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How To Do Life Insurance Mathematics

How To Do Life Insurance Mathematics

After spending most of my work life, over 20 years, in the health and life insurance business, I still find the average consumer has no idea how to do life insurance mathematics. According to LIMRA’s research, the authority of the life insurance industry, over 30% of US households do not have life insurance. A staggering 55% of US households or 58 million people admit they do not have enough life insurance and need more.  Not only are average US families not buying enough life insurance but those households that do have life insurance have had their face amounts decrease over $30,000 average since 2004. The most alarming number comes from a survey stating that 70% of US households admit they would have serious financial problems if the primary wage earner were to die within just a few months including 30% of households admitting their problem would be immediate. Let’s explore your life insurance mathematics.

The first formula to life insurance mathematics is to calculate all of the primary debt the family has accumulated. Include the mortgage payoff, vehicles loans, credit card debt and consumer debt and loans. Next if there are minor children involved, how much will it take to educate them? If you have started a college savings plan, how much would you be short if you died today? If you haven’t started saving for college, what will it take to educate your child/children? Do your homework on the college your child wants to attend. The fees vary from $9,000 per year for in state students to over $25,000 per year for private institutions. Regardless, you will want to relieve the debt from your loved ones if you pass today.

The next formula to calculate is income replacement. This is the simplest calculation to do to replace your income. Keep in mind the debt will be paid off. If you take 10 times your annual income, invested properly at 7-8% rate of return long term, your family can live financially the same as if you were still alive and earning your annual wages. For example, if the primary wage earner makes $75,000 annually, the formula would be to purchase $750,000 face amount plus the total debt. With $750,000 properly invested with an 8% rate of return long term, the $75,000 annual income would be replaced with the interest from the proceeds because the mortgage and other debts would be eliminated. This calculation would insure income for the family without ever touching the original $750,000. To figure out which type of life insurance policy to purchase and how long of a term would be needed, we recommend reading this article Life Insurance 101. If you need help reading your new life insurance policy we recommend reading this article How To Read a Life Insurance Policy.

This may seem to be a very simplified use of life insurance mathematics example, and it is. Most American households only need this formula to protect their loved ones in case of a sudden death. Remember if most Americans knew how to do this calculation, 70% of households would not be underinsured.  We do recommend using an independent experienced life insurance broker to find the right product at the right price for your unique situation.

If a child, a spouse, a life partner, or a parent depends on you and your income, you need life insurance”.Suze Orman

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Tim Wilhoit is owner/principal of Your Friend 4 Life Insurance Agency in Nashville, TN. He is a family man, father of 3, entrepreneur, insurance agent, life insurance broker, salesman, sales trainer, recruiter, public speaker, blogger and team leader with over 26 years of experience in sales and marketing in the insurance and beverage industries.

38 Responses to How To Do Life Insurance Mathematics

  • Good statistics Tim…likely the reason why the stats are going down is because fewer life agents are selling insurance.

  • Jack, I never thought about it like that, but I think you may be on to something. There are a lot less life insurance agents in the market today. Especially the younger generation. The average age of an agent today is 50. Kind of scary when you look at all of the results.

  • Unfortunately this is true. I started as a debit agent with Western Southern back in 1988 and was full time in the life/health, part time P

  • Noel, thank you for your kind feedback.

  • Tim, Your thoughts on a Whole life Policy?

  • I’ll repost this. 🙂 Will put credit.

  • Fortune Life, thank you very much, I am flattered. James, whole life certainly has it’s nitche in the life products. From my personal experinece it is way over sold. It has to be the right product for the right situation. I find most clients just need to create an instant estate upon sudden death, which means more often than not the proper solution is term insurance or at least a mixture of term, whole or I prefer UL and IUL for cash value accumulations. My personal favorite is term deposit, because of the options to the client. Thank you both for sharing.

  • Tim, I shared your post (with credit to you of course) across my social media platforms. Nice work!

    Best Wishes,
    Doug

  • Doug, thank you so much for sharing. I am very grateful!

  • Thank you for your article. I am also a fan of a mixture; Term insurance for their temporary needs, affordability for buying a larger amount of coverage and then UL for their permenant needs. I very rarley lein toward whole life. The UL has great flexibility to it and is more affordable.

  • Kim, thank you for sharing, we are in agreement with UL and IUL versus whole life insurance.

  • Life Insurance is such a tough “sell” and finding that niche that that makes it emotional is the key. Just spoke with a 25 year old that I sold an Auto Policy too and discussed life (unfortunately over the phone) and he stated that his life wasn’t “worth much”. So, when he comes in this afternoon to pick up some documents I get to “overcome” that objection. Easier said/written than done but, hey, keep on asking and informing and eventually it will pay off. I hope 🙂

  • Kelli, I understand young people and life insurance. He really may not have a need at 25 yrs old. If he has no debt or loved ones, this could be true. I would approach it with there is only one type of l insurance that is guaranteed to pay a claim. You may never get sick, have a car accident or house fire, but you are guaranteed to die one day. A 25 yr old healthy male can buy 100,000 term for only $7,18/mo. It is so affordable at an early age, it is crazy not to own. Never sell insurance, create the need and let them buy insurance. Good luck!

  • Every male should require his spouse to purchase a $500,000 policy with him as the owner and permanent beneficiary. Beyond that life insurance is lousy buy except for those with huge trusts and estates. then it may make sense. otherwise it is a total waste of money

  • Bill, what you are stating applies to the top8% of earners. My market is the 80% of middle Americans who lose everything they own if the primary wage earner dies suddenly. I have counseled countless families who have lost their homes and possesions for the lack of life insurance. I couldn’t disagree more with your statement that life insurance is a waste of money.

  • I have to disagree with you Bill to say it’s a lousy buy. If bought & structured correctly it’s a great deal. Where you are probably right is most people buy the policies incorrectly & usually it favors the agent & not the client.

  • If you could be guaranteed to live to be 100…How much Life insurance would you need? 0?
    If life insurance were free how much would you want? 10,000,000?
    Chances are we’re somewhere in the middle.
    As George Burns once said.. the trick is to live to be 100 because not many people die after age 100.

  • David, I agree somewhere in the middle. The real trick is knowing when you will die. That’s why we sell life insurance. Thank you for sharing!

  • Good stuff Tim! Nice job explaining life insurance mathematics for calculating the amount of life insurance needed.

    In addition, I would suggest a 3rd formula that advisors and clients could/should use to calculate which policies best fill that need. While agents/brokers (too) often use illustrations of HYPOTHETICAL policy performance to determine which products (supposedly) best fill a given need, comparing these illustrations can be “misleading” and is “strictly prohibited” by the chief regulatory body of the financial services industry, and are “fundamentally inappropriate” according to a study by the chief actuarial body of the life insurance industry, and “are subject to a high degree of fluctuation” and thus not reliable for dterming the suitability of a given policy according to the U.S. Office of the Comptroller of the Currency.

    Alternatively, the pricing and performance of any/ever policy is/will ultimately be a function of:

    Cost of Insurance Charge (COIs) + Policy Expenses (E) – Interest/Earnings (i%)

    Using the above mathematics to measure pricing and performance factors SEPARATELY is the only way to determine which policy holding(s) best fill a given need according to both proven Prudent Investor principles and established industry authority.

  • I think the other aspect of Life Assurance aside from death benefit should also be another selling tool. That is – term Assurance, whereby the paid premium generate certain amount of income to the assured as such funds is invested on a certain rate of interest. Everybody needs reserve for the future. Therefore, no matter the age, especially as from 18 years, all should be encouraged to imbibe savings culture for both expected and unforeseen happenings/needs of the future

  • Dipo, we are certainly in agreement. Barry, that is an excellent point. There is a third side to the life insurance mathematics that I omitted. Thank you so much for incuding it.

  • Thanks Tim – A good reminder for both Brokers and Individuals on how important it is to know the numbers and read the small print.

  • Hi Tim,

    Thank you for your article! I think your message is great and keep on doing it! I find the name of the article to be a bit misleading. Perhaps you can take me through this math:

    You say:

    “For example, if the primary wage earner makes $75,000 annually, the formula would be to purchase $750,000 face amount plus the total debt. With $750,000 properly invested with an 8% rate of return long term, the $75,000 annual income would be replaced with the interest from the proceeds because the mortgage and other debts would be eliminated.”

    By my calculations, 8% of $750,000 would be $60,000. Not arguing with your logic, just your mathematics. I think that the 10x is nice, however, if you want to replace $75,000 of income, you might want to re-calculate. Also, the casual 8% long term return is a bit agressive. Realistically, a survivor would not be able to guarantee, nor any financial advisor, 8%. Unfortunately, they still seem a bit underinsured in your example.

  • Jeremy, you are absolutely correct. It would be 60,000 and 8% is aggressive in today’s market. However, over the long haul 7% to 8% has been used for years. The blog was more about the concept of a consumer purchasing life insurance than to create a plan. Most of the prospects I sit down with really have no idea of how much life insurance they need. I just wanted to keep it simple. I really appreciate you sharing.

  • The roadmap to actually achieving this financial model

    I calculated that in order for someone to reach a investment amount of 10 times their annual salary they would need to at least invest 30% of their income monthly for the next 33 – 34 years. Chances are the average person:
    1. Doesn’t know that this needs to happen.
    2. If they know what to do don’t have the discipline to implement a plan like this.
    Therefore the solution would be a much broader education system where children:
    1. Are taught about financial planning.
    2. Practice financial planning with real money.
    3. Are given the opportunity to teach others how to manage their finances.
    The issue is more lifestyle based than income based. What do you think?

  • Yami, you are going on to a totally different subject, but you are absolutely correct. This country has a HUGE savings problem. According to statistics the average hard working American has less than $2,000 saved for retirement. Over 65% of those retiring today use Social Security as their primary source of income. In my opinion you are absolutely spot on with teaching children. Unfortunately for many years finances were not taught in public schools. We do not have near the health care crisis in this country as we have a savings crisis, and spending problem. thank you for sharing this point.

  • Tim, Good Article and Good Points Put Forth but the problem is even advisors don’t take life insurance calculation so deeply. My points vis-a-vis your article;

    1) Nothing is better than Something Wrong.
    2) Something is better than Nothing.
    3) We shouldn’t burden the individuals and families with too much of life insurance otherwise they will not enjoy their present life. You can see that the younger generation, and for that reason we middle aged people as well, are getting carried away by the glam so much that they create too much of unwarranted liabilities and thus they reduce their saving potential.
    4) Term Insurance is the best solution to replace income.
    5) Another way to calculate Life Insurance Amount is that we go by the Human Life Value. As you have mentioned in the beginning, it has to do with the future length of working lifespan, then the current income, then the expected annual inflation, all expenses, all liabilities etc. This gives the correct amount of life insurance that an individual needs.
    6) Product is always secondary, first thing is the concept. If a client understands the concept and the need, then it becomes easier for advisors like us to suggest the solutions.
    7) Across the world, the experience about life insurance penetration and amount of cover is same. Either it over-insured or under-insured. In most cases it is under-insurance.
    8) It happens because we sell a promise which will be fulfilled on the happening of a certain event in future.
    9) In all other products, a buyer can feel it but in life insurance a buyer can only keep it for the benefit of others. And now-a-days we are less philanthropic.
    10) Even in the developed world, all sorts of regulations are there to insure non-living things but you don’t find any regulation for insuring living things like us human beings. We always talk about the colossal material losses for very long when a catastrophe takes place but we hardly talk about the lives lost. Our attention is also not there to attach that sort of importance to the lives lost.
    11) If the Governments also start talking about the life insurance then it will change the mindset of everyone toward it.
    12) Whatever it is, we need to keep talking about it as it is a very satisfying job for each one of us and it gives us immense pleasure when we see people thanking us profusely for pushing them for the life insurances.
    I needn’t be very longish.
    Thanks n Regards!

  • Alok,
    Wow, your response is as long as my blog, :). Thank you for the thought and sharing you put into this. I agree with a lot of what you are stating. I disagree that this country has too much life insurance and it is a burden. LIMRA stats suggest the total opposite. 70% of Americans are either under insured or not insured. This saddles surviving family members with a lot of debt that can’t be repaid. Term is the most affordable it has been in 40 years. There is “no excuse” for not having enough life insurance versus having a large enough big screen TV. It is all about priorities.

  • True Tim. I agree to what you say. It is all about priorities. But the fam n glam of the time we live drive people to materialistic things which are temporary and not long lasting. By insurance, I mean it will always be a case of under-insurance as no one does insurance analysis the same way we do health analysis, every 2 or 3 years. That’s why we see cases of under-insurance. Besides, Governments should also promote life insurance investments as it gives them and the companies long term revenues to take care of developments.

  • Alok, this I do agree with you on 100%. We just don’t need more government intervention in our lives. Life insurance is very affordable right now. I can only imagine what premiums would do once the government sticks their hands in it. Thank you again for sharing your thoughts.

  • Tim, excellent article…thank you. I have been in this profession for only a year but I already know the reasons why so few people have life insurance. The health of most Americans is marginal at best so this drives up the cost of life insurance. Speaking of cost, unless a healthy, young, individual is buying term insurance…it’s expensive. People simply cannot afford the amount of coverage they need because of health factors, age, and income. People tell me all the time that they know they need more life insurance but they are living pay check to pay check and simply cannot afford it. Again, excellent article…spells everything out as it should be.

  • Rod, thank you for your kind words, I always appreciate positive feedback. I do have to disagree with you on affordability of life insurance. Most of those “pay check to pay check” folks are broke by choice and if they budget right they can afford life insurance. If you walk in their home, they have a couple of computers, a 50’+ TV, cable, internet and probably a new car. Living within their means would certainly free up enough cash to afford life insurance premiums. With most people it’s about priorities. I wish you much success in our industry. Stay with it, it is an amazing industry to make a living.

  • It’s amazing how simple a basic needs analysis is, yet how few people understand it. You can plug all the numbers into an online calculator or figure it on a napkin

  • Brian, I agree there are a lot of formulas to calculate life insurance needs. However, it is the simple ones that the client responds to. Thank you for sharing.

  • Kelli.weakly.r4js@statefarm.com email me and I will e mail you back, I have a cute little demo that will calculate your need. Pretty cool!!

  • Thank you for sharing Kelli!

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