The Gift of Life Insurance
By Richard P. Halverson

It is not really such a bad idea, giving life insurance for Christmas. Many people that seem to have everything do not have sufficient life insurance. The value of life insurance to loved ones goes well beyond most of the gifts they will receive this Christmas. And you have got to admit it will be a surprise. I’ll bet not one of the people on your list is expecting a life insurance policy.

Whether you are thinking about life insurance now or sometime in the future, you want to buy the right amount. Of the various major categories of insurance I believe life insurance is the most difficult type of insurance to figure out what the right amount is.

For example, many people feel invincible, figure they are too busy to die any time soon, and assume there is no particular need for life insurance right now. These people may be woefully under-insured and exposing their loved ones to considerable financial risk.

On the other hand, life insurance decisions frequently become clouded with emotion — often leading buyers to buy too much insurance. Compare this to homeowners insurance. The mortgage company will insist you insure the property, so you are unlikely to just ignore it. At the same time, the insurance company will only insure for the value of the property so there is no incentive to buy too much.

Things to Generally be Aware Of

Here are some thoughts on figuring out the right amount. In the next article I will spend time on some of the life insurance products out there and where they can be purchased.

First, please do not ignore the need for life insurance. Many of us put thoughts of death, especially our own, on the back shelf as far away as possible. It isn’t wise and we all know it.

Second, remember as with all insurance insure only the risk you cannot afford to take yourself. In the case of life insurance that should read insure only the risk your loved ones cannot afford to take.

Third, be aware that life insurance is frequently sold rather than purchased. Once a person lets on that he is in the market for life insurance, it is easy for a good salesperson to introduce emotion into the decision process.

Fourth, as with all types of insurance hope that every dime of premium you pay is totally wasted. You never really want to collect. For example, the hassle of having your house burn down is not worth collecting on your insurance. And hopefully your family does not want to collect on your life insurance.

Two Risks

As you begin to evaluate your need for life insurance, you realize there are two risks:

There is a risk you will suffer an untimely death.
There is a risk you will not suffer an untimely death.

The second risk is far greater than the first. Oh, we will all die — but the odds are you will still live a long time before you die. The odds are you will live long enough to retire. It is expensive to live during your working years. It is expensive to live during your retirement years. Paying unneeded insurance premiums reduces what there is to live on today and what can be saved for tomorrow. So, it is important to get it correct.

Needs Change with Every Stage of Life

The correct amount of insurance is different for almost everyone, and the correct amount changes often during the course of a person’s life. Because of that, this analysis needs to be repeated especially as the person passes from one of life’s stages to another. Here are some of the obvious stages.

Single. A small amount might be nice so that loved ones are not saddled with unexpected funeral costs.
Married without children or significant obligations. A small amount covering burial costs.
Married with significant obligations. Say you have purchased a house or taken on other significant obligations. You may need insurance to insure the survivor can bridge the gap between the sudden loss of one income and proper realignment of obligations. Significant obligations do not need to be large items. It seems like many people don’t own hardly anything but have managed to rack up $30,000 or $40,000+ of credit card debt. Dumping that on a spouse is a risk.
Married with children and obligations. Generally this is the stage of life when the financial risks to survivors are at their greatest and, of course, the need for insurance is at its highest.
Working empty nesters. Financial risks to survivors tend to decline during these years.
Retired. Depending on how well a person has planned and saved, there may be little or no need for life insurance at this point.

Insure Your Risks, Not Your Emotions

I said much of the life insurance in the world is sold rather than purchased. Let me focus on life stage #4 as an example. The insurance agent sits down with the couple and says, “Now Jim, if you were to be trampled by an enraged herd of jackalopes tomorrow it would be important that Sally and the kids be well taken care of. With your loss it would be necessary for Sally to be at home full time because she would need to be both mother and father to the kids. You certainly would want her to stay in this lovely home and it would be well if she could buy a new more reliable mini-van. And with the kids growing up without a father, you want to be sure their college and missions are completely paid for.”

A really good salesperson can talk Jim and Sally into such a large policy that Jim and/or Sally could become worth more dead than alive. Unfortunately, Jim (in this example) will probably live. I say unfortunately because some of the money he would like to use on his wife and kids right now — while he is alive — is going to pay insurance premiums. And some of the money he hopes to have in the future for their educations and his retirement is going to pay insurance premiums. Jim and Sally should sit down without the agent around and try and assess their real risks.

The real risk is that level below which the survivors can no longer live with health and dignity. Those levels are different for everyone. No one can say what the correct answers are for Jim and Sally, or for you and me. However, this couple might say Jim’s death would be heartbreaking in so very many ways. But, if that were to occur difficult adjustments could be made. Adjustments that many people face all the time.

For example, Sally may return to work full time. Most single moms do work. Sally working full-time may be an acceptable risk for this couple, but it may be unacceptable for her to work a full- and part-time job just to make ends meet. It is possible the family may conclude that under the circumstances they could live in a less expensive home and not compromise their health or dignity. However, they may conclude a rundown apartment in the slum is unacceptable.

Many kids work to put themselves through college or on missions. In fact, many kids coming from families where the parents are still alive must work to put themselves through college or on missions. That may be acceptable to the couple. Having the kids forced to drop out of middle school because they cannot afford clothes may not be acceptable.

Where are the real financial risks for this family? Once again, only they can decide. Depending on the answers and the insurance products chosen the annual premiums can vary between say a $100 and $1,000 a month or more. (I have been using Jim in my little example but it is every bit as important to analyze the “what if” risks related to Sally’s death.)

Calculating the Right Amount of Insurance

Analyzing the risks requires budgeting type skills. Most people hate to budget. Still there is no really good alternative. Simple solutions such as a multiple of your income are completely inaccurate. These simple rules of thumb do not recognize either your stage of life or your acceptable levels of risk. The following abbreviated work sheet can get you started in the right direction. Be certain to work this through assuming the death of one spouse, then the other and finally the untimely death of both.

If you are fortunate enough to show a positive net income at this point, you may not even need life insurance beyond covering the death-related expenses.

If you are like the majority of working people the “Net income or deficiency” line will show a deficiency. This is the unacceptable risk that you should not inflict upon your loved ones in the event of your untimely death. If they cannot fill in this deficiency they will sink to a level of poverty you have deemed unacceptable. The best way to make up the deficiency is with life insurance.

This deficiency is not a one-time number. The deficit must be filled every year. The idea is to carry enough life insurance that the proceeds can be invested and the survivors can live off the investment income. The simplest answer is to divide the annual deficit by the percent your survivors can earn on the investment after tax.

For example.

This person should buy a life insurance policy with a face value of $510,000. If you are comfortable with worksheet programs like Excel, you can improve on the accuracy of this answer considerably. For example, this does not allow for inflation. Thirty thousand dollars may be enough right now, but inflation will make it less workable every year. Further, this calculation assumes none of the insurance principle proceeds will ever be used. A more sophisticated answer can be obtained by setting the deficit up as an annuity payment with the goal that the money will last through the life of the principal survivor.

In the end it is recognized that these are just estimates. However, your thoughtful estimates are far better than ignoring the problem or letting someone else make the estimates for you.

Save your worksheets. Your circumstances and assumptions will change all the time. You need to repeat this process regularly.

You Have to Admit — It Would be a Surprise

Well, there are still a few shopping days until Christmas. What will it be — a shiny new table saw for your wife or crisp new insurance policy? If you do decide to get an insurance policy for Christmas there are a few things I can guarantee. First, the recipient will be pleasantly surprised. Second, he won’t return it.