21 December 2012 0 Comments

Financial Justification for the Amount of Life Insurance

financial justificationInsurance companies want to sell life insurance and you might be a perfect physical specimen.

But if you are applying for a $7,000,000 life insurance policy and are a 35 year old laborer earning $30,000 per year with a minimal net worth, your application will likely be declined.  The reason:  lack of financial justification.

Life insurance is not intended to be used as a lottery.  Insurance companies will not want to participate in a gambling scheme that results in your being much more valuable dead than alive.  There are far too many actual cases where this type of financial advantage to death has resulted in just that—death from extenuating circumstances.

For personal needs, the total amount of life insurance in force and applied for, must not exceed the total of:

  • Potential future earned income of the deceased,
  • Final expenses,
  • Obligations created as the result of death such as estate taxes.

Life insurance used for business purposes with a third party owner will apply different criteria, but I’ll get to that later.

Future earned income potential will generally be calculated as a multiple of current income.  The multiple that is acceptable will depend on the age and the occupation of the applicant.  A Medical Doctor in her first year of practice whose income will likely increase could easily justify a policy equal to twenty times current annual income.  The multiplier for a 55 year old truck driver whose income has capped would likely be much less.

If you are applying for a large amount of insurance, make sure your agent has accurate information on current income.  Make your tax return available if requested.  Be sure the agent is aware of your potential, education and skills that would justify a large multiple.

Final expenses to cover burial costs and potential medical costs can usually be justified at $50,000.

Estate taxes are uncertain at this time.  As this is being written, the Bush tax breaks are due to come to an end on January 1, 2013 which would re-establish a 55% tax with a $1,000,000 exclusion.  Wherever that ends up, who knows?  But, life insurance underwriters are willing to issue an amount of insurance sufficient to pay anticipated estate tax.

It’s important that you are aware of the importance of the accurate disclosure of financial information in order to deal with the Financial Justification issue.

Next, I’ll be dealing with Financial Justification of third party owned policies and the matter of “Insurable Interest.”

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