The idea of life insurance is unpleasant in nature. I’m going to give you, the insurance company, money every month. I know that I will never see any benefit in exchange for this premium. The only way my family gets anything is if I die while the policy is in force. As I write this, I now get why people really hate this insurance. But you know what’s worse? Seeing a family who has lost a key earner have to sell their home because they can no longer afford the payment.
There are many methodologies to quantify your life insurance need. At their core is protecting against outstanding debts, replacing human capital and paying for future goals, like college. Human capital in this context represents the present value of future earnings: If I were to buy you out of your career, what would it take?
Needs change over the years
If life insurance needs are the Y axis and your age is the X axis, the chart tends to look like the top of a triangle over your lifetime. Early in your career, when you’re living with three friends from college and paying $485 a month in rent, your life insurance needs aren’t very high. By the time you have kids and buy that “forever home” but still have a long career ahead, you have reached the tip of the triangle. As you pay down your debts, your kids get older and you approach retirement, that need decreases.
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Now, here you are, retired. Those cute little babies made paying the premiums bearable. Those babies are now 35 and not so cute. You’d rather write a check for a down payment on a trip to Italy than to Northwestern Mutual.
Because we work with retirees, we are dropping much more insurance for clients than we are adding it. We always start with a needs analysis. Most financial planning programs can put together an actual needs analysis by plugging in all the other necessary inputs of a financial plan: assets, liabilities, income, expenses and goals. If a client comes back, as many do, with no insurance need but is carrying three policies with $500,000 in combined coverage, we will figure out which policies we should drop today, let expire or keep. We generally drop annual renewable term policies first, as they can get very expensive for the age demographic we work with.
More goes into the decision than math, though
I should mention that this is never a purely mathematical decision. About 10 years ago, we had a client with $5 million in assets and no liabilities drop a significant amount of insurance. He later got cancer and died. Yes, on paper, dropping the insurance was the right decision, but it makes me think twice every time we make the recommendation. It makes me have a conversation with the spouse regarding the trade-off of premium payments and a check should an untimely death occur.
It's interesting how underinsured people are early in life and how overinsured they are in their later years. Wherever you are in life, I’d encourage you to do an analysis and to close that gap.
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