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How Much Life Insurance Is Enough?

There are two common methods for calculating the answer.

By Richard A. Dulisse, CLU, MSFS, LUTCF

In the aftermath of the World Trade Center tragedy of Sept. 11, 2001, countless Americans are re-evaluating their life insurance portfolios. Many people are taking a hard look at their coverage and asking themselves whether they are adequately protected. They are seeking our guidance in determining exactly how much is required to sufficiently provide for their loved ones if they were to die. To that end, we need to be familiar with the two generally recognized life insurance industry methods for quantifying these desired amounts of coverage.

Human Life Value method
The concept of comprehensive life insurance planning is not new. There is certainly a moral obligation to provide adequate protection for one’s family. Dr. Solomon S. Huebner, founder of the American College in 1927, said, “The growth of life insurance implies an increasing development of the sense of responsibility.” But how do we do it properly?

Dr. Huebner purported the Human Life Value approach. This theory says that, like a corporation, a person who works has capitalized earning capacity over his or her lifetime. Therefore, although everyone is unique and irreplaceable, “each human life potentially has an economic value, which is derived from its earning capacity and the financial dependency of other lives on that earning capacity.” Human Life Value is the present capitalized value of a person’s net future earnings after subtracting self-maintenance costs, income taxes and life insurance premiums being paid.

To practically apply this concept, let’s take an example. Suppose you have a 35-year-old client whose gross salary today is $60,000. His net take-home contribution to the family after subtracting self-maintenance, life insurance premiums and taxes, is $40,000. Also, assume that this person will work until age 65, which is 30 years. If we discount this earnings stream at a reasonably conservative after-tax discount rate of interest of 4 percent, the amount of insurance required to continue this income stream for the worker’s loved ones would be as follows: $40,000 x 17.29 = $691,600.

Explanation: Using a compound discount table, the present value factor for a series of payments of $1 due at the end of each year for 30 years discounted at 4 percent is rounded to 17.29. Therefore, $691,600 today, earning 4 percent interest after taxes, would provide the insured’s family with the $40,000 a year that they would have received if the worker lived and worked until age 65. This disregards the effect of inflation. If we factor in a 3-percent inflation rate over those 30 years, $1,036,714 of capital or life insurance would be required.

Although this is a simplification of a process that can be very complex, it demonstrates the point.

However, there are several issues overlooked in the application of the Human Life Value method. First, it presumes that a non-wage-earning spouse has no economic value. Second, it does not take into account that there may be a lump sum needed immediately upon the death of a worker to satisfy certain financial obligations such as loans that may be called in by various creditors.

These quandaries have led to the adoption of the second, and generally more widely used, approach to adequately insuring lives.

Total Needs method
This approach attempts to quantify how much life insurance would be needed to maintain the surviving loved ones’ lifestyle by looking at two categories of need: cash needs and income needs.

There is certainly a moral obligation to provide adequate protection for one’s family.

Cash needs consist of lump sums required at death for such items as final expenses, an emergency fund, a readjustment fund, a home-care fund, a mortgage/debt liquidation fund, and possibly even an education fund. Income needs address the replacement of a wage earner’s income for at least their working years, reduced by any available cash resources already in place such as existing life insurance or possibly even savings. Further reductions in calculating the income need would include factoring in Social Security survivor benefits payable to the dependents of a covered worker. (Many practitioners choose to disregard or plan on a reduced percentage of these benefits due to the perceived uncertainty of the Social Security program.)

To apply the Total Needs approach, let’s carry forward some assumptions from our previous case. Suppose the 35-year-old worker had a 30-year-old spouse and two children ages two and five. Let’s say that the cash needs at death included a $20,000 final expense fund, a $30,000 emergency fund, an $80,000 mortgage fund and a $160,000 education fund. These amounts total $290,000 of cash needs at death. Let’s further assume that the family needs $3,400 per month during the two-year adjustment period, declining to $2,920 per month for the next 14 years until the youngest child turns age 18, and then to $1,942 per month for the rest of the surviving spouse’s life. If we discount the stream of income needed at 4 percent, then $589,600 of capital would be needed to provide this income. Thus, the total funds for both cash and income needs would be $879,600.

However, if we factored Social Security into the formula, the income need may be reduced to about $200,000. On the other hand, if instead of systematically liquidating the capital sums required to fulfill the income needs, we take a capital conservation approach, as in the Human Life Value method, then the capital needed would be significantly higher than $589,600. Of course, inflation would compound that number further.

So, which method is better? You need to decide which approach is best for your client. Your company’s software programs will surely allow you to make an educated comparison based on a given set of facts.

In the final analysis, it is important to remain focused on our primary mission: to provide comprehensive life insurance protection and thus financial stability for the families of those we serve.

Richard A. Dulisse, CLU, MSFS, LUTCF, is an LUTC author and editor. He can be reached at


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