How to answer the question, "What kind of life insurance do I need?"
By John L. Olsen, CLU, ChFC, AEP
Olsen & Marrion, LLC
When clients ask me, "Which type of life insurance do I need?" my answer is always, "It depends upon your answers to a couple of key questions."
"How much do you need?"
Advisors can help their clients assess how much they need by doing a financial needs analysis. It's a process that works like a balance beam. We put all the client's needs on one side of the balance by adding together all the lump sums he or she wants paid at death (such as paying off the mortgage and other debts) and all the income streams that he or she wants to provide (survivor income needs, college funding needs, etc.)
We reduce all those income streams to a net present value, the amount of money required today to pay all those income amounts, assuming both inflation and the interest that the lump sum can earn over time. We then take into account all the financial resources the client has — existing life insurance, Social Security survivor payments, and all existing investments and savings — and put those on the other side of the balance beam. If the total resources exceed the total needs, then they "weigh more" than the total needs and he or she doesn't need additional life insurance. The client may even be over-insured.
If the needs side of the balance is heavier, then the client needs additional life insurance, in the amount that will equalize both sides of the balance beam. Your clients' needs — what they want to guarantee, should they die early — and their assumptions as to future inflation and interest earnings are what drives this process.
"Which kind do you need?"
After you establish the additional amount of insurance the client needs (if any), then you can proceed to the question, "Which kind of insurance do you need?" If his or her budget will allow only the premium for term insurance (which pays off if they die but will terminate without value after the term of coverage), I'll recommend term insurance — with the term of coverage as long as possible, given the budget. If the client's budget will accommodate more than the term premium, I'll recommend a blend of term insurance and cash value permanent insurance. The more premium he or she can afford, the more permanent coverage I'll recommend. Permanent insurance not only won't expire before they do, but will build cash value that they can use later on for any purpose.