How Much Life Insurance is 'Too Much' Life Insurance?

Solomon S. Huebner, the father of the CLU (College of Life Underwriters) and the insurance profession, told all his incoming students at the Wharton School that a “person who dies without life insurance absconds.”

Most of us didn’t end up as life insurance agents, but that idea had a lasting effect on many of our lives. Yes, we all should have life insurance – but how much is enough?

Huebner typically followed that thought with a lesson about “insurable interest” – the economic and psychological human connection between the insured and the beneficiary. It is apparent that policy coverage should replace lost earning power from such intangible assets as a family business, creative talent, patents, copyrights, and, in this era, even software.

It’s clear that defining “insurable interest” in specific dollar terms is more of an art than a science. To undertake an appraisal, though, adds professionalism to the life agent, separating them from the guesstimate. The client knows that coverage is based on a reasonable economic logic and not in any way tied to what the market will bear. The policy fills and satisfies a specific estate’s need, and provides comfort to the insured.

Until we know exactly where our economy is heading and future rates of return, we must estimate – not specify – insurable interest. It is critical that we undertake the valuation of the several sources of income.

The family business

The biggest ‘black hole’ is the family business. Most of these are closely and privately owned, and most do not have succession plans or a critical first step – an agreement about the transfer of ownership with a regular and objective appraisal and funded with life insurance.

The valuation of a family business starts with the past five years of financial statements and tax returns. Comparable company survey data is available from several sources, and in the process of comparing a business with its peers, it becomes apparent that the business is a going concern – worth more alive than dead.

Most businesses are worth more alive than in liquidation; however, bankruptcy and senility go hand in hand, and the affected party is sometimes the last one to know the condition exists. The delusion can go on for generations because of the sentiment attached to an enterprise that carries the family name and reputation, but fewer and fewer customers.

IRS Revenue Ruling 59-60 offers three valuation approaches – the asset, earnings, and market techniques. Defining a “going concern” usually requires the formulation of a model of future performance, which measures the returns from the business and from alternative investments.