Life Insurance Needs Analysis

Key Principle

Life insurance need = total survivor economic needs minus available financial resources. The difference is the coverage gap insurance must fill. This three-step needs analysis method is the only reliable way to determine how much coverage to buy.

Why This Matters

The popular multiple-of-earnings shortcut (income x 5-10) is dangerously wrong because it ignores actual obligations and resources. Two families earning $85K can have vastly different needs — one with a $210K mortgage and young children, another debt-free with grown children. The needs analysis method catches these differences; the earnings multiple does not. Social Security survivor benefits create discontinuous coverage with gap periods of zero income that families must plan around.

Good Examples

Klauder Family Case (pp. 262-263): Harry (37, $85K income), Denise (35), two children (ages 6, 8). Denise's life expectancy: 87.

Needs span three periods with different monthly requirements ($3,500 / $3,000 / $2,750) and different resource profiles — illustrating why single-number methods fail.

Social Security coverage cliffs (p. 262):

• Children's benefits end at age 18 (19 if in high school)
• Surviving spouse's caretaker benefits end when youngest child turns 16
• Spouse's own survivor benefits don't begin until age 65
• This creates a gap period with zero Social Security income. The Klauder case: Period 1 receives $38,400/year from SS; Period 2 drops to $0 (p. 263).

Counterpoints

• The non-wage-earner blind spot: Families that insure only the wage earner ignore the replacement cost of household services. A stay-at-home parent's death creates no income loss but generates immediate new expenses (childcare, cleaning, cooking) that "can stretch a family budget to the breaking point" (p. 260).
• Dual-income households need dual coverage: The assumption that only the higher earner needs insurance ignores that both incomes support the family's financial structure (p. 287).
• "Dependents" extends beyond nuclear family: Miriam Epstein (40, single) needs coverage because her mother has Alzheimer's with escalating care costs — $2K to $5K/month (pp. 285-286).

Key Quotes (ALL with page citations)

• "The multiple-of-earnings method fails to fully recognize the financial obligations and resources of the individual and his or her family." (p. 259)
• "Can stretch a family budget to the breaking point" — on replacing household services after a non-wage-earning spouse's death (p. 260)
• "Life insurance needs are not static." (p. 261)
• "Life insurance fills the gap between the financial resources available to your dependents if you should die prematurely and what they need to maintain a given lifestyle." (p. 284)
• "Adequate life insurance coverage is vital to sound personal financial planning because it not only protects what you've already acquired but also helps ensure the attainment of unfulfilled financial goals." (p. 284)

Rules of Thumb

1. Three-step method always: (1) total economic needs, (2) available resources, (3) gap = insurance needed.
2. Step 1 must be multi-period: Lifestyle income changes across children-at-home, empty nest, and retirement periods.
3. Don't forget: service replacement costs, debt liquidation, emergency fund, college fund, and liquidity bridge for illiquid assets (p. 260).
4. Step 2 resources include: savings, investments, Social Security survivor benefits, surviving spouse's earnings, group life, pension death benefits, other liquidatable assets (p. 260).
5. Review every 5 years or after any major family change — birth, home purchase, job change, divorce (p. 261).
6. Never rely solely on group life — it typically covers only ~1 year's salary and is tied to employment (p. 274).
7. Estimation risk is real: Asset values change, surviving spouse's future employability is uncertain, and multi-period projection inherently involves assumptions.

Related References

• core-framework.md — The four risk management strategies and who needs life insurance
• life-insurance-types.md — Choosing the right policy type to fill the gap
• life-insurance-features.md — Settlement options and riders that affect how benefits are received