How Much Life Insurance Is Enough?

The economic value of a life depends on

• spending patterns
• income
• obligations to dependents and others
• value judgments

There are different ways to estimate how much life insurance you may need

• capitalization of income
• capital needs
• personal income needs

# Capitalization of Income (Human Life Value)

The intent is to replace the income lost upon the death of the life insured.

(1)
\begin{align} Need = \frac{AnnualIncome }{real Rate Of Return } \end{align}

• simple

Drawbacks

• ignores other sources of income
• ignores inflation (e.g., wage growth)
• ignores how long the capital is needed
• using only the interest on the capital without using the capital overstates how much insurance is needed

# Capital Needs (Capital Retention)

• reflects
• final expenses
• assumes mortgage will be repaid so that the family can remain living in the home (so ignores the market value of the home)
• ongoing income needs
(2)
\begin{align} Need = \frac{Ongoing Income - Ongoing Expenses}{real Rate Of Return} + (Assets - Final Expenses) \end{align}

Memory Aid
Assets - Bills = Cash needs (at death)
Dollars in - Expenses = Funds required (ongoing)
(Funds required) / (real Rate of Return) = Gross value of life
How much insurance = Gross value of life + Cash needs

# Personal Income Needs

This formula is not widely used.

Need = Needs and objectives of family during

• dependency period
• survivor income needs

• based on the family's needs and objectives
• considers all financial assets

Drawbacks

• needs regular re-evaluation
• may ignore inflation
• ignores estate creation and estate preservation