There are many factors to consider when evaluating your clients’ need for life insurance. Each client’s situation is different and there are many approaches to arriving at what can be considered the suitable amount of life insurance.
“There is no magic number,” says Prem Malik, a chartered accountant and financial advisor with Queensbury Securities Inc. in Toronto. “The insurance coverage that’s important to some clients is not necessarily as important to others.”
Although some clients recognize that they need life insurance, Malik says, they tend to ignore its importance because it is not seen as a necessity or, in some cases, a requirement, as with home or car insurance.
Heather Holjevac, a certified financial planner with TriDelta Financial Partners Inc. in Oakville, Ont., believes the reason for the often nonchalant attitude toward life insurance is that it forces clients to address the difficult but inevitable question: what would happen if you passed away today?
However, Raymond Yates, a financial advisor and senior partner with Save Right Financial Inc., a Mississauga, Ont.-based managing general agency, contends that there is a generational shift toward accepting the importance of life insurance as a risk-management mechanism.
“More and more younger individuals,” Yates says, “are warming up to buying life insurance.”
Indeed, life insurance is all about personal risk management. If your client were to die suddenly, will he or she leave sufficient money to take care of his or her debts and other expenses? Can his or her survivors afford to maintain their lifestyle? Will the client’s family members have to sell their home if left with a mortgage? Will the client’s widowed spouse have sufficient funds to take care of the children’s education? What if the client is the sole breadwinner?
While the circumstances for each individual are different, these are just some of the risks associated with not having life insurance — unless your client has sufficient funds to mitigate these risks.
“Life insurance should be a critical part of a client’s overall financial plan,” Malik says. “You must have a holistic picture of their situation.”
Life insurance, Yates says, “bridges the gap between current and future assets and liabilities.”
So, how do you determine how much life insurance your clients should have?
There are different approaches to determining how much life insurance, if any, each client needs. However, there are certain basic variables that must be assessed to arrive at a reasonable amount of coverage.
> Assessing liabilities
Yates recommends starting with an assessment of all current and future liabilities. The easy part is determining current liabilities, such as outstanding mortgages, loans and other debts, he says, because the amounts are known.
But other expenses — such as education costs for children, lifestyle expenses, income replacement and final expenses, including estate taxes — must be estimated.
“You’ll have to determine what works for the family,” Malik says, “based on their current situation. Typically, younger families have greater liabilities, as they could be carrying a higher debt burden.”
> Evaluating assets
The next step is to determine your client’s current assets. These could include savings, investments, sources of income (including survivor benefits, existing life insurance and other assets).
“Don’t forget to include any insurance coverage at work,” Malik says.
He cautions, however, that insurance coverage through an employer is useful only for assessing your client’s current situation. Such coverage can change if the client’s job changes.
You also should estimate the projected income of either surviving spouse, using assumptions for both spouses.
> Evaluating the gap
The difference between a client’s assets and his or her liabilities represents the financial risk the individual or the family faces. Put simply, this gap represents the amount of life insurance the client requires.
It is best to err on the side of caution, Yates says, and recommend a marginally higher level of coverage to take care of any unforeseen expenses.
Adds Holjevac: “It is important that the lifestyle of the survivors is not compromised.”
And, says Malik, “Older clients may wish to leave an inheritance for their estate or grandchildren” — which must be taken into account, effectively becoming part of the liability side of the calculation.
> Affordability
If affordability of the premium payments is a problem for your client, Yates says, there are options.
“You’ll have to look at different product variations,” he says. “For example, you might recommend term insurance, which is less expensive, instead of more expensive permanent insurance.”
Yates cautions, however, that in all cases, you should explain the merits of the different products: “Don’t just try to fit the cost of coverage into the client’s budget.”
If your client cannot afford to cover all of his or her insurable risks or if the product that is chosen can work only for the short term, Malik recommends that you “advise the client that you will need to revisit their situation annually.”
In some cases, as your clients’ financial situation or risks change, the need for insurance might diminish.
“Some clients may be able to self-fund their risks.” Holjevac says. “Or they might not need life insurance.”
Life insurance should be a part of a client’s overall financial plan, she adds: “It should not be a split-second decision.” IE