Determining the proper amount of insurance needed

MR. WATSON: How do agents determine how much insurance somebody needs? There are two methods.

1. The human life value approach and
2. The needs approach . Let's start with the human life value.

Human Life Value

MR. WATSON: Dr. Solomon S. Heubner, an economist, said that every life was a money machine. And the output of this machine could be measured. You only need to be able to identify it. There is some math, but you don't have to apply it, you just have to identify it.

1. Take gross income.
2. Figure out the net income.
3. Multiply net income by the number of years the guy is going to work.
4. Then you discount that at a certain interest rate.

MR. WATSON: Ex: First, we'll have to find out how long the money machine is going to put out. If he is 35, he will put out to age 65. He will be working for 30 years. Now, he's making $50,000 gross, but we have to subtract his taxes, his personal living expenses, everything it takes to make the $50,000. Let's just say it's $20,000, just to make it easy math. That leaves us with $30,000. If we multiplied the net ($30,000), which is what his family consumes-and by consumption, I mean savings, investments, and expenditures. If we multiplied the net by the number of years he was working (30 years), it would come out to $900,000. But his family doesn't need $900,000 today if he died, do they? How much do they normally receive from this money machine? $30,000.

MR. WATSON: What we need to do is discount this $900,000 down to an amount that over the next 30 years would generate $900,000. Does that make sense?

STUDENTS: Yes.

MR. WATSON: There are tables used to find this number. So, how much money needs to be in the bucket? Let's just say at 4 percent interest, that when we opened up the spigot, it would produce a constant stream of $30,000 (from principal and interest) for the next 30 years. 30 years multiplied by $30,000 would be $900,000. Let's say for laughs it's $425,000, the amount we need right now to get a return of $900,000 down the road.

MR. WATSON: What's the big problem with this?

STUDENT: Who has $425,000 to invest right now?

MR. WATSON: Exactly.

MR. WATSON: That's why you need insurance. You need to provide $425,000 worth of insurance. But what's the problem with this? Inflation. Also, this doesn't take into account that this guy is probably going to make a dollar more as a raise. Does that make sense?

STUDENTS: Yes.

MR. WATSON: Could you identify the Human Life Value?

STUDENTS: Yes.

MR. WATSON: Yes, we can.

1. Take gross income.
2. Figure out the net income.
3. Multiply net by the number of years the guy is going to work.
4. Then you discount that at a certain interest rate.

MR. WATSON: And, again, there are tables and formulas that show you how to do that. Okay?

STUDENTS: Okay.