How Much Life Insurance Do You Need? (part 1)

What is your life insurance “need”? Well, to get things started off I think that a distinction between “needs” and “wants” is important.

For the sake of simplicity I won’t be discussing other forms of insurance (i.e. critical illness, disability insurance).

An insurance “need” arises where there are definite, identifiable risks to the people that depend on you should you die prematurely.  These risks could be things like income loss, debt payments, funeral expenses, business loss, child care, and the list can go on and on.  Each family’s or business’s situation can be different.  I’ll focus more on the family dynamic rather than the business one at this time.

An insurance “want” is typically vague.  For example, someone who is a single (unmarried) professional may say to me; “I would like to have $1,000,000 of coverage and have my parents as beneficiaries.  While this is a respectable gesture, it falls into the category of insurance “want”.  The parents in this situation are not dependent on the young professional and there is no way to quantify a loss of $1,000,000 to them in the event of their independent child’s death.

So now that we have a general understanding of what insurance “need” is, we can talk more about specific risks and how your life insurance advisor should go about helping you calculate the insurance need.

Step One: Identifying the Risks

Which risks will lead to unmanageable financial loss and who is exposed to the risk?  What is unmanageable to some may be manageable to others – this usually depends on cash flow and current savings.  For example, the death of a parent in a family with young children is an identifiable risk and most often unmanageable.  Even if the deceased parent were a home-maker, there is significant risk because the work done by this person must be replaced (i.e. daycare, driving kids to school/activities, cleaning, cooking, etc…).  The loss of the deceased spouse’s effort or income will present a large financial shortfall that, while improbable, must be managed.

Step Two:  Evaluation the Risks

Let’s assume that we’ve identified a significant risk for a family with one child and one spouse working outside the home.  The risk to the home-making spouse and child is a loss of income should the working spouse die prematurely.  The risk to the spouse working outside the home is loss of cash flow from increased expenses or wage reduction (from a reduced work week to care for the child).  With this in mind, how do we quantify, or put a number on, the amount of insurance to buy and for how long?

a)      Duration – How long will the risk be a factor to consider?

In the example mentioned in the previous paragraph let’s assume the child is a newborn baby.  This means that there is a risk to the family for at least another 20 – 25 years (until the child is independent).

b)      Valuation – What is the present value (in dollars) of the risk for the risk duration?

This is where things get more technical and 2 approaches can be taken.

Income Approach – Estimates the amount of insurance coverage needed to provide a consistent level of income to the beneficiaries for the risk duration.  This would apply to the breadwinner spouse because we would be insuring his/her income.

Expense Approach – Estimates the amount of insurance coverage needed to provide adequate cash flow to cover the identified expenses (child care, etc…) for the risk duration.  This would apply to the homemaking spouse because replacing his/her efforts in the event of their death has a quantifiable expense.

The calculation to determine the amount of coverage is the same regardless of which approach, but the income approach will replace income (maintain lifestyle), and the expense approach only addresses the expenses (no discretionary funds).


By Jonathan at


*This article is for information purposes only and is not intended as specific advice for any individual.  Please review your policy contract for complete details of your existing coverage and speak with a licensed professional if you have any questions or concerns.

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