Needs Approach

The Needs Approach in life insurance is a method used to evaluate an individual's financial requirements and obligations. Its purpose is to determine the appropriate amount of coverage necessary to safeguard their dependents and loved ones in case of the policyholder's death.

The significance of the needs approach lies in its personalized evaluation of an individual's financial situation. By considering various factors, it helps tailor the life insurance coverage to meet the unique needs of the policyholder and their beneficiaries. This ensures that the coverage amount isn't excessive or insufficient. It provides a strong financial safety net for loved ones in the event of the insured individual's passing.

• The needs approach in insurance refers to a method used to determine the appropriate amount of life insurance coverage an individual requires.
•  Its goal is to evaluate a variety of financial commitments, including debts, upcoming costs, the need for income replacement, and particular financial objectives.
• It ensures the insurance coverage adequately meets the individual's and their beneficiaries' financial needs in case of death.
• Unlike this approach, the human life value approach concentrates on the monetary value of the insured's life based on their earning potential.

The needs approach for life insurance involves a comprehensive evaluation of an individual's financial situation to ascertain the necessary level of coverage. It's based on two main variables:

Immediate Obligations At Death

• Debts and Expenses: This includes outstanding financial obligations such as mortgages, car loans, credit card debt, and any other debts that would need to be settled upon the policyholder's death.
• Final Expenses: Costs associated with funeral arrangements, medical bills, and other immediate expenses that arise after the individual's passing.

Future Income Replacement

• Income for Dependents: Calculating the income needed to sustain the household and support dependents after the policyholder's death. This can involve replacing a portion or all of the insured individual's income.
• Future Expenses: Anticipated expenses like children's education, ongoing household maintenance, or other long-term financial needs.

The needs approach involves a structured process listed below:

• Gather Information: Compile details of current debts, monthly expenses, future financial goals, and income sources.
• Assess Obligations: Evaluate outstanding debts and immediate expenses to be covered in case of the policyholder's death.
• Calculate Income Replacement: Determine the required income to sustain the household and support dependents after the insured's passing.
• Consider Future Changes: Account for changes in financial needs over time, such as children becoming financially independent or a spouse's potential remarriage.

Let us look at these examples to understand the concept better:

Example #1

Let us consider Amy, aged 40, as a single parent with a 10-year-old child. She has a mortgage on her house and some outstanding debts. Her primary concern is ensuring that her child's future expenses and education are covered in case of her untimely passing.

Using the Needs Approach:

• Immediate Obligations: Amy has a mortgage of $250,000 and outstanding debts amounting to $60,000. Including final expenses and immediate financial obligations, an estimated $20,000 is required.
• Future Income Replacement: To support her child until they reach adulthood and cover educational expenses, Amy estimates needing an annual income equivalent to $45,000.
• Calculation: Considering immediate obligations and annual income needs, Amy should consider a life insurance policy that covers at least:
• Immediate obligations: $250,000 (mortgage) + $60,000 (debts) + $20,000 (final expenses) = $330,000
• Future income replacement: An amount that, invested, could generate an income of $45,000 per year until her child becomes financially independent.

Example #2

Let us look at the situation of a married couple with two small children named Joseph and Sandra. They each have full-time employment and several financial responsibilities, such as a mortgage, auto loans, and children's school costs.

They evaluate their financial condition using the needs approach in the following ways:

Direct Liabilities:

• $300,000 is the mortgage
• $20,000 is for car loan
• Debt on credit cards: $10,000
• $15,000 is the last expense (estimated funeral costs, unpaid medical bills, etc.)
• $345,000 is the total immediate obligation

Replacement of Future Income:

• $100,000 a year is required to support a family (to cover living expenses, education, etc.)
• $2,000,000 is the total income needed during a 20-year period (until children become financially independent)

Joseph and Sandra conclude from their computations that they require a life insurance policy with a minimum of $2,345,000 coverage. This would ensure their family's financial stability in the unfortunate event of their passing.

This example illustrates how families apply this approach to assess their financial needs and choose the right level of life insurance to safeguard their loved ones.

The differences between the two approaches are as follows:

This has been a guide to what is Needs Approach. We explain the concept in detail along with its examples, process, and comparison with human life approach. You may also have a look at the following articles to learn more –

• Long-Term Care Insurance
• Supplemental Needs Trust
• Insurance Rider