If finding the “right” amount of life insurance for an individual remains a stubbornly subjective calculation, it’s not for lack of the insurance industry’s attempts to arrive at definitive quantifications.
Windsor, Connecticut-based LIMRA (formerly Life Insurance Marketing and Research Association), for instance, uses a model that heavily weighs income replacement, assuming that workers with household dependents need coverage greater than five years’ income (net financial assets in place reduce or eliminate any need for insurance.)
But insufficient death benefits are a secondary worry for the sector these days. Recent research by LIMRA shows that not only are there 30 million underinsured Americans but that the percentage of people with no life insurance has increased sharply in recent years.
“What surprised us,” says LIMRA CEO David Levenson, “was that households with $100,000 income or more were most likely to be underinsured. About a quarter of these households (26%) had, on average, a life insurance coverage gap of nearly $400,000. Our data suggest that nearly 20% of families with that income have no life insurance coverage at all.”
Mary McGrath, executive vice president at Cozad Asset Management in Champaign, Illinois, confirms that underinsurance tends to skew towards clients with higher incomes, who therefore need more income replacement. “The higher the income, usually the higher the standard of living,” she says. “Social Security caps benefits at a much lower amount, as a percentage of higher incomes, so the life insurance need is greater.”
Few happy mediums
But are financial planning clients really underinsured? Mitch Reiner, managing partner at Capital Investment Advisors in Atlanta, says that it’s “50/50.”
“Many people are approached and sold on life insurance earlier in their lives because of the ‘affordable’ cost of insurance [albeit with] the high commissions that are associated with young salespeople who call on their friends to get their career going,” Reiner says. “Therefore, a lot of clients have enough coverage because of having too much earlier in their lives.”
Assuming a policy is affordable, with minimal risk of lapsing, excess coverage may not be a huge concern. Few beneficiaries will object to receiving a large payout, income tax-free, at the insured individual’s death.
Underinsurance might pose problems, however, so the answer might be to increase coverage. “If someone is uninsurable, then using the group rates through work can be great,” says Reiner. “Most times, my recommendation is to buy enough term until you can accumulate enough assets to cover your liabilities.”
McGrath suggests comparing group life to individual term insurance to see if the group insurance is cost effective. “It’s also vital to know whether group coverage is portable if the client leaves employment,” she adds. “For a high-net-worth earner we might emphasize the benefits of cash value life insurance, which can be a tax-efficient asset.”
Matters of time
In most cases of addressing underinsurance, McGrath will recommend lower-cost term insurance, extending the term to cover the period of risk. “I just had a client buy 30-year term because the couple is beginning to start a family,” she says. “Another client bought 10-year term because the protection was just needed to age 65. It’s important to find the right fit of insurance with the client’s needs, assets and cash flow.”
Some underinsured clients may not want to buy more coverage. Are there other strategies that can provide needed protection? “If they balk on buying life insurance, I emphasize additional savings in retirement plans or investments,” says McGrath. “The more they are able to save, the lesser the risk over time.”
One plan for the underinsured, says Reiner, is to have such clients allocate enough assets to cash in order to take care of the survivor’s immediate needs. “They should think about living expenses needed for a period of time, including child care and health care. Make sure to have enough in emergency reserves for these needs if they won’t have enough insurance. Less insurance puts more burden on the surviving loved one, but the initial burden can be eased by having cash set aside for catastrophic needs.”
True consequences
LIMRA’s Levenson responds that while such hedging may help but there are real consequences for families that don’t have enough coverage. He reports that LIMRA’s surveys have found that the premature death of the primary breadwinner would result in financial hardship within six months for 44% of responding households — for 28%, within one month.
McGrath has seen that the deaths of underinsured individuals can bring severe results. “Watching a family adjust to the loss of a loved one and facing the reality of needing to sell the house is heartbreaking,” she says.
For advisors, the challenge is to help clients get necessary coverage without impairing their ability to reach other financial planning goals.
