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2.8 Determining Amount of Personal Life Insurance

Two primary methods used to determine the appropriate amount of life insurance coverage are the Human Life Value Approach and the Needs Analysis Approach.

Human Life Value Approach​

The Human Life Value Approach estimates the present value of an individual's projected future earnings in the event of premature death. Its purpose is to determine the amount of insurance necessary to replace the economic value the individual provides to dependents.

Factors considered in this approach include:

  • Age and gender
  • Occupation
  • Annual income and employment benefits
  • Anticipated retirement age
  • Inflation

By projecting future earnings and adjusting for inflation, this method calculates the amount of coverage needed to replace lost income over the insured's expected working lifetime.

Needs Analysis Approach​

The Needs Analysis Approach focuses on the immediate and ongoing financial needs that would arise upon the insured's premature death. It assumes death occurs immediately and calculates the funds required to meet specific financial obligations.

This method typically includes:

  • Paying outstanding debts, medical expenses, and final expenses
  • Providing ongoing income for a surviving spouse
  • Paying off a mortgage or other Funding children's education
  • Establishing an emergency reserve for unexpected expenses
  • Subtracting available assets and existing resources

The resulting figure represents the amount of insurance required to meet the family's total financial needs.

Income Objective​

When using either method, the producer must also determine the income objective — how benefits will be structured to provide financial support. Two common approaches are:

Capital Liquidation: Assumes both principal and interest will be spent over a defined period to provide income. As distributions are made, the remaining balance declines until fully exhausted.

Capital Retention/Conservation: Assumes only the interest earned will be used to provide income, preserving the principal intact.

Quiz​

1. The Human Life Value approach is primarily designed to:

A. Determine the insured's current debts only

B. Estimate the present value of the insured's future earnings

C. Calculate funeral expenses

D. Preserve estate assets for taxation purposes

Correct Answer: B

Rationale: The Human Life Value approach calculates the economic value of an individual based on projected future income and benefits. Its purpose is to replace the income the insured would have earned for dependents.

2. Which of the following factors is typically considered when using the Human Life Value approach?

A. The beneficiary's credit score

B. The insured's favorite investment strategy

C. The insured's anticipated retirement age

D. The number of insurance companies in the marketplace

Correct Answer: C

Rationale: The Human Life Value method considers factors such as age, gender, occupation, income, benefits, retirement age, and inflation to determine the economic value of future earnings.

3. The Needs Analysis approach assumes:

A. The insured will live to life expectancy

B. Death will occur immediately

C. Only retirement needs must be calculated

D. Inflation is ignored

Correct Answer: B

Rationale: The Needs Analysis approach assumes immediate death and calculates the funds required to meet financial obligations such as debts, income replacement, education funding, and emergency reserves.

4. When calculating life insurance needs under the Needs Analysis approach, which of the following would be subtracted from the total financial needs?

A. Mortgage balance

B. Funeral expenses

C. Available assets and existing resources

D. Future income projections

Correct Answer: C

Rationale: The Needs Analysis approach calculates total financial obligations and then subtracts available assets to determine the net amount of life insurance required.

5. Under the Capital Retention (Conservation) income objective, income for beneficiaries is generated from:

A. Both principal and interest

B. Principal only

C. Interest only, preserving the principal

D. Additional premium payments

Correct Answer: C

Rationale: The Capital Retention method assumes the principal remains intact, and only the interest earnings are used to provide income to beneficiaries. In contrast, Capital Liquidation uses both principal and interest over time.