A fundamental purpose of life insurance is to replace an individual’s economic value should they die earlier than anticipated. Considering that the ability to earn an income is one’s greatest financial asset, it is logical to select an amount of life insurance that reflects this lifetime earning potential. Yet this logic is sometimes skewed by a misguided emphasis on reducing costs. Instead of fully insuring one’s economic value, some consumers and financial professionals focus on determining the minimum amount of life insurance needed for the economic survival of beneficiaries.
A simple illustration highlights both the ethical and practical shortcomings of obtaining the least amount of life insurance.
A 35-year-old husband is killed by an intoxicated motorist. The event is devastating to his family, both emotionally and financially. Beyond any criminal prosecution, the family of the deceased will almost certainly pursue a civil action to secure a financial judgment against the drunk driver.
In court, representatives for the family will establish the lifetime economic value of the deceased. This will be an assumption of future lifetime earnings, reflecting the victim’s vocation, anticipated raises, professional advancement, remaining working years, the impact of inflation etc. Projected future earnings will then be reconfigured as a present-value amount, i.e., a lump sum needed today to replicate this projected stream of income. This present-value number would be the baseline for determining financial compensation due to surviving family members.
The logic and justice of seeking financial compensation equal to the lifetime economic value of the victim should be easy to comprehend. Two follow-up questions, and their answers, should make it apparent that this rationale applies to other circumstances.
Question 1: Is there any reason the family should consider asking for an amount less than the husband’s full lifetime economic value? For example, if the family already had enough assets to survive, and didn’t “need” a judgment for the full economic value of the deceased, would it be advisable to seek a lower amount, or perhaps nothing at all?
Question 2: If this death occurred in a one-car accident, where the husband lost control of his vehicle due to weather conditions, would the lifetime economic loss be any less than if another party was responsible?
The correct answers, and their implications, should be obvious. Regardless of the level of financial well-being of the survivors, they deserve to be fully compensated. There is no moral justification for seeking a lower settlement amount by arguing the survivors “don’t need it.” And the magnitude of the economic damage does not change if there is no one to blame for the husband’s death; a drunk driver, a one-car accident or a sudden illness all cause the same financial loss.
Lifetime Economic Value: The Only Logical Approach
If it is reasonable to pursue legal action to have someone else pay your full economic value in the event of a wrongful death, how can you justify using a different standard for insuring an untimely death that can’t be blamed on anyone? “Well, Dear, if a drunk driver kills me, you’ll receive $2 million dollars, but if I slip and fall, it will be $200,000—because that’s all you really need to survive without me.”
Making a life insurance decision based only on what is thought to be needed by survivors may appeal to cost-focused consumers, but the premise is wrong. It is impossible to accurately calculate the costs that might result from an untimely death today, and those costs would surely be different if a death occurs two years, five years or 20 years later. Since tomorrow’s financial “needs” will be different from today’s (and might be far greater), any needs-based calculation is flawed the day it is made.
There may be occasions when a household cannot presently afford to fully insure one’s full economic value, but the standard should be a factor in any life insurance discussion. Insuring for full value is the only way to effectively address any financial needs that might result from an untimely death.
Who Determines Lifetime Economic Value?
In a legal action, arriving at your lifetime economic value is a detailed process. You could probably replicate the calculations, but there’s an easier way: Simply ask a life insurance company.
All insurers have underwriting parameters for how much life insurance they will consider offering an individual, and these guidelines roughly reflect lifetime economic value. Here’s the verbiage and amounts from a highly rated American life insurance company:
The following information reflects general life insurance guidelines equal to the present value of potential future earnings which would be lost at the death of the insured.
Age Maximum Life Insurance
18-40 30 times income
41-50 20 times income
51-60 15 times income
61-65 10 times income
66-70 1 times net worth
71-80 1/2 times net worth
81+ case by case
As applicants get older, the declining income multiples reflect shorter time periods; a 51-year-old has 20 fewer earning years than a 31-year-old counterpart. And as people move into retirement, the criterion switches from their future economic value as earners to the future economic value of the assets they have accumulated.
Don’t Underestimate Your Value (or What You Can Afford)
Many consumers are surprised when they see an insurance company’s assessment of their lifetime economic value, especially in light of the amount of insurance they actually have. (“You mean to tell me I’m worth $3 million? I only have $250,000!”) And shortly thereafter comes the thought: “That’s a big number. How could I afford to insure my lifetime economic value?”
In reality, securing life insurance equal to lifetime economic value today may be quite doable, especially for younger applicants. Term insurance, graduated premiums, even financing options, can all be used to maximize current life insurance protection. A life insurance professional can not only provide the policies, but also offer guidance on how to pay the premiums. Instead of thinking you can’t afford to insure your lifetime economic value, you should find out how much you can insure.
Buying as much life insurance as the insurance company will offer is a sound risk-management strategy because obtaining individual life insurance is dependent on one’s health. Insuring for full economic value today means not having to re-apply later, and avoids the risk of being declined because of health conditions that were not apparent decades earlier.
This article was prepared by an independent third party. Material discussed is meant for general informational purposes only and is not to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS), 355 Lexington Avenue, 9 Fl., New York, NY 10017, 212-541-8800. Securities products/services and advisory services offered through PAS, a registered broker/dealer and investment adviser. Financial Representative, The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly owned subsidiary of Guardian. Wealth Advisory Group LLC is not an affiliate or subsidiary of PAS or Guardian.
PAS is a member FINRA, SIPC.
Neither Guardian, PAS, Wealth Advisory Group, their affiliates/subsidiaries, nor their representatives render tax or legal advice. Please consult your own independent CPA/accountant/tax adviser and/or your attorney for advice concerning your particular circumstances.
2017-48173 Exp. 10/2019
By Elozor Preil
