Broker Check

How Much Insurance Do I Need? Determining Human Life Value

| April 27, 2016


How Much Insurance Do I Need? Determining Human Life Value

Allan Sternberg


I’ll be celebrating my 30th year in the insurance industry soon, and whenever anybody asks, “How much life insurance do I need?” I politely ask them if they mind if I ask them a question first. I tell them the answer really depends on how you answer this question: “Do you want to leave your family, your spouse, your children, with the lifestyle they’ve grown accustomed to, or something less?” You can imagine that 100 percent of the time people want their surviving family to retain their current lifestyle. Once people acknowledge that then I answer that they really need to buy life insurance up to their economic replacement value, otherwise known as their human life value.

Determining your human life value is quite simple, and Penn Mutual has just launched an online calculator that can help you determine yours. Your human life value is the maximum amount of life insurance that the insurance company will underwrite you for based on your age and your income. Your health only determines the premium charge.

For example, a 45-year-old — male or female makes no difference — would qualify for, say, a factor of 20 times their annual income. If that individual made $100,000, they would qualify for up to $2 million minus any coverage personally owned already. If the person owned a half million dollars of term insurance or permanent insurance, the insurance company could write up an additional $1.5 million to get them to their human life value. It’s that simple.

I know you’re probably taken aback by the size of that number, but follow the logic for a moment. A 45-year-old can expect another 20 years of working, and at $100,000 a year, their lifetime earning potential is $2 million. That’s without accounting for inflation, raises, and promotions. With a $2 million life insurance policy, the beneficiary of that policy can invest that money to generate an income. At a five percent return that would generate $100,000 per year. Human life value reflects what it would take your family to replace you or your income and maintain their current standard of living.

(Even stay-at-home parents have a human life value. Underwriting standards suggest using half the working spouse’s annual income in determining how much insurance is needed.)

Everybody insures their home to its replacement value, because if there’s a fire or other catastrophe, we want our home replaced. We all need a place to live. Same with our cars and our possessions. But when it comes to our lives, we tend to undervalue ourselves and buy less insurance than we should. Yet the chances of our house burning down are close to zero, and car accidents are relatively rare phenomena in most people’s lives, while the chances of dying are 100 percent.

A few years ago at our “Bring Your Child to Work Day” event, I was asked to teach a group of young children about life insurance. After my initial panic, I came up with the idea of using the old fairy tale of the goose that laid the golden eggs. If each golden egg is worth $100, I asked the kids, would you pay $5 out of that $100 to make sure that your goose is always going to be there? Half the class said yes, and the other half said no. So the first go around the kids who paid me $5 received $95 for their eggs while the others received $100. But the second go around wasn’t so kind to a few of the geese. There were 4 geese that didn’t let’s say “show up for work.” Two of the owners of the missing geese paid the $5 so they received $95 even though their goose was not “present.” The other 2 owners didn’t pay the $5 and unfortunately, we all know what happened. You can imagine the drama that caused, but the kids started to get it. That’s exactly what life insurance is.

Penn Mutual’s new human life value calculator is starkly different from a needs-based calculation, which is what you would find on other insurance carriers’ websites, Penn Mutual’s included until recently. I’ve been a long-time critic of such needs-based assessments, because I think they do our clients a disservice. A few years ago, I was on a task force to refresh our calculator. There was an underwriter in the group, and I asked him, “Bottom line, do you care what’s in a client’s 401(k)? Do you care what’s in their emergency fund? Do you care what their mortgage is? It’s not on the application for insurance!” He said no, the underwriters didn’t care about those. My response: “The only factors you care about are their income and their age when determining the amount of coverage they can purchase. Yes, or no?” He replied yes. I asked the group, then why are we going through this exercise to ask them about their assets and their needs? I should note that the type of coverage applied for can impact the amount they can qualify for based on the client’s ability to pay the premium. Typically one can’t buy all permanent life to get to their human life value.

I believe we have an obligation to tell our clients the total amount of insurance they qualify for, their full human life value. The client ultimately is going to make the decision. They might not be comfortable with that number, and that’s fine. They may or may not be financially ready to do it. But at least they understand what the number is, and it could be something they work towards through a combination of term and permanent insurance. I see these TV commercials pitching a low premium for a 10-year level term life insurance policy for a 35-year-old. What’s going to happen when this person turns 45 and they suddenly don’t have insurance? Because life happens, and they may still need insurance and yet be uninsurable because of a health issue.

I speak on this topic a lot. I put up the underwriting chart that determines someone’s human life value, and then I ask my audience, by a show of hands, whether they have insured themselves for their full human life value. If I have an audience of 20, maybe four people will raise their hands. It’s tough to hit that number, but I think it’s important that we all know what it is. Here’s why. I was on an airplane, and the pilot told everybody to fasten their seatbelts and prepare for an emergency landing. There was smoke and the smell of burning rubber in the back cabin, and people were flipping out. Yet I was eerily calm because — and I actually said this to myself — thank God I practice what I preach and have enough life insurance. I called my wife and I left her a voicemail saying that I loved her and the kids and that everything will be okay for them.

We did finally land safely. The guy next to me was an attorney, and he asked me what I do for a living. I told him I sell life insurance. He said, “You should have been up and down that aisle, handing out your card.”