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FAMILY PURPOSES

Source of the Economic Value of the Human Life

In terms of its physical composition, the human body is worth only a few dollars. In terms of earning capacity, however, it may be worth millions of dollars. Yet earning power alone does not create an economic value that can logically serve as the basis of life insurance. A human life has an economic value only if some other person or organization can expect to derive a pecuniary advantage through its existence. If an individual is without dependents and no other person or organization stands to profit through his or her living either now or in the future, then that life, for all practical purposes, has no monetary value that needs to be perpetuated. Such an individual is rare. Most income producers either have dependents or can expect to acquire them in the normal course of events. Even those income earners with no family dependents often provide financial support to charitable organizations. In either case, a basis exists for insurance.

Preservation of Family�s Economic Security

In many cases an income producer�s family is completely dependent on his or her personal earnings for subsistence and the amenities of life. In other words, the "potential" estate is far more substantial than the existing estate�the savings that the family has been able to accumulate. The family�s economic security lies in the earning capacity of each income earner, which is represented by his or her "character and health, training and experience, personality and power of industry, judgment and power of initiative, and driving force to put across in tangible form the economic images of his mind." Over a period of time, these economic forces are gradually converted into income, a portion of which is devoted to self-maintenance, a portion to support of dependents, and if the income is large enough, a portion to savings to meet future needs and contingencies. If the individual lives and stays in good health, the total income potential will eventually be realized, all to the benefit of the family and others who derive financial gain from his or her efforts. If an income earner dies or becomes permanently and totally disabled, the unrealized portion of his or her total earnings potential will be lost, and in the absence of other measures, the family will soon find itself destitute or reduced to a lower income than it previously enjoyed.

This need not happen, however, since there are contracts that can create a fund at death at least to partially, and possibly to fully, offset the lost income of the insured. Those contracts, of course, are life insurance. By means of life insurance, an individual can assure that the family will receive the monetary value of those income-producing qualities that lie within his or her physical being, regardless of when death occurs. By capitalizing this life value, an income earner can leave the family in the same economic position that they would have enjoyed had he or she lived.

The Moral Obligation to Provide Protection

Most people assume major responsibility for the support and maintenance of their dependent children during their lifetime. In fact, they consider it one of the rewarding experiences of life. In any case, the law attaches a legal obligation to the support of a spouse and children. Thus if there is a divorce or a legal separation, the court will normally decree support payments for dependent children and possibly alimony for the dependent spouse. In some cases such payments, including alimony, are to continue beyond the provider�s death, if the children are still dependent or if the alimony recipient has not remarried. Nevertheless, it takes a high order of responsibility for a parent to voluntarily provide for continuation of income to dependents after his or her own death. It virtually always involves a reduction in the individual�s own standard of living. Yet few would deny that any person with a dependent spouse, children, or parents has a moral obligation to provide them with the protection afforded by life insurance, as far as his or her financial means permit.

Dr. S. S. Huebner had the following to say concerning the obligation to insure:

 

From the family standpoint, life insurance is a necessary business proposition which may be expected of every person with dependents as a matter of course, just like any other necessary business transaction which ordinary decency requires him to meet. The care of his family is man�s first and most important business. The family should be established and run on a sound business basis. It should be protected against needless bankruptcy. The death or disability of the head of this business should not involve its impairment or dissolution any more than the death of the head of a bank, railroad, or store. Every corporation and firm represents capitalized earning capacity and goodwill. Why then, when men and women are about to organize the business called a family should there not be a capitalization in the form of a life insurance policy of the only real value and goodwill behind that business? Why is it not fully as reasonable to have a life insurance policy accompany a marriage certificate as it is to have a marine insurance certificate invariably attached to a foreign bill of exchange? The voyage in the first instance is, on the average, much longer, subject to much greater risk, and in case of wreck, the loss is of infinitely greater consequence.

The growth of life insurance implies an increasing development of the sense of responsibility. The idea of providing only for the present must give way to recognition of the fact that a person�s responsibility to his family is not limited to the years of survival. Emphasis should be laid on the "crime of not insuring," and the finger of scorn should be pointed at any man who, although he has provided well while he was alive, has not seen fit to discount the uncertain future for the benefit of a dependent household . . . Life insurance is a sure means of changing uncertainty into certainty and is the opposite of gambling. He who does not insure gambles with the greatest of all chances and, if he loses, makes those dearest to him pay the forfeit.

Measurement of Monetary Value

It seems agreed that an individual should protect his or her earning capacity for the benefit of dependents by carrying life insurance in an appropriate amount. The question logically arises at this point as to how much is an "appropriate" amount.

Some have suggested that a person should capitalize this economic value at an amount large enough to yield, at a reasonable rate of interest, an income equal to the family�s share of those earnings. In an attempt to obtain the same general result, others have recommended that a person capitalize this value at a figure large enough to yield an annual income equal to a specified percentage, such as 50 percent, of those personal earnings at the time of the provider�s death. In response to the significant inflation in recent decades, some suggest capitalizing the worker�s full income (or more) so that the income portion that would otherwise have gone to income taxes and the insured�s self-maintenance can be used to offset general price inflation. All of these approaches are based on the assumption that the income from personal efforts is a perpetuity. All would preserve the capitalized value of a portion of those earnings into perpetuity. Such an assumption is theoretically invalid. Personal earnings are subject to termination at any time by the producer�s death or disability and, in any case, will generally not continue beyond the date of retirement. Therefore in capitalizing the earnings of an individual, their terminable nature can be taken into account.

The technically accurate method of computing the monetary value of a person is too complex for general use. It involves an estimate of the individual�s personal earnings for each year from his or her present age to the date of retirement, taking into account the normal trend of earnings and inflation. From each year�s income the cost of self-maintenance, life insurance premiums, and personal income taxes is deducted. The residual income for each year is then discounted at an assumed rate of interest and against the possibility of its not being earned. In the latter calculation, the three contingencies of death, disability, and unemployment have to be considered. The sum of the discounted values for each year of potential income is the present value of future earnings or the monetary value of the life in question.

When determining the economic value of a human life for purposes of insuring that value against loss by death, one should consider the projected flow of income to the family rather than the probability of the provider�s death. The objective is to determine the present value of the income flow to the family if the family provider survives to the end of his or her income-producing period since ideally insurance will be sufficient to permit the family to enjoy the same standard of living that it would have enjoyed had the provider(s) not died.

Five-step Procedure for Estimating Economic Value

A reasonably accurate estimate of a person�s economic value for purposes of life insurance can be derived by a simple-to-understand method that can be used by anyone with access to a computer, a financial calculator, or compound-interest discount tables. There are five steps in this procedure:

 

1) Estimate the individual�s average annual earnings from personal efforts over the remaining years of his or her income-producing lifetime.

2) Deduct federal and state income taxes, life insurance premiums, and the cost of self-maintenance.

3) Determine the number of years between the individual�s present age and the contemplated age of retirement.

4) Select a reasonable rate of interest at which future earnings will be discounted.

5) Multiply (1) minus (2) by the present value of $1 per annum for the period determined in (3), discounted at the rate of interest selected in (4).

 

In the first step an effort should be made to anticipate the pattern of future earnings. In the majority of cases, particularly among semiskilled and clerical workers, earnings will reach their maximum at a fairly early age, perhaps around 40, and will remain at that level (except for inflation adjustments) until retirement. The earnings of professional people continue to increase until about age 55, after which they level off or decline somewhat unless they are adjusted for inflation. The earnings of still other groups may continue to rise until shortly before retirement. It is difficult to estimate accurately the average annual income that can be expected. Inflation, technological change, and increased global competition are accelerating the rate of change and our society�s economic volatility.

The costs in the second step are also difficult to estimate, but income taxes and the cost of self-maintenance can be approximated within a reasonably close margin of error unless Congress makes a drastic change in the future tax rates. The purpose of step (2), of course, is to arrive at the family�s share of personal earnings. The determination of the income tax liability, life insurance premiums, and the cost of self-maintenance can be dispensed with if the individual can directly estimate what portion of personal earnings goes to the support of the family. In the typical case it is probably relatively accurate to assume that less than half of the provider�s gross personal earnings is devoted to the support of the family. In the low-income brackets, the percentage is undoubtedly a little higher but in no event more than two-thirds; in the higher-income brackets, the percentage might be lower than one-half.

The purpose of step (3) is to determine how long the family can expect to receive the income projected in step (2), ignoring, for reasons indicated above, the probability that the individual may die before reaching normal retirement age.

The rate of interest selected in step (4) should be in line with the rate generally payable on proceeds left with the insurance company since it is usually a conservative estimate of conditions over the relevant future period. Another acceptable interest rate estimate is the rate used by the Pension Benefit Guaranty Corporation (PBGC is a federal agency located in Washington, DC) for valuing defined-benefit pension liabilities.

Calculating Present Value

The present value of $1 per annum, the only new element involved in step (5), is obtained directly from a financial calculator or a computer using financial software. Alternatively it can be derived from a compound-discount table that shows the present value of a series of future income payments�specifically, $1 per annum�for various periods of time and at various rates of interest. The present value of a series of annual end-of-the-year payments of $1 per annum for 40 years at 5 percent interest, for example, is $17.16. If a 4.5 percent interest rate is assumed, the present value is $18.40. Such a computation recognizes that a dollar due some years hence is not worth a dollar in the pocket now. A dollar due 40 years from now is worth only 14 cents today if a discount rate of 5 percent is assumed. This is equivalent to saying that 14 cents (actually $0.142045682) invested at 5 percent compound interest will amount to $1 at the end of 40 years.

The entire process of computing the monetary value of a human life can be illustrated with the example of a married man aged 35, with gross annual earnings of $40,000, whose income is expected to remain at that level until retirement. It can probably be assumed that $20,000 per year will be devoted to the family. If the person plans to retire at age 65, the income can be expected to flow in for the next 30 years. At 5 percent interest, $1 per year for 30 years is worth $15.37 today. Therefore an income flow of $20,000 per year for 30 years is worth $20,000 x $15.37, or $307,400 ($307,449 without rounding). A person aged 35 who can be expected to devote an average of $45,000 per year to his or her family over the next 30 years is worth $691,650 (when $15.37 is the rounded-off version of $15.37245103; $691,760 without rounding) to the family today if the income is discounted at 5 percent. If possible, that income should be capitalized in the form of a life insurance policy on the producer of the income.

Diminishing Nature of the Economic Value

It must be apparent that, from any given point, the economic value of a producer tends to diminish with the passage of time. His or her earning level may continue to increase for a certain period or indefinitely, but with each passing year, the remaining period of productivity becomes shorter. Each year of income that is realized means that there is less that remains to be earned. Since an individual�s economic value is nothing more than the unrealized earning capacity represented by native ability and acquired skills, his or her value must diminish as potential income is converted into actual income. This principle is illustrated by the diagram in figure 1�1.

 

 

FIGURE 1�1
Hypothetical Illustration of Economic Value of a Human Life

 

 

The chord AB represents the lifetime of an individual born at point A and dying at point B. The arc AB represents the cost of maintenance and, during his or her productive years, the individual�s income tax liability. The arc CD represents earning capacity. During the period A to C, there are no earnings, but there are costs of maintenance represented by the triangle AEC. Earnings commence at C and may represent part-time work or sums earned for running errands. The area of arc CD that extends above arc AB represents earnings in excess of taxes and the cost of self-maintenance. Point D marks the age of retirement, and the area DFB symbolizes the second major period in the individual�s life, during which the cost of self-maintenance exceeds his or her income.

In figure 1�2 the monetary value of the individual is at its peak at point E since net earnings are just commencing. At the point where xx1 intersects the arcs, the earnings rate has increased, but potential future earnings have declined. The earnings potential shows further decreases at yy1 and zz1; at point F, it has shrunk to zero.

Figure 1�1 is diagrammatic and obviously unrealistic. Neither earnings nor maintenance expenses follow a symmetrical curve. For example, the childhood period starts with a highly unsymmetrical outlay for maternity costs. Income is also likely to commence earlier than at point C, particularly among lower-income groups, and under no circumstances is it likely to decline so gradually to the age of retirement. In most occupations people reach their maximum earnings in their 40s, and earnings decline only slightly to retirement, when they terminate abruptly. Figure 1�2 shows a fairly typical pattern of earnings among clerical and professional groups.

FIGURE 1�2
Typical Pattern of Earnings

Bases for Insurance

These diagrams roughly illustrate the economic foundation of three broad categories of life insurance. The first is represented by the area AEC. During this period the individual�s needs are met by the parents or other persons responsible for the child�s welfare. If the child dies before becoming a producer, the investment in nurturing, maintenance, and education is sacrificed. This can be a sizable sum, especially if the child has been educated at private schools. Various studies have shown that the cost of rearing a child to age 18 ranges from 1.5 times to 3.25 times the parents� annual income. At today�s prices the cost may be even higher. While most parents regard these expenditures as one of the duties and privileges of parenthood and justifiably shrink from labeling them as an investment to be recovered in the event of the child�s death, such costs do create a substantial insurable value. This value can logically serve as one of the bases for juvenile insurance�a strong segment of the life insurance business.

The second category of insurance is portrayed by the area in arc CD lying above arc AB. The surplus earnings represented by this area are the source of support for the individual�s dependents and a broad measure of the economic loss to the family if the producer(s) should die. A portion of these earnings will go toward insurance premiums, and another portion should be set aside for both spouses� old-age needs, but the share that is destined for the care and maintenance of the family should be capitalized and preserved for the family through the medium of life insurance. This is family insurance in the purest sense.

Finally, the individual�s retirement needs are represented by the area DFB. Although the income vacuum may be partially filled by federal OASDI (Old Age, Survivors, and Disability Income)�social security�benefits, pension plans and other tax-qualified plans (such as profit sharing, income deferral, and thrift or savings), and individual investments, the most realistic source of funds to cover any income shortage is through investment income life insurance and annuities. This remaining need can be satisfied with group life insurance through employment and/or a personal insurance program. For long-term planning purposes, however, individuals should not rely on group life insurance for any more than the funds that can�and will�be kept in force after an unforeseen job loss. Individuals should check their employer�s plan to find out how much of the group life insurance they can convert to individual insurance after termination.

Analysis of Needs

The foregoing approach to the problem of determining how much life insurance a person should carry has been termed the human life value approach. It is based on the proposition that a person should carry life insurance in an amount equal to the capitalized value of his or her net earnings. Another approach is to analyze the various needs that the family would experience if the income producer dies. The presumption is that these needs will have to be met through life insurance, although other resources, particularly federal OASDI benefits, are taken into account in the ultimate determination of the amount of insurance needed. This technique is identified as the needs approach and, purely from a sales standpoint, is regarded as more realistic than the human life value approach.

It would be difficult, if not impossible, to prepare a list of all needs that might possibly arise after the death of the income producer. Family circumstances differ, and a list of needs that would be appropriate for one family might be quite unsuitable for another. Moreover, within any particular family, the needs picture changes from time to time. The most that can be attempted in this section is to outline the general categories of needs that are likely to be found in any family situation. These categories are discussed in the order in which they arise, which in most cases is also the order of importance.

Cleanup Fund

The first need is a fund to meet the expenses resulting from the insured�s death and to liquidate all current outstanding obligations. There are many types of obligations to be met, and ready cash should be available for that purpose. Such a fund is usually referred to as a cleanup fund, although some planners prefer to substitute the terms probate fund or estate clearance fund.

The principal items of expense to consider include the following:

 

 

Mortgages might well be included in the list, but in view of their size and the special problems frequently encountered in their connection, they are usually treated as a separate need.

It is difficult to estimate precisely the size of the fund that will be needed since an individual�s obligations vary from year to year. Moreover, last-illness expenses can be estimated only within a broad range since the person may die suddenly or may linger for months or years. The needs will also vary with the size of the estate. In the typical estate, for example, estate and inheritance taxes will be insignificant items, if present at all; in a sizable estate, they may constitute the largest item of expense, running into hundreds of thousands or even millions of dollars. Executors� or administrators� fees and legal expenses are based on the size of the estate, the former normally being a fixed percentage of the probate estate. In the typical estate, however, a cleanup fund equal to half the annual family income should suffice, although individual circumstances may justify a larger cleanup fund.

Readjustment Income

Few individuals are able to leave an estate, including life insurance, substantial enough to provide their dependents with an income as large as they enjoyed while the income earner was alive. This means that an adjustment will generally have to be made in the family�s standard of living. To cushion the economic and emotional shock, however, it is desirable to postpone that adjustment for a period following the income producer�s death. The length of the period depends largely on the magnitude of the change that the family will have to make in living standards. If the adjustment is slight, a year should suffice. If the adjustment is drastic, 2 years or more should be allowed. If the surviving spouse must refresh or acquire skills to gain employment, an even longer period may be needed. Whatever the duration, the income during this readjustment period should be approximately equivalent to the family�s share of the producer�s earnings at the time of his or her death.

Income during Dependency Period

After the expiration of the readjustment period, income should be provided in a reduced amount until the children, if any, are able to support themselves. This is sometimes called the critical period income. Two concepts are involved: how much income should be provided and for how long.

Obviously, as much income as is consistent with the family�s other needs should be provided. As a minimum, there should be enough income that the family can remain intact and the surviving spouse can devote adequate time to the care and guidance of the children during their formative years. Although the children may have to engage in part-time employment, it should not be so extensive that it impairs their health or interferes with their education. The needs of this period constitute a large portion of the total demand for individual life insurance policies.

The most important determinants of the income�s duration are the present ages of the insured�s children and the type of education they will receive. In any case, income should continue until the youngest child is 18. If there are several children, the income can be reduced somewhat as each reaches the age of self- sufficiency. If the children are to receive a college education, income will have to continue for a longer period. In that event, the income during the period the children are in college may be provided by special educational insurance policies. For planning purposes, the immediate death of the income producer is assumed. The projected income is then presumed to be needed for a period equal to the difference between the present age of the youngest child and the age at which the child is expected to become self-supporting.

 

Life Income for Surviving Dependent Spouse

The needs that exist during the readjustment and dependency periods are primarily family needs. It is presumed that the family unit will be preserved under the guidance of the surviving parent and that the resources of the various members of the family will be pooled to meet the needs of the group. After the children have become self-supporting, however, the widow(er) will still have needs as an individual and will require an income from some source.

If the surviving spouse is a full-time homemaker until the children finish at least part of their education, he or she may subsequently be able to obtain employment, but the earning power for people entering the workforce at that age will have declined substantially. After the birth of children, for example, a wife sometimes gives up her job or the opportunity to become self-supporting. As the years pass, whatever occupational skills she may have possessed are either obsolete or have atrophied and she will most likely have to return to the labor market as a middle-aged woman with deficient skills. Under such circumstances, employment opportunities are limited. Many individuals feel a moral obligation therefore to provide their spouses with incomes that will continue throughout the remaining years of their lives. The income may be modest, but it can be the difference between complete dependency on welfare services and reasonable self-sufficiency.

Special Needs

There are certain needs that are not found in every family situation and, even when they are found, are not likely to enjoy as high a priority as those previously discussed. Three of the most prominent of these are mortgage redemption, educational, and emergency needs.

 

Mortgage Redemption Needs. Home ownership is very prevalent among American families today, but most of the homes are burdened with a mortgage, frequently financed by a life insurance company. These mortgages are usually amortized over a period of 15 or 30 years, but it is highly probable that an unliquidated balance will still be outstanding upon the death of a person with dependent children.

In some cases, of course, the widow(er) may want to sell the house and move into a smaller one or into an apartment, and it would not be essential to provide funds for the liquidation of the mortgage. In fact, it may actually be easier to dispose of a home if it has an assumable mortgage (becoming rare) with favorable terms than if it is clear of debt. In many�if not most�cases, however, it is contemplated that the survivors will continue to occupy the family residence, and funds to pay off the mortgage may be needed. If the family can occupy the home rent free, it will greatly reduce the amount of income that they would otherwise require.

 

Educational Needs. The income provided for a surviving spouse during the period when the children are dependent should normally be adequate for secondary school expenses, as well as for general maintenance. If a college education for one or more of the children is envisioned, however, additional income will be needed. Under present conditions, college expenses range from about $4,000 to $25,000 per year. The cost might be less if the family happens to live in the vicinity of a college or university and the college student resides at home; it might be considerably higher if the institution has a high tuition schedule. In any event, there is no question that a college or professional education is beyond the means of many dependent children who lose an income-earning parent. Life insurance companies have a variety of policies that will meet this need in a very convenient manner. In many cases, however, the limited funds available for life insurance premiums must be devoted to higher-priority needs.

 

Emergency Needs. From time to time in the life of a family, unforeseen needs for money arise because of illness, surgery, major dental work, home repairs, or many other reasons. It is unrealistic for the family income providers to leave enough income for the family to subsist on only if everything goes well and no unusual expenditures are incurred. Therefore a liquid fund should be set up from which additional income can be provided if and when it is needed. Some financial planners suggest that the emergency fund often warrants a higher priority than income for dependents. The actual setting of priorities is properly the responsibility of the income earner(s).

Retirement Needs

Retirement needs do not fall within the categories previously described. On the contrary, the need arises only if the others do not. Yet retirement planning is a contingency that the financial planner and estate planner must anticipate and one that must be considered in arriving at the amount of insurance a family head should carry. To be more precise, this contingency determines the type of insurance the family provider(s) should purchase since if the family needs are met with the right kind of insurance (assuming adequate funds for premiums), the cash values under this insurance will usually be sufficient to take care of the postretirement needs of the insured and the spouse, if still living.

Monetary Evaluation of the Foregoing Needs

It is interesting to compare the monetary value of the above needs with the economic value of the human life computed earlier. For purposes of comparison, assume�as in the earlier illustration�that the family head is a male aged 35, has gross annual earnings of $40,000, and devotes $20,000 per year to his family. Assume further that he has a wife aged 30 and two children, ages 2 and 5, and that an income of $1,700 per month is to be provided during the first 2 years, $1,460 per month during the next 14 years, and $971 per month thereafter for the life of the surviving spouse.

In computing the present value of the foregoing series of income payments, it is advisable to treat them as a life income of $971 per month payable from the surviving spouse�s age 30 with an additional income of $240 per month for 16 years and another $50 per month for 2 years. On the basis of the 1983 Individual Annuity Table and 4 percent interest, a life income of $971 per month for a female aged 30, with payments guaranteed for 20 years, has a present value of approximately $220,000. Provision must be made for guaranteed payments during the children�s dependency, since in the event of the widow�s early death, the income to the children will be reduced from $971 per month to $489 ($729 per month during the first 2 years). Guaranteed installments are available only in multiples of 5 years (up to 20 years), and at age 30, a 20-year guarantee can be obtained at a sacrifice of only 1 cent per $1,000 of principal sum, compared to the cost of a 15-year guarantee that would be one year short of the 16-year dependency period. The present value on a 4 percent interest basis of $489 per month for 16 years is $69,263, and the present value of $240 per month for 2 years is $5,526. The present value of the family�s income needs when the figures are rounded to the nearest hundred dollars is $294,800.

The total increases when the lump-sum needs (cleanup fund and mortgage redemption fund), educational needs, and emergency needs are added. Even if no provision is made for the children�s college education, a cleanup fund of $20,000, a mortgage redemption fund of $80,000, and an emergency fund of $30,000 will increase the total to $424,800. If $80,000 is provided to each of the children for a college education, the total income requirements reach $584,800.

It is not likely that these needs will have to be met entirely through personal life insurance. If the individual in the example is covered under the federal OASDI program with benefits approaching the maximum�which, in view of his earnings, is very probable�nearly two-thirds of the income needed until the youngest child is 18 will be provided by the federal government. This would reduce the personal insurance requirements by approximately $170,000. If the husband had attained "fully" insured status for social security at the time of his death�also a reasonable assumption�the widow at age 62 would become entitled to a life income of $800 per month, which would reduce the personal insurance requirements by another $29,600. The individual may also be covered by group life insurance, with benefits of possibly $150,000 or more. Therefore it is not beyond the realm of possibility that all the needs, including those requiring lump-sum payments, may be met in full with the purchase of $235,000 of additional life insurance.

The retirement needs of the husband do not impose additional quantitative requirements. If the husband purchases $300,000 of life insurance (roughly the equivalent of the income needs computed earlier) on the ordinary life plan (the lowest premium type of permanent insurance) before age 35, it will have accumulated at least $125,000 in cash values by age 65. This will provide him with a life income, with payments guaranteed for 10 years, of more than $1,012 per month. If his wife is also alive and in need of old-age protection, the accumulated sum could be converted into a joint-and-last-survivor annuity, which would provide a lower (a 7.5 percent to 14 percent reduction) income per month as long as either the husband or the wife survives. Such an income, supplemented by federal OASDI benefits and possibly retirement benefits from an employer pension plan, should meet their old-age needs with ample margins. (If the insured keeps premium outlays down through a liberal use of term insurance, the cash values available at age 65 will be reduced accordingly.)

Amount of Insurance Needed

Ideally, the life of each productive member of society should be insured for an amount equal to his or her full economic value, as measured by contributions to those who depend on that income. Upon the death of the income producer, the insured sum should then be liquidated in a manner consistent with the purposes for which it was created, meeting the various needs in the order of their importance. If the insured lives to retirement, the sums accumulated through premium payments should, with the exception of amounts required for cleanup and other necessary purposes, be used to satisfy the postretirement needs of the insured and his or her spouse.

As a practical matter, attaining this ideal is difficult, even when death benefits available under the federal OASDI program and employer benefit plans are taken into account. The basic obstacle is that when both the economic value and the needs are at their maximum�at younger ages�the funds available for premium payments are at their minimum. In the lower income groups, the bulk of the family income is spent on the necessities of life; very little is saved. As the family income rises, aggregate expenditures for consumer goods increase, but they constitute a smaller percentage of total income. Thus more money is available for insurance premiums and other forms of savings. By that time, however, the need for insurance may have declined somewhat.

Various formulas have been developed in an attempt to establish the proper relationship between family income and the amount of insurance to carry. A rule of thumb that has gained some acceptance is that 10 percent of gross family income should be devoted to life insurance premiums. Although this ratio is probably unrealistic at lower income levels, it becomes attainable as the income level increases. Another rule states that the typical wage earner should carry insurance equal to some specified multiple of annual gross income, while persons in the higher income brackets should capitalize a higher multiple of annual earnings. Such rules of thumb are too simplistic because they do not take into consideration either (1) accumulated assets or (2) family composition and objectives.

Note that in the early 1990s approximately 1.88 percent of American families� disposable personal income went into life insurance premiums. This reflects a long slow decline from the high of 5.5 percent back in 1935 and is approximately the same percentage that prevailed during the last decade.

The average American family in the early 1990s owned enough life insurance of all types to replace approximately 27 months of its disposable income after federal income taxes. This reflects a slight increase from the characteristic 21 months of disposable income coverage prior to 1985.

For a discussion of how to ascertain the amount of life insurance an individual should purchase, see chapter 10 and the appendix, "How Much Life Insurance Is Enough?"

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