Life’s Persistent Questions #4: How Much Life Insurance Do I Need?

By: Eric Sondergeld
11/27/2023

So far in this series, I’ve covered the questions about when someone needs life insurance[1] what type they should buy,[2] and what makes life insurance special[3]. For us industry insiders, these may seem like simple questions. However, as I’ve demonstrated, identifying whether and when you need life insurance isn’t always obvious, and thus, the need may instead sneak up on most consumers. The question of “what type” can lead to more questions to which consumers may not readily know the answers. One of those questions is just how much life insurance to buy.

The question of “how much” is relatively unique to life insurance.         

Assuming someone has determined they might need life insurance (and even which type to buy), they must figure out how big a policy to purchase. This is something they don’t necessarily need to do when buying other types of insurance. Different health insurance policies share costs with the insured in different ways and may come with different maximums, deductibles, etc. With auto insurance coverage, the consumer can select from a limited set of options for bodily injury liability, property damage, etc. Home insurance coverage amounts are predicated on the value of the home. Disability income and long-term care insurance offer different coverage amounts, though the range of coverage amounts is much more limited than with life insurance.

How much do we need? There is no right answer.

When it comes to life insurance, there are seemingly countless needs calculators, rules of thumb, and other techniques for figuring out how much life insurance to buy. Different needs calculators provide a wide range of recommended amounts for a particular individual. Most ask questions that the consumer may not be able to easily answer, such as how many years of income replacement they want or need. Behind this question is an implicit assumption that life insurance is intended to help the policyholder’s loved ones recover financially following their death, but only for a time, after which they’ll need to support themselves. This is never explained to would-be buyers, nor do buyers explain to their beneficiaries why they bought life insurance and what the death benefit is intended to accomplish.

Payout options don’t align with the idea of life insurance as income replacement.

The fact that income replacement often contributes the most to the “how much” question suggests that life insurance is an income replacement product. Why then do policies pay a lump sum upon death? If beneficiaries were to read the policy, they would find that in most cases the ability to receive the benefit in installments exists. Yet at claim time, such options are seldom presented.

Coverage amounts diverge from needs as they change over time.

What’s more is that once a policy is purchased, the underlying “need” can change significantly over time. With most coverage having a level face amount, coverage amounts and underlying needs can diverge over time. There is usually no mechanism for proactively adjusting coverage to account for changes in these assumptions.

Life insurance is for the beneficiary.

In my previous blog on what makes life insurance so special, I reminded readers that life insurance is the only insurance where the insured is not the beneficiary. I argue that the two main benefits of life insurance are the peace of mind it brings to the insured and the financial benefit to dependents. If someone other than the insured is going to benefit from the policy, then shouldn’t we give more consideration to them in designing products, determining coverage amounts (over time), etc.?

It’s time to innovate around “how much” life insurance people need.

While there certainly have been many innovations in life insurance in recent years, such as life-LTC combination products, indexed universal life, etc., the basic structure of life insurance has remained relatively unchanged. The question of “how much” offers tremendous opportunities for innovation. This includes new ways to define how much (because there is no right answer), how benefits are paid, whether coverage amounts are set to change over time or could be changed as needed, designing for the ultimate user (e.g., the beneficiary), whether coverage is purchased all at once or over time, etc.

 

Please contact us if you’d like to test any of the above concepts or understand how consumers think about the “how much” question.

 

 

[1]Life’s Persistent Questions #1: When is the Best Time to Buy Life Insurance?

[2]Life’s Persistent Questions #2: What Type of Life Insurance Should I Buy?

[3]Life’s Persistent Questions #3: What Makes Life Insurance Special?