Assumptions Matter: When purchasing life insurance, we make certain assumptions about our future needs, income, and financial capacity. These assumptions form the basis of our decision-making process.
Adapting to Changing Conditions: Over time, our circumstances can change, and the assumptions we made initially may no longer hold true. For example, our income might increase or decrease significantly. It’s essential to be aware of these changes and adjust our insurance accordingly.
Correcting Assumptions: If our initial assumptions about our needs or financial capacity were incorrect, simply adjusting future assumptions won’t solve the problem. It’s crucial to recognize and correct any inaccuracies in our original assumptions.
Regular Assessment: Regularly reassessing our life insurance needs and related factors is important. However, the accuracy of these reassessments depends on the accuracy of our prior assumptions.
Re-Assessment from Present Perspective: Instead of relying solely on past analyses, it’s better to re-evaluate our insurance needs from our current perspective. This involves redoing all the relevant calculations without taking shortcuts.
Verification of Assumptions: If our original assumptions were correct and still hold true, verifying them during the reassessment process can provide confidence in our insurance decisions. However, assuming our initial assumptions were correct without verification could lead to long-term miscalculations.
Factoring in Wealth Accumulation Over Time
Incorporating Personal Resources: When calculating life insurance needs, it’s essential to take into account personal resources, such as savings, that can provide financial support over time. If individuals are actively saving money, it can gradually reduce their reliance on life insurance coverage.
Adjusting Spending and Saving: If someone is not currently saving money, it may be prudent to adjust their spending habits and allocate funds toward savings. Building savings can play a role in reducing future life insurance needs.
Dynamic Nature of Life Insurance Needs: Life insurance needs are not fixed but evolve over time. As individuals save more, their reliance on life insurance may decrease, and they may require less coverage.
Unpredictability of Life: While future needs may reduce due to savings, it’s not possible to predict exactly when or if someone will die. Therefore, it’s essential to have appropriate life insurance coverage in place to protect against unforeseen events.
Over-Insurance Concerns: It’s important not to be over-insured, as having excessive coverage can lead to higher costs without proportional benefits. The excess funds might be better utilized by retaining and adding to personal savings.
Revisiting Coverage Periodically: Due to the changing nature of life insurance needs, it’s advisable to revisit coverage every few years. This allows for adjustments based on updated financial circumstances, savings, and changing needs.
The Role of Inflation
Long-Term Nature of Life Insurance: Life insurance policies often span several decades, and predicting inflation over such extended periods becomes more challenging.
Changing Inflation Outlook: Inflation rates can fluctuate over time. They may increase significantly, leading to a need for higher coverage, or decrease, potentially reducing life insurance needs.
Ignoring Inflation Effects: Many individuals may overlook the impact of inflation on life insurance coverage. They might focus solely on the nominal amount of insurance without considering the reduced purchasing power of money in the future.
Value Erosion due to Inflation: Inflation erodes the value of money over time. A fixed amount of coverage, such as $100,000, will buy less in the future compared to what it could purchase in the past.
Rules of Thumb for Estimation: Some rules of thumb suggest doubling current insurance needs to estimate future requirements. However, using updated tables and calculations can provide a more accurate projection of inflation’s effect.
Unpredictable Need for Coverage: Since the exact time when the policy might be needed (due to a person’s death) is unknown, it’s better to err on the side of caution and base decisions on longer-term inflation projections.
Regularly Reassessing Coverage: To maintain sufficient coverage, it’s essential to periodically reevaluate insurance needs, taking into account changes in inflation rates and updated projections.
Changing Financial Needs
Assumptions and Changing Needs: When selecting a life insurance coverage amount, individuals make assumptions about their future needs. However, these needs can change over time due to various life events, such as the birth of children, changes in net worth, health conditions, and more.
Continuous Evaluation of Needs: Life insurance decisions are made based on the knowledge available at the time. As new factors emerge, they need to be considered in reassessing coverage requirements.
Increasing Needs: In many cases, life insurance needs tend to increase over time due to changing life circumstances and responsibilities. This may necessitate the addition of additional coverage to ensure sufficient protection.
Flexibility with Term Life Insurance: Term life insurance policies have fixed terms, but additional policies can be purchased as needs arise, without canceling the existing policy. This provides flexibility to adjust coverage without starting from scratch.
Reassessing at Policy Expiry: When term life insurance policies expire, it’s an opportune time to reassess coverage needs. This allows individuals to address both reduced and increased needs and adjust coverage accordingly.
Ongoing Assessment during Policy Term: It’s essential to continually evaluate life insurance needs during the term of the policy to maintain sufficient coverage and make additions or reductions when appropriate.
Assessments with Permanent Life Policies
Two Components: Permanent life insurance policies consist of both an insurance component and an investment or savings component. The insurance part should be approached similarly to term life insurance, while the savings aspect needs to be evaluated as an investment.
Limited Flexibility: Unlike other investments, reallocating funds in whole life policies is not as easy. This limitation should not deter individuals from regularly analyzing the performance and suitability of the investment component.
Changing Objectives: People may initially buy whole life policies to ensure lifelong insurance coverage. However, as financial circumstances change, it’s essential to reevaluate whether continued coverage in old age is necessary or advantageous.
Weaning Off Insurance Needs: The goal should be to gradually reduce the need for life insurance as individuals progress into the later stages of life and become financially self-sufficient.
Comparing Returns: It’s important to assess how well the savings or investments within the policy are performing compared to other available options. Different market conditions may influence the relative attractiveness of the policy’s returns.
Adapting to Changing Circumstances: Financial needs and goals change over time. What might have seemed appropriate earlier may no longer align with one’s current situation. Regular evaluations are necessary to ensure the policy remains suitable.
Continual Reevaluation: Purchasing life insurance should not be a one-time decision. Life insurance needs evolve over time, and policyholders should periodically reassess their coverage requirements.
