Needs Approach
Last Updated :
21 Aug, 2024
Blog Author :
N/A
Edited by :
Fatema Aliasgar
Reviewed by :
Dheeraj Vaidya
Table Of Contents
What Is 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.
Table of contents
- 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.
Needs Approach In Insurance Explained
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.
Process
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.
Examples
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.
Needs Approach vs Human Life Approach
The differences between the two approaches are as follows:
Needs Approach | Human Life Approach |
---|---|
It concentrates on calculating the financial needs of dependents and beneficiaries after the insured's death. | It emphasizes the economic value of the insured individual's life based on their earning potential and contributions to their dependents. |
It assesses immediate obligations (such as debts, funeral expenses, and outstanding payments). Moreover, it also considers future financial needs, including income replacement, education expenses, and ongoing living costs, to determine the required coverage amount. | It quantifies the insured's potential future earnings, taking into consideration factors like salary, potential career advancements, and expected years of work. |
Frequently Asked Questions (FAQs)
The basic needs approach focuses on ensuring individuals have access to essential resources such as food, shelter, healthcare, education, and sanitation to achieve a minimum acceptable standard of living.
Yes, this approach can be modified for coverage of critical illnesses or disabilities. One needs to evaluate the financial impact of possible diseases or disabilities on income and expenses. This adjustment offers full coverage catered to specific needs and situations.
Unlike the needs approach, which considers individual financial circumstances, other methods may rely on fixed multiples of income or a standard amount. They may lack tailored evaluation for life insurance coverage.
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