Recommending how much life insurance a client should buy can be crucial, say insurance producers and registered reps. Getting the figure right depends on critical decisions relative to the technique employed, and the assumptions made, in calculating the death benefit amount.
These decisions, in turn, hinge on a proper understanding of the client’s goals and objectives.
“I initially concentrate on the soft facts: how clients think and feel and what matters to them,” says Philip Harriman, a second vice president of the Million Dollar Round Table and a partner at Lebel & Harriman, Falmouth, Maine. “That makes it easy to decide which approach will motivate the client to take action.”
Prospects who desire to provide for family needs after their death–replacing income to cover monthly expenses, paying off the mortgage or funding a child’s college education–will be receptive to basic financial needs analysis, says Harriman.
A more advanced evaluation would be appropriate for, say, the business owner who is reluctant to engage in a corporate restructuring because the transaction is contingent upon purchase of a life insurance policy.
How much life insurance is enough? Reps say a rough estimate for an individual policy can be had by multiplying the client’s income by some multiple. The American Banker’s Association advises securing a death benefit equal to 12 times the client’s after-tax income, for example.
Usually, however, reps use more sophisticated techniques. The first of these, the needs analysis, determines the income replacement needs of one’s survivors.
Arriving at this number requires a determination of the “present value” of the collective needs, say sources. The term derives from the “time value of money” concept, which says that a dollar received today is worth more than a dollar received tomorrow because, when invested in an interest-bearing account, its value compounds over time.
The needs analysis may factor in, for example, the income required by policy beneficiaries during a “readjustment period”; an estate clearance fund or comparable vehicle for liquidating assets; life income to a widow(er); educational funds for dependents; plus emergency and retirement funds. After summing the present values of income replacement for all financial needs of dependents, existing assets, plus the face amount of current life insurance in force, can be subtracted to determine the life insurance needed.
A second technique, the human life value approach, determines the value of a human life as one’s monetary contribution to one’s dependents. The technique calculates the expected amount of money available to a client’s family each year of the client’s life; determines the number of years the client is expected to generate income; then derives the present value of the client’s stream of expected earnings.
Richard Murphy, a registered rep and president of Richard C. Murphy Insurance, Syracuse, N.Y., says that he finds the human life value approach especially useful when highlighting to clients the disparity in coverage levels among the insurance policies they own. Many individuals, he notes, insure their home, auto or personal property for a high percentage (typically 80% or more) of their replacement costs, but underinsure “the money machine” (themselves) because they don’t know their human life value.
A third technique, the capital retention approach, arrives at a dollar figure by determining the amount of life insurance needed in addition to existing income-producing assets to provide the desired level of income. The technique, observes Marc Silverman, a registered rep and president of Silverman Financial, Miami, Fla., lends itself well to high-net-worth individuals and business owners who have complex financial planning needs.