the event of death only. It also considers a family’s (or business’s) living needs, such as providing for a child’s education and planning for retirement.
In short, The amount of life insurance required to me these needs is coordinated with other assets that may be available.
Click Here to view our Slideshow Presentation
on Life Insurance
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