16/07/2020

How Much Life Insurance Should I Have?

In this post, I answer the question “How Much Life Insurance Should I Have?” Understanding the purpose behind why you feel you need life insurance is critical. What you hope to achieve by having life insurance in place. Details of any existing policies taken on privately or through work are also important. We will look at:

  1. Purpose of Insurance & Existing Plans
  2. Debts
  3. Your Expenses
  4. Doing the Sums
  5. Calculating the Cost
  6. Applying for Life Insurance
  7. When to Review Your Plan

Purpose

Knowing the purpose of the insurance is the starting point. Are you looking to repay your debts if you die? Do you want a policy which repays debt if you are seriously ill or unable to work? If so, see my posts on critical illness cover and income protection. Are you a business owner seeking to protect fellow shareholders or key employees? Or is it a policy which will provide for your family if you pass away when they are still dependent on you?

Having established the purpose, the next thing to consider is whether you need insurance. Insurance provides capital or an income. If you already have enough capital or income is generated from a source unrelated to your health, then you may not need any life insurance.

You should also consider life assurance which is already provided via employers (see my article on Death In Service Benefits) and any income which may be paid from pensions to your family in the event of your death.

Debts

Starting with the simplest situation first. If you die, please make sure those you leave behind do not have to repay your debts. Term assurance has no investment value and is relatively cheap. The amount of insurance should have the value of the loan and the length of the policy should match the length of your loan. If you repay early, you can cancel the life insurance without penalty.

Some lenders, such as credit card companies, mortgage lenders and banks have life insurance built into their products, so ask when you take on the debt if the bank repays it on your death. As always, get the response in writing and hold it with the loan agreement, your Will and other legal documents.

Expenses

STEP 1: The first step is to understand what your expenses are now. If you do not know, get your last 6 months bank and credit card statements out and see what your current standard of living costs. This is a useful exercise in itself and is a habit I would encourage you to do once a quarter.

STEP 2: Having arrived at a current figure, remove the expenses which would be stop event of your death. This may include a mortgage, golf club membership, health insurance, lower grocery bills etc.

STEP 3: The next step is to work out whether your family would relocate if you died or stay in the UAE. For many, this will be decided based on whether your surviving spouse has a job. If the decision is to return to your home country, the life insurance should be denominated in the currency of that currency where possible. This is because the expenses related to raising your family will be denominated in that currency.

STEP 4: Life Events such as university fees should be factored into your future expenses. These costs generally increase at a faster rate than standard inflation, so they should be separately identified in your calculation. Helping children with a deposit on their first home is also a popular purpose which needs to be provided for. For each child and purpose have a figure. So if I have a 10-year-old who will be going to university at 18 and I expect the cost to be $20,000 today that is one figure. If I also want to provide him with a deposit for his first home at 25 which I estimate to be $50,000 today that is another.

Doing The Sums

Life assurance covering debt is straight-forward as I have described above. The policy should be for the amount of the loan and the term of the policies should be for the same length of time as the loan.

Many advisers recommend 10-20 times family living expenses calculated in Step 2 is the answer. However, this is just a rough guide and there are more sophisticated ways of calculating the amount of life assurance you need.

To calculate the future cost of items like university fees etc, you will need to factor in inflation using the following equation.

Where X is the present value, R is the rate of inflation and N is the number of years.

In my example, my son’s university place costs $20,000 today, he has 8 years to go before he will go to university and education fees rise at 5% per annum. How much life insurance must I have to make sure the money is available for my son’s first-year at uni?

$20,000 x 1.05⁸

$20,000 x 1.4774

$29,549 for the first year

Year 2 will be $29,549 + 5% = $31,026

Year 3 will be $31,026 + 5% = $32,577

Assuming it is a 3-year course, the total will be $93,153, which is the same as a course costing $60,000 today.

If you need to calculate any future values you can use the equation above by substituting my numbers for your own goals.

Calculating The Cost

Whilst no widow ever complained about her deceased husband had too much life assurance, there are plenty of husbands who would prefer to keep the cost as low as possible.

The cost of life assurance is based on the age and health of the person to be insured. Other factors are the amount of insurance and length of time the plan is to be in place. So a 5 year plan for $1,000,000 will cost less than a 10 yr plan for $1,000,000.

Whatever the cost, it is important that it is affordable. If it is not and you experience financial hardship, one of the first items you be tempted to cut is your life assurance which undermines your family’s financial security.

Applying for Life Insurance

Applying for life assurance will involve completing an application form. The application form details the type and amount of cover you want and details of your health. The form is sent to the insurance company.

Once they have assessed the application they will ask you to attend a medical. Most insurance companies pay for this. A few only refund the cost of the medical when you start the plan. (So make sure you know which applies to the company you use).

After the medical results have been returned to the insurance company they will write to you or your broker informing you of their decision to accept your application or not. Insurance companies are not obliged to accept applications from everyone. People with poor medical histories or on-going medical problems may find obtaining cover difficult. Insurance companies can decline to offer terms or increase the premium.

If the terms offered are acceptable to the applicant the insurance will become effective once the first premium is paid. All premiums should be paid on time to keep the cover in place.

When To Review Your Life Insurance

It is important to review the level of cover you have regularly. Examples of when you should review your plan are:

  • change of job,
  • increase in income,
  • the birth of a child,
  • marriage
  • buying a new home.

Contact Me For More Information

If you would like to discuss any of the points raised, please contact me on 00 971 50 594 5217 or via e-mail stuart.porter@aesinternational.com Alternatively, if you would like a free initial planning consultation please book it here.

ABOUT STUART

Stuart Porter - Expat Financial Advisor UAE
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