Life insurance needs analysis for individuals and businesses

Why needs analysis comes first

A life insurance recommendation is only defensible if it starts with a number the client can trace. Needs analysis is the disciplined process of quantifying what money would have to appear if the insured died today, subtracting what is already available, and treating the difference as the coverage gap.

Two classic approaches for individuals

The human life value approach treats the insured as an income-producing asset. You estimate future earnings to retirement, subtract self-consumption and taxes, and discount the remainder to a present value. It answers: what is this person's economic contribution worth to the survivors?

The needs approach builds the number from obligations instead of earnings. Producers often organize it as immediate cash needs plus ongoing income needs:

• Liquidity and final expenses -- funeral costs, medical bills, estate settlement, probate costs
• Debt clearance -- mortgage, consumer debt, business guarantees
• Income replacement -- a monthly amount for the dependency period, then a readjustment period, then possibly a life income for a surviving spouse
• Special goals -- education funding, care for a dependent with special needs

Both totals are then reduced by existing resources: current policies, group coverage, savings and retirement accounts, and survivor benefits.

Capital liquidation versus capital retention

When you convert an income need into a lump sum, the assumption matters. Capital liquidation lets the survivors spend both interest and principal over a defined period, producing a smaller face amount. Capital retention (capital conservation) funds the income entirely from earnings so the principal survives intact, producing a larger face amount. Always tell the client which assumption you used.

Business needs analysis

Businesses buy life insurance for reasons an individual never has:

• Key person coverage -- the entity insures an employee whose death would cost it profits, recruiting expense, and lost credit standing. The business is applicant, owner, premium payer, and beneficiary.
• Buy-sell funding -- policies supply cash so surviving owners or the entity can purchase a deceased owner's interest at an agreed price. In a cross-purchase plan each owner insures the others; in an entity (stock redemption) plan the business owns one policy per owner.
• Business continuation and creditor needs -- coverage sized to loans, lines of credit, and the working capital needed to survive a transition.

An employer's purchase depends on having an insurable interest in the employee's life, a requirement governed by Texas's life insurance statutes (Tex. Ins. Code Title 7).

The tax overlay

Death proceeds paid by reason of the insured's death are generally excluded from the beneficiary's gross income (26 U.S.C. § 101). Premiums on a policy in which the business is directly or indirectly a beneficiary are generally not deductible (26 U.S.C. § 264). And transferring an existing policy for valuable consideration -- a temptation when owners restructure a buy-sell arrangement -- can make part of the proceeds taxable under the transfer-for-value rule (26 U.S.C. § 101).

Document the assumptions, not just the answer. Inflation rate, discount rate, and the liquidation-versus-retention choice each move the recommended face amount substantially.