How Much Insurance Do I Need?

Insurance planning, often referred to as “risk management,” is an integral part of a comprehensive financial plan. The term “risk management” appropriately describes why insurance policies exist in addition to why you should consider how they best fit in your financial plan.

The Certified Financial Planner (CFP®) Board suggests that insurance is appropriate to protect against risks that occur infrequently but are costly to endure. The more likely an event is to occur, the cost of insuring against that risk increases. As an example, consider that life insurance rates for a healthy 35-year-old are considerably less expensive than the rates for a 65-year-old in poor health (if coverage can be obtained at all).

This same principle applies to other areas of insurance planning as well. When trying to determine whether an insurance policy is appropriate, ask yourself two questions:

1. How likely is the event to occur?
2. How costly is the damage resulting from the event?

If the event is frequent and/or inexpensive to remedy, consider self-insuring (assuming the risk yourself). Otherwise, an insurance policy may be appropriate.

The next step is to determine how much coverage is necessary. Regardless of the risk (death, disability or liability) being insured, this question is answered with the same assessment. Again, ask yourself two questions:

1. What risk (valued in dollars) is the policy protecting?
2. How much of that risk can I self-insure?

For example, a life insurance policy is intended to protect beneficiaries in the event of a premature death. To determine the risk being insured, add the value of the future income that the insured party will no longer generate to any liabilities if he or she dies prematurely. Then, subtract any expenses that will no longer be incurred if that person is deceased. Determining how much life insurance is appropriate is as simple as determining how much of that future income needs to be replaced to protect the interests of the beneficiaries.

Risk management is a broader subject than can be summed up within a short article. However, it remains a vital part of a comprehensive financial plan, and the information in this article provides a good starting point. Please consult your financial advisor for additional guidance.

Waverly Advisors is a fee-only investment advisory firm that does not sell any products, including insurance.