How Much Life Insurance Do I Need?

Life Insurance Policy

Protect your family.

Often the question of how much life insurance is needed is a difficult question because no one actually knows what their exact life circumstances will be when they pass away.  Certainly, the need for life insurance is imperative as the responsible adult would like to leave this world in a better way than they found it, and what better way to do that, than a life insurance policy that allows your family members to continue living in a manner to which they are accustomed.  We would hate to think of our family strapped with a pile of expenses and then having to change their life radically because there is not enough income to support the household.  As such, this gives rise to two very important questions.

First, how much is needed to cover a person’s obligations at the time of death?  To determine that amount one needs to consider medical bills, funeral expenses, outstanding debt, and mortgages.  Often there are costs that many forget like the costs to settle the estate which includes attorneys and accountants who all will expect to be paid for their services, so your beneficiaries can take what remains and hopefully maximize what remains within the laws of the probate code.  Since there are many unknowns you simply need to do your best to estimate those costs given the information you have now.  Certainly, the average cost of a funeral and the average cost to settle an estate are readily available.

Rest assured, there will be unknown and unexpected costs and bills that arise, but they are exactly that – unexpected and unknown, and thus there is nothing you can do about it except maybe factor in a safety margin to an extent that you feel comfortable.  Again, you are seeking peace of mind knowing there is enought to take care of your loved ones.  Let go of that which is completely out of your control but put a safety cushion in just in case if that make you feel better.

Second, how much will be needed to support the household after you are gone?  This largely takes into account the income stream that you would have otherwise brought into the household over a period of time.  Certainly, it would not be reasonable to think that period of time would run into perpetuity.  Although life insurance is often used as a wealth building vehicle, we are not dealing with that question here and that will be left for another day.  Here, however, we are considering that which reasonably would be expected to allow the family to comfortably sustain their household while matters readjust to account for the income that has been lost.  That may be perhaps a period of time until all the children reach the age of majority or until one’s spouse is ready to retire.

Whatever that period of time may be, you must also remember that a dollar tomorrow is not worth the same amount as a dollar is today.  Thus to determine what is needed you will have to consider the time value of money.  If you seek to be exact, some mathematics will be involved.  Or, just add 10% for every year until your expected age of death using any actuarial table.  Note, most spread sheets have built in financial function that can make those calculations for you. (click here to go to our Life Insurance Tools, where we have spreadsheets and other widgets to help in you in you quest for Life Insurance information.)

An alternative approach, is the notion that you just want your family to have a lot of money and they can figure out what to do with it.  That may be $500,000, $750,000, $1,000,000, or more.  This is a very technical approach that those in the business say “what does your gut tell you?” Which takes into account that your gut is usually right.  However, keep in mind that what your gut tells you may not be what your wallet says you can afford.  Even though you may want your family to inherit a multi-million dollar insurance policy, you may suffer in the short run as the premiums chew up your disposable income.  You need to put a line item in your budget that includes the premium to be paid each month and for each year and most have a budget that figures what they pay out of each paycheck.  That life insurance line item needs to be at the top of the budget with those important matters of necessity such as mortgage, utilities, food, and college.  You may have to adjust those more expendable items at the bottom of the budget.

However that happens, make sure the premiums fit within your budget so that you maximize the amount of the policy with the dollars you have available.  That’s why you shop for insurance to make sure you get the biggest bang for your buck.  You also have to keep in mind that you need to pay that premium for many years, which may be a daunting thought at the outset.  However, we have all experienced a payment that at one time seemed to be somewhat expensive, seem so much more affordable years later.  Think about the mortgage you had 20 years ago.  It seems like a drop in the bucket compared to your current house payment.  This is just another effect of the time value of money.

With life insurance, the premium needs to be affordable today so that years later that payment will seem, and actually be, easier as you pay the same amount with dollars that are worth less.  Also, you want to make sure you can continue to support the policy, as there is nothing worse than paying for many years and then allowing the policy to lapse, which could happen right when your family may need that policy – ouch.  So despite whatever calculations are made, or what your gut tells you, the perect  life insurance policy for you may be that which you can afford.  In fact, getting what you can afford is the most responsible approach you can take.  Even if its not that multi-million dollar payout, you are taking care of the ones you love and doing the best you can with what you have.

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Special Form Insurance Policies Don’t Actually Cover “All-Risks”

Basic, Broad and Special Form Insurance Policiesread your insurance policy

Often when purchasing an insurance policy the insured has a choice between three different types of coverage. This usually comes up in homeowner’s, renters and commercial property policies. The three different types are referred to as basic, broad or special form insurance. The coverage increases from basic to special form insurance and special form insurance is often referred to as an “all risk” insurance policy.

Basic Form Insurance Policy

The basic form policy is usually just the bare bones in insurance and for homeowners policies only includes coverage or certain named perils. This means that if the loss is caused by a peril that is not specifically named in the policy there is no coverage. The perils named in the basic form Homeowner’s policies include:
• Fire
• Lightning
• Windstorm or Hail
• Explosion
• Smoke
• Vandalism
• Aircraft or Vehicle Collision
• Riot or Civil Commotion
• Sinkhole Collapse
• Volcanic Activity

Broad Form Insurance Policy

The next policy that expands upon the basic form is the broad form policy which is still a named peril policy but is “broader” than the basic form and thus names more perils for which there will be coverage. This is again a named peril policy such that if the peril is not named and a loss occurrs there is no coverage for the loss. In homowner’s policies the named perils include the basic form list of perils above and then add the following:
• Burglary/Break-in damage
• Falling Objects (like tree limbs)
• Weight of Ice and Snow
• Freezing of Plumbing
• Accidental Water Damage
• Artificially Generated Electricity

Special Form Insurance Policy

The confusion arises with the third type of policy known as the special form which is often erroneously referred to as an “all risk” policy. This is not a named perils policy, but covers all perils except that which is excluded. It is the “that which is excluded” language that generally confuses the insured. Sometimes the policy owner reads that he has purchased an “all risks” policy and doesn’t read any further. On a special form the named perils are that which are excluded. So if the excluded peril causes the damage, then there is no coveraage. So in a homeowners policy that which is excluded is the following:
• Ordinance of Law
• Earthquake
• Flood
• Power Failure
• Neglect
• War
• Nuclear Hazard
• Intentional Acts

Not “all risks” are covered in a special form insurance policy

It is generally well known by most insureds that earthquake and flood are excluded from homeowners and only covered by special endorsement or a separate policy. In fact earthquake in California was only written by the state’s California Earthquake Authority up until just recently when two private insurers have now entered the fray of earthquake coverage.

It is important to remember however, that an “all risk” policy does not exactly cover everything and in fact most insurers will not use the term “all risks” because of the confusion that title causes.  Remember, if you are confused as to your coverage, you need to talk to your agent or broker who should be able to explain your coverage. Certainly you can always call First Capital Insurance Services at (818) 451-3878 and they will find the insurance you need and carefully explain the  coverage you are getting.

Types of Coverage in Homeowners Policies

Oddly in the Insurance industry agents and brokers will use confusing codes in letters to refer to certain types of coverage.  Even more confusing Coverage A for one type of insurance may have an entirely different meaning in another type of insurance.  As to Homeowners Insurance, the following describes the types of coverage that are typically found in such policies:

MAKE SURE TO READ YOUR POLICY TO KNOW YOUR COVERAGES.

CoverageType

Description

Coverage A:
Damage to House
Covers damage to the house. The face amount of the policy (for example $100,000) is the most you will receive if your house is totally destroyed.
Coverage B:
Other Structures
Covers damage to other structures or buildings, such as a detached garage, work shed, or fencing.
Coverage C:
Personal Property
Covers damage to, or loss of personal property. Personal property includes household contents and other personal belongings used, owned or worn by you and your family.
Coverage D:
Additional Living Expense
Covers additional living expenses when incurred. This means that the policy covers the necessary living expenses up to the stated limit, incurred by the insured to continue, as nearly as possible, the normal standard of living when the house cannot be occupied due to a covered loss.
Coverage E:
Comprehensive Personal Liability
Covers personal liability. This coverage protects you against claims arising from accidents to others on property that you own or rent. With a few exceptions, such as auto or boating accidents, it is an all purpose liability policy that follows you wherever you go.
Coverage F:
Medical Expense
Covers medical expenses. Coverage is limited to an amount per person and per accident for injuries occurring on your premises to persons other than an insured, or elsewhere, if caused by you, a member of your family, or your pets. An important feature of this coverage is that payment is made regardless of legal liability.