Life insurance very often represents the major building block in the estate planning process; life insurance should be purchased for one or two reasons:
- To create an estate that does not exists.
- To protect an existing estate from losses that will be sustained through death and the probate and administrative processes.
Although Bahamians are among the largest per capita purchasers of life insurance, it still presents a real mystery to many of them. Many do not fully understand the need for life insurance, let alone the bewildering array of products on the market today. Although life insurance does not have the same glamour as some financial products, it is still one of the most important purchases one will make and a key element in a sound financial plan.
Life insurance purchased to create an estate should be looked upon as casualty insurance, i.e., Insurance purchased to replace economic loss resulting from the death of a family’s sole wage earner. The problem resulting from this loss is lost income over a period of years. The solution that life insurance provides is that it creates a fund of cash dollars that can be used to sustain family members who do not have an alternative source of income for a projected period of time.
In this vein, life insurance can also be used to replace the monetary value of a no-wage earner’s contribution to a marriage. There are substantial costs involved in replacing the parent who cares for the children and the home.
Loss of a marriage partner or a significant other can cause significant hardship if there are not sufficient discretionary funds available to hire an individual to replace his or her functions. The amount of life insurance purchased, should be tailored to the family’s lifestyle, as it existed before the death of the wage earner and his or her spouse. The idea that should be stressed here is that the policy owner would want their dependents to maintain their current standard of living to which they would have become accustomed.
Additionally, the amount of life insurance that is purchased should be tempered with the income the proceeds will generate after the death to living beneficiaries. Subsequently, the income that can be generated from prudent investment of life insurance proceeds should be calculated by using a conservative interests factor. Unreasonably high estimates of income resulting from the investment of insurance proceeds generally result in inadequate insurance portfolios.
It has been my experience that most persons who need estate creation or [income replacement of a wage earner] are significantly underinsured. This is where the task of educating customers comes in. Many insurance persons do not realize the value of their ability to earn an income as being their most valuable asset. Further, they do not realize the value of their income contributions to their dependents. They do not consider the present dollar value of their income over a period of years required to care for those dependents. Often they forget that their most important asset is their ability to earn an income – earning power – trading their skills for pay. Most financial plans are built around one’s employment income continuing for a number of years. Without that income, one’s financial security could be at risk.
Many individuals are surprised when they calculate what their income is really worth. Let’s look at a simple example. Suppose you are 35 and currently earn $4000 per month. Assuming you work until the age of 65 and receive a 5% increase each year, your total earnings would be $3,189,000. In a typical case, it is highly unlikely that your family can maintain their standard of living without at least a portion of this income. Life insurance will provide the capital base to replace the lost income if you die prematurely.
Life insurance may not be affordable in the minds of many individuals. These individuals are trying to build their estates, and at the same time, are trying to maintain a reasonable standard of living, I might add, that appears difficult to sustain much less improve upon. Most persons that I know prefer to maintain their lifestyles at the expense of realistic insurance portfolios. They are betting that they will survive at least for the foreseeable future. They often reason that, “I’ll buy it later; when I can afford it, or I will do without it and use my surplus funds to create an estate that will care for my family and after my death”.
Finally, good estate planning dictates that all reasonable needs must be planned for on a current basis. Clients, who bet that they will survive, are betting against themselves, in our opinion. Fortunately, most of our clients who find themselves in the situation that we are discussing do have adequate life insurance coverage.