Life Insurance Needs Analysis without Numbers

Journal of Financial Planning; May 2014


David M. Cordell, Ph.D., CFP®, CFA, CLU®, is director of finance programs at the University of Texas at Dallas.

Clients often ask questions about investments. Investing is interesting, even sexy. Clients know that their funds are going into something that will generate even more funds. Doesn’t that sound like fun? 

Now, mention insurance to clients. Watch as their shoulders droop and their brows furrow.

Is Insurance Simply No Fun?

Consider a baseball analogy. Investing is like playing offense in baseball. Everyone likes to swing, make solid contact, and hear the crack of the bat. Sure, we may strike out sometimes, but we may connect for a game-winning home run.

Insurance is like playing defense in baseball. You can’t score any runs. You’re just trying to keep the other team from scoring runs. It is a necessary evil between at-bats.

Now, think about famous investors—Warren Buffett, Peter Lynch, John Templeton. You can name many others. How many kings of the insurance world can you think of? Hank Greenberg—not the baseball hall-of-famer, the Hank Greenberg whose given name was Maurice and who is still trying to clear his name after the AIG debacle. No fun.

The investments part of financial planning is like taking two steps forward, and the insurance part is like trying to avoid taking one step back. It’s useful, but doesn’t capture the imagination. It costs a lot of money and offers nothing tangible in return. It’s hard to like insurance.

Hollywood Piles On

As if there weren’t enough natural enmity toward insurance, Hollywood maligns the industry. In The Rainmaker with Matt Damon, a health insurance company denies a claim, declaring bankruptcy to avoid paying a judgment after losing a lawsuit. Then there’s Sicko, Michael Moore’s mean-spirited hatchet job on the evil health insurance industry. You will find the prototype of the obnoxious life insurance salesman in Groundhog Day with Needlenose Ned Ryerson, who upon seeing a high school acquaintance after 20 years busts into a sales pitch before completing the handshake. 

On the positive side, Lloyds of London, the 1936 classic starring Tyrone Power tells the semi-true story of how a syndicate at Lloyds, led by a childhood friend of Admiral Horatio Nelson, assumed risks that allowed Nelson to keep his fleet together, buying time to gather strength to defeat France at Trafalgar. 

Sadly, even saving Great Britain is insufficient to improve the bad PR of insurance. To many, insurance is a great sinkhole that swallows their money and leaves nothing behind.

Insurance Is Personal

Let me share a personal story, and no, it isn’t a story about how an insurance policy saved the day.

When I was a new father and deemed myself invincible, life insurance seemed like an unnecessary expense, to me. It was all about me. Then I extended the “me” analysis to the time when I was a little boy. My father had been a professor, and my parents had no money. Armed with a doctorate in micropaleontology, Dad accepted a job as a petroleum geologist for something over $6,000 per year, doubling his Colgate University salary, two months before my birth. He, my mother, and brother packed most of their possessions into their old, beat-up Willys sedan and began the 1,800-mile trek from Hamilton, New York, to Abilene, Texas, stopping at my mother’s parents’ house in St. Louis along the way. 

My grandparents begged my mother to stay in St. Louis for my birth, but she refused. “We’re making our life in Texas, so this child will be born a Texan,” she said. So back into the rough-riding Willys for the remaining 800 miles.

Mother and Dad began saving for a down payment to buy a home; we lived in rental houses until I was 4. Then Dad was promoted and transferred to a lab near Dallas, and they were able to buy their dream house. Well, it was a dream house in the sense that they dreamed about owning a house, and what they bought was a house. Three small bedrooms, two small baths, a single living area, and a one-car garage. My sister had her own room, and my brother and I shared one. In truth, it wasn’t much, and we had outgrown it before we moved in. Still, that promotion represented a dramatic turn in our lives. Life was good, and I was happy. 

As my father’s career developed, his income increased substantially.
Four years later, we moved into the house that my parents would live in for 40 years. It was much larger and in a much nicer neighborhood, but it was less than they could afford. There was money for private school for me and a trip to Europe when I was 15. Life was even better, and I was even happier. My father’s success helped put all three of us through college, and my mother never held a job outside the home. None of us kids incurred education loans, and we always had more than we needed.

Now, back to the invincible-young-father version of me. I suddenly remembered a kid named Kenny who lived down the street from our family’s first house. When I was 6, his father died in a car accident. Shortly thereafter, Kenny’s family moved in with his grandparents in another city, and I never saw him again.

I started rolling a series of what-ifs through my mind. What if my father had died somewhere along the way between Hamilton and my college graduation? Aside from the emotional/psychological part, which can’t be quantified, what would have been the course of my life?

I don’t know how much life insurance my father had, but I strongly suspect it was less than the minimum of the rule-of-thumb range. What if he had died while we were in the rental houses in Abilene? We certainly would have moved in with my grandparents in St. Louis. Even after the move to Dallas, the insurance proceeds would have been insufficient to sustain the household, much less to finance the improvements in lifestyle that we were privileged to experience.

The plain truth is that I have had an amazingly fortunate life, and a critical aspect of that good fortune is the simple fact that my father didn’t die or become disabled during my youth. Kenny couldn’t make that statement.

How Much Life and Disability Insurance Does One Need?

Insurance is protection. We protect what we have, but we should also protect what we hope to build in the future. 

My new-father-self decided to make some financial projections of his career path. I determined to carry enough insurance to protect more than our then-current lifestyle. I applied for enough insurance so that my family would experience the same improvements in lifestyle after my death that they would have experienced if I were to live a full life. The policy amounts may have seemed a bit extreme and pricey at the time, but I kept thinking about little-boy-me, and wondering what might have been. Then I thought about my own little boy, and what I wanted for him. 

There is good news and bad news. The bad news is that all of those insurance premiums are gone, never to be recovered. The good news is that I’m still here, and no one collected on those policies. Did my money—my family’s money—go down a sinkhole? Not at all. I don’t ponder how much money those premiums would have accumulated to if they had been invested instead of being allocated to insurance.
I think buying the insurance was a damn good investment.

Risk Management & Insurance Planning