Michael Bonevento, a senior financial advisor at Ameriprise Financial Services, Inc.,warns that most Americans are vastly underinsured, which means if disaster strikes, their loved one would be left in financial disarray. He recently spoke with U.S. News about the benefits of taking an unemotional, mathematical approach to help avoid some of the paralysis people tend to feel when talking about life insurance. Excerpts:
What mistakes do people tend to make when it comes to insurance?
What I've come to realize is that the biggest mistake folks make with regard to risk management is that they don't even address the topic. It's very emotional and forces you think about your own mortality and what would happen to your family if something tragic were to occur. Many advisors don't want to approach this topic because they don't want to be labeled an insurance salesperson. Advisors have a fear of wearing that label. And finally, folks don't address it because they realize they haven't done as good a job of insulating their families from tragedy.
How widespread is that problem?
It's an epidemic. I've been in the industry for 15 years and have conducted hundreds of risk management audits. It's extremely rare that I find a client or prospective client who has an adequate amount of insurance. Then, when tragedy strikes, they face financial problems on top of everything else. When September 11 occurred, I was heavily involved as a financial professional. Many folks were grossly underinsured. Had it not been for the steps that the federal government took—returning tax dollars that were previously paid and using the victims' compensation fund—I can tell you the financial position of many of these families would have been very different. It would have been dire.
How can a person figure out how much life insurance he needs?
There are two proven mathematical methodologies that we use. First, human life value. It's the economic loss that a family realizes in the event that the breadwinner were to pass away. Say I make $100,000 a year and I'm 40 and plan to work until I’m 60. Twenty times $100,000 per year is $2 million. I subtract from that taxes and add all of the other benefits that I'm paid, such as contributions to my 401(k) plan, health insurance, vision plans, etc. Then, since any individual has a 3 percent chance of being unemployed, I shrink the amount by 3 percent, and also shrink it by the amount I would consume myself, around 8 percent. Then I calculate the present value of that amount.
The second approach is needs-based. I ask my client, if something were to happen, what would you like to see happen? He might say, "I'd like my mortgage paid off, I want to make sure there's a cash reserve for my family, and I want to make sure college education has been addressed." So we run a present value calculation of the future cost of college.
Typically the human-value number is higher than the needs-based number. I tell my clients, "I don't care where you fall, I just want you to be between those two numbers." Then I know if tragedy strikes their family, they would be well-insulated.
Are those standard calculations that have been around for awhile?
The standard that people usually use is what I think of as an inappropriate rule. That rule of thumb is "six times my earnings." But if you're married and have five small kids, that's probably not enough. If you have no children, then that's probably too much. So I think it should be done unemotionally and mathematically. When you talk to folks about life insurance, they immediately shut down, so I talk to them about "risk management."
Do only married people and people with kids need life insurance?
It's more important to those folks who are married and married with children, or married with children with special needs who may never be able to fend for themselves. However, there are instances where single individuals have insurance, too. One of our clients, a man who was adopted at age 38 by a family without much has insurance so if something happened to him, they would have assets. Another young man, his stepfather is disabled and mother doesn't have a good employee skill set, and he has two younger step-brothers, so he's heavily insured. He wants to make sure they'd be okay financially. So there are instances where single people will have life insurance. If you're single in a high tax bracket, then you could use permanent life insurance to accrue wealth on a tax-deferred basis. But it's very important to people who are married with children.