How much life insurance should I have?

There are basically three ways to answer “How much life insurance should I have?”, and each method results in a substantially different amount of insurance.

The first method is probably the oldest method.  It is called “Human Life Value,” and it an idea that has become very popular among insurance agents and brokers in the last 10 years.  The basic point is that the economic value of a human life involves more than just replacing his income; it involves future salary increases, maintaining a standard of living for the family, and inflation.  Long-story-short: get as much as the insurance company will give you, which, depending on your age, is between 20x and 30x your income.

The second method is called “Capitalization of Earnings.”  The basic concept is that you are the goose (income earner) laying golden eggs (income), and when the goose dies we still want the same number of golden eggs.  For example, if you are earning $100,000 per year, how much money (insurance) would it take to generate $100,000 per year?  The answer depends on the interest rate earned on the deposit, but for an example, if you earned 5% you would need $2,000,000 to generate $100,000 per year.  So, the amount of insurance is $2,000,000.

The third method I call the “Transition Approach.”  The idea is that the surviving spouse can earn a reasonable living, and the insurance is just there to help clean up the financial affairs, pay off loans, and give the spouse some breathing room.  Paying off the mortgage and any credit cards would be a big relief to the spouse of course, as would putting some money aside for future emergencies (roof, appliances, etc.), college money for kids, and something to help for a year or two during the transition.  Obviously this isn’t a romantic approach, but then, finances are usually the first place where romance wanes.

This entry was posted in Consumer Advice, Term Life Insurance. Bookmark the permalink.

One Response to How much life insurance should I have?

  1. Marica says:

    Thx for making the effort to explain the terminlogy towards the inexperienced persons!

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