Needs Approach

The human life value approach estimates insurance need based on:

1. A.The current cash valueCash value measures what an existing policy has accumulated. This approach works forward from earnings and applies whether or not any policy is currently in place.
2. B.The face amount of existing policies onlyExisting coverage matters when deciding how much more to buy, but it does not measure the need itself. This approach begins from the economic value of the insured's future earnings.
3. C.The insured's expected future earningsCorrect - it capitalizes future income.
4. D.The premium paid last yearLast year's premium reflects what was purchased and at what rating, not what the family stands to lose. Cost paid is a budgeting input, not a measure of need.

Why: This approach values the insured's expected future earnings (economic contribution) to survivors.

The needs approach to determining life insurance coverage estimates:

1. A.The family's specific financial needs (expenses, income, debts, education)Correct - needs-based coverage.
2. B.The cash value of existing policies onlyExisting coverage does enter the calculation, as an offset subtracted at the end, so this is not wholly beside the point. It is not what the method estimates, though: the needs approach starts from what the survivors will require, then nets out resources already in place.
3. C.Only the insured's salaryDescribes the human life value approach, which capitalizes the insured's future earnings. The needs approach reasons from the other direction, adding up specific obligations such as final expenses, debts, income replacement, and education funding.
4. D.A random round numberDescribes the rule-of-thumb guessing that the needs approach exists to replace. A recommendation the producer can defend has to be built from the family's actual obligations.

Why: The needs approach sums the family's specific needs: final expenses, income replacement, debts, and education funding.

Two advisers size a life insurance recommendation for the same client using different methods. Which statement correctly distinguishes the human life value approach from the needs approach?

1. A.Human life value totals survivors' specific obligations, while the needs approach discounts future earnings.This reverses the two methods.
2. B.Human life value discounts the insured's future earnings, while the needs approach totals survivors' obligations less existing resources.Correct. One insures the earnings stream, the other funds identified obligations net of resources.
3. C.Both methods produce the same recommended face amount for any given client.The two methods commonly produce materially different figures.
4. D.The needs approach ignores existing savings and Social Security survivor benefits.Subtracting existing resources is a defining step of the needs approach.

Why: The human life value approach estimates the present value of the insured's future earnings over the remaining working life, net of self-consumption and taxes, and insures that economic value. The needs approach instead totals the specific obligations survivors would face, such as final expenses, debt repayment, income replacement, education funding and an emergency reserve, and subtracts existing resources such as savings and Social Security survivor benefits. The needs approach is generally more tailored, while human life value is quicker and tends to produce a larger figure for a high earner.

Adviser Tomasz Wierzbicki is sizing life insurance for Amaka Chidozie, 35, who supports a spouse and children aged 4 and 7. He adds up final expenses, the outstanding mortgage, an education fund for both children and the income the family would need until the younger child finishes college, then subtracts existing group coverage, current savings and expected survivor benefits. The method he is using is:

1. A.The human life value approach, which capitalizes the insured projected lifetime earnings into a present value.Incorrect. Human life value works from future earnings, not from an itemized list of survivor obligations.
2. B.The estate liquidity approach, which sizes coverage to pay anticipated federal estate tax and settlement costs.Incorrect. Estate liquidity analysis is aimed at paying transfer taxes, which is not what this calculation covers.
3. C.The multiple-of-income rule of thumb, which applies a standard factor to annual earnings.Incorrect. A rule of thumb uses one multiplier and no itemization, the opposite of what he did.
4. D.The needs approach, which totals the specific obligations survivors would face and subtracts the resources already available.Correct. Itemizing obligations and netting out existing coverage and assets is exactly the needs approach.

Why: The needs approach builds the recommended face amount from the specific obligations survivors would actually face, then credits the resources already in place. It produces a number tied to this family circumstances rather than to a generic formula, and it naturally changes as the mortgage amortizes and the children age. The human life value approach takes a different route entirely, capitalizing the insured projected future earnings into a present value without reference to particular obligations.