Module 6

The Life Insurance

Selection Process

David Mannaioni, CPCU, CLU, ChFC, CFP®

7486
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Table of Contents
Study Plan/Syllabus ................................................................1
Learning Activities .............................................................2
Chapter 1: How Client Data Affects the Life Insurance
Selection Process ................................................................5
Quantification of Client Life Insurance Needs and Policy
Evaluation ..........................................................................5
Stage 1: Identify a Client’s Life Insurance Selection Facts ...6
Chapter 2: The Life Insurance Selection Process ................. 13
Stage 2: Establish Goals ................................................... 14
Stage 3: Identify Resources............................................... 14
Stage 4: Identify Economic Assumptions .......................... 15
Stage 5: Determine Life Insurance Needs .......................... 16
Chapter 3: Selecting an Appropriate, Cost-Effective
Policy ................................................................................ 33
Stage 6: Determine Appropriate Type and Product ............ 33
Selection Process .............................................................. 34
Selection Process Example ............................................... 37
Stage 7: Evaluate Existing Type and Product ..................... 39
Stage 8: Appropriate Amount ............................................ 46
Stage 9: Sufficient Resources ............................................ 46
Stage 10: Purchase Appropriate Coverage ......................... 47
Additional Considerations ................................................ 47
Chapter 4: Deciding to Keep or Cancel a Policy .................. 51
Stage 11: Cancel Inappropriate Coverage .......................... 51
Stage 12: Modify Goals .................................................... 54
Stage 13: Purchase a Lesser Amount ................................. 54
Other Approaches to Programming ................................... 55
Interest-Adjusted Cost Index Calculation .......................... 57
 Premarital (Prenuptial) Agreement ................................... 59
Summary .............................................................................. 61
Module Review ..................................................................... 62
Questions ......................................................................... 62
Answers........................................................................... 78
References .......................................................................... 101
Appendix A ........................................................................ 102
Mr. and Mrs. Delgado: An Example ............................... 102
Life Insurance Needs Determination Worksheet
(Completed) for Mirralee Delgado .................................. 114
Appendix B ........................................................................ 122
The Life Insurance Selection Process .............................. 122
Appendix C ........................................................................ 123
Life Insurance Needs Determination Sample Worksheet .. 123
About the Author ............................................................... 130
Index .................................................................................. 131
Study Plan/Syllabus

T
his module focuses on quantifying the client’s life insurance needs based
on established financial planning and risk management assessments. It
evaluates existing and proposed insurances to meet these needs. It
presents in detail methods for determining the amount of insurance a client
needs, along with discussion and a comparison of alternate approaches. It also
focuses on the use of time value of money principles applied to life insurance
needs.
The selection of the appropriate type of insurance—another topic in this
module—is not a scientific process. You will be given selection criteria and some
methods that will help you make assessments, decisions, and recommendations.
This module will not make you an expert, but will provide you with some
valuable insights. In some cases, even though rules of thumb are generally not
recommended in the financial planning process, their use may yield even more
viable recommendations than scientific objective analysis. Remember, there are
times when financial planning is as much an art as it is a science. This module
will also introduce you to issues surrounding the replacement of existing
insurance, which isn’t as simple as just finding a lower premium.
The chapters in this module are:
How Client Data Affects the Life Insurance Selection Process
The Life Insurance Selection Process
Selecting an Appropriate, Cost-Effective Policy
Deciding to Keep or Cancel a Policy

Upon successful completion of this module, you will be able to determine the
amount of life insurance needed by a client in a particular situation.
Remember, exam questions for this course are based on the learning
objectives in each module.

Study Plan/Syllabus  1
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Learning Activities
Learning Activities
Module Review
Learning Objective Readings Questions
6-1 Analyze client data to Chapter 1: How Client 1–6
identify the facts affecting Data Affects the Life
the selection of life Insurance Selection
insurance policies. Process.

6–2 Analyze a client’s financial Chapter 2: The Life 7

situation and goals to Insurance Selection
calculate the amount of Process
life insurance needed
under either the annuity
or interest-only method.

6–3 Evaluate the client’s life Chapter 3: Selecting an 8–12

insurance selection facts to Appropriate, Cost-
select the most appropriate effective Policy
type of life insurance for
the client.
6–4 Calculate life insurance Chapter 3: Selecting an 13, 14
costs to determine the Appropriate, Cost-
most cost-effective policy. effective Policy

6–5 Evaluate factors that Chapter 4: Deciding to 15–20

might influence the Keep or Cancel a Policy
decision to keep or
replace a policy.

Determining how much insurance clients need in order to meet their goals is one
basic function of a financial planner. Many clients do not want to focus on life
insurance needs because it requires facing one’s mortality. For a client to be
willing to purchase a recommended amount of insurance, he or she must be
comfortable that the amount recommended is appropriate. Learning Objectives 6-
1 and 6-2 focus on the process of making an insurance needs determination that
meets the client’s needs. LO 6-3 focuses on the process of identifying the type of
policy or policies that will best meet the needs of a specific client.

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Please note: For the course exam, you will not have to work through the
entire 10-step life insurance needs-determination process. Rather, you may
be given one area of need, such as college funding, and be asked to
determine how much life insurance may be required to meet this need.
Each form of insurance has a unique combination of characteristics. A planner
needs to be familiar with these characteristics in order to recommend appropriate
forms of insurance. The evaluation process that is undertaken to determine which
company’s insurance policy best meets the needs of a client, as well as whether
an existing policy should be retained, is covered in LOs 6-4 and 6-5. Making
these recommendations is not an exact science, but there are reasonable
approaches that a financial planner may take.

Study Plan/Syllabus  3
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4  The Life Insurance Selection Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 1: How Client Data Affects
the Life Insurance Selection
Process
Reading this chapter will enable you to:

6–1 Analyze client data to identify the facts affecting the selection of life
insurance policies.

Quantification of Client Life Insurance Needs

and Policy Evaluation

I
n the sections that follow, the focus is on the process of quantifying client
needs for life insurance, and then evaluating both existing and proposed
insurance to effectively meet these needs. A single method for determining
amounts of insurance clients may need is presented in this module in specific
detail. Additionally, there is a brief discussion and comparison of alternative
approaches and their effectiveness.
Selection of the appropriate type of insurance is seldom a simple task. You are
given some selection criteria that should be considered and some methodologies
that may be followed. Due to the complexity of the decision-making process,
completing this module should be seen more as an excellent starting point to the
process, rather than the last word.
On occasion, rules of thumb may end up being substituted for objective analysis.
Though this is not normally the best choice for a financial planner (and certainly
no substitute for prior experience, careful thought, spreadsheet modeling, and
analysis), it may serve the greater purpose when combined with a study of how
the unique attributes of the available products fit each particular client’s needs.
Most often, a fine blend of objective methodologies, and subjective experience
provide the best results. The tax and investment principles on which the products
are based must also be studied as part of this process; until you, as the planner

Chapter 1: How Client Data Affects the Life Insurance Selection Process  5
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
come to an informed opinion on the strengths and weaknesses of each product as
each relates to a specific client’s needs and objectives.
You will be presented with methods used for evaluating existing insurance. There
are a number of advantages associated with keeping existing insurance. The
client has already paid the acquisition costs associated with the purchase of a new
policy. Time periods for the incontestability and suicide clauses must be
considered, and may have already expired. If the policy pays dividends, an older
policy may have qualified for higher dividends than a new policy is likely to pay.
The client has qualified for the insurance and does not have to go through the
time, bother, and discomfort associated with taking out new insurance and
undergoing any required medical tests. For all of these reasons, existing
insurance should generally be protected. The evaluation methods presented in
this module will assist you in making an informed decision and reveal when the
advantages of existing insurance are overshadowed by the economic inefficiency
of such a policy.

Stage 1: Identify a Client’s Life Insurance

Selection Facts
The first stage in needs analysis is determining client facts in relation to the life
insurance selection process. These facts impact a client’s available alternatives.
Facts affecting this process include the following:
 client profile
 client goals and objectives
 survivors’ needs
 estate liquidity
 risk tolerance
 existing insurance
 amount of insurance needed
The client’s key facts must be identified and evaluated in selecting the
appropriate type of life insurance. For example, the key facts for the client profile

6  The Life Insurance Selection Process

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are the client’s age, income, and health. The key facts for the survivors’ needs are
the client’s specific long-term or short-term goals for dependents. These facts all
play a part in determining what type of insurance is most appropriate. No single
fact is considered in isolation; rather, all the key facts should be considered in the
selection process.
The process can be somewhat subjective. One financial planner may determine
that a client has a need for a retirement fund at age 65 and that a cash value form
of insurance is needed even though the client’s income is relatively low. Another
planner may view the client’s current low income as the most significant factor
and determine that term insurance is the most appropriate option.
It is also imperative that the financial planner review these facts annually, as the
client’s situation may change from year to year. For example, you may have a
client who likes the idea of buying term and investing the difference. After a year
or two, if the client’s actions show that the “difference” is not really being
invested for the long term, a move to permanent insurance may be appropriate.

Client Profile
Age, income, health, and savings and investment levels are important in
determining which insurance products are realistic possibilities and what they
will cost. Remember that while term insurance products are relatively
inexpensive at younger ages, so are permanent products. In fact, term insurance
initially has a lower premium than permanent insurance at any issue age. It is
what happens to the cost of term relative to permanent insurance in the long run
(which, depending on the client’s age and the assumptions used, may be as few
as five or ten years) that makes it inappropriate in some situations.
Since the premiums on permanent products either are guaranteed to remain level
(in the case of several types of whole life products) or can be designed so they
are likely to remain level (in the case of universal life products), locking in a
relatively low level premium can be a big plus. Further, permanent products may
become paid up or made self-supporting while the client is young and the product
is relatively inexpensive. This can be a very good choice, especially for a client
who is likely to have long-term needs. On the other hand, young people often
have substantial insurance needs and very little discretionary income (consider a

Chapter 1: How Client Data Affects the Life Insurance Selection Process  7
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young married couple with a few children, but early enough in their careers so
that income is still relatively low). In this situation, term insurance may be the most
effective use of the client’s limited resources. Once term insurance is in place, it
usually can be converted to permanent insurance as needs and income dictate.
The client’s health has a direct impact on the cost of insurance. Underwriters
determine whether the client is a preferred, standard, or substandard risk, based
in part on the client’s health. If a client is considered a preferred risk (belonging
to a group with a lower-than-average loss experience), he or she receives
coverage at a lower premium rate.
On the other hand, if a client is considered a substandard risk (belonging to a
group with a higher-than-average loss experience), he or she may be offered
modified coverage for the standard premium or standard coverage at a higher
premium. It is rare that a client is rejected for coverage altogether, but that also is
an underwriting option with a substandard risk. Usually, some type of impaired
risk policy is available at an increased cost. This is an important consideration
when trying to decide whether to replace an existing policy. If the client’s health
has changed and is now rated substandard, it is generally far safer and more cost-
effective to retain an existing standard issue policy than to try to find another
policy at a reasonable premium based on substandard rates.
A client rated (i.e., charged extra) by one insurance company may not be rated by
another insurance company. Some insurance companies use aggressive
underwriting for certain health or occupational problems that otherwise may lead
to extra premiums.
Conversion privileges should be considered when evaluating term policies. If a
rated client eventually wants to change to permanent insurance, it is much easier
to convert a policy with the same company than to apply for new coverage with
another company.

Client Goals and Objectives

In some instances, it may seem clear to the financial planner that there is a
critical need for a large amount of insurance to protect a client’s family; however,
the planner has no control over what the client wants to do. Some clients may be
so focused on current goals that they have a hard time dealing with future needs
that their family may have.

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A planner also may encounter clients who have large insurance needs but can
afford only term insurance. That client may insist on purchasing a much smaller
permanent policy because of a desire to have the benefit of a cash value policy.
While the personal goals and objectives of a given client may not coincide with
what most people would want, the planner must nevertheless consider those goals
when making recommendations.

Survivors’ Needs
These facts are determined through discussions with the client and the process of
determining life insurance needs. Through fact finding conversations, a planner
can learn whether there is need for:
 an education fund and how large a fund is needed;
 providing dependents with income and how large an income is desired;
 a preretirement income fund and postretirement income fund for the spouse,
and how large of an income is desired; and
 an adequate postmortem emergency fund.
In actual practice, a client may have other specific personal income needs, but the
needs outlined in the life insurance needs determination process are considered
the most basic. The worksheet described in Stage 5 (in Chapter 2 of this module)
can be used to determine needed funds.
It is possible that one or more funds are not needed or are adequately covered by
other means. One often-overlooked need is an adjustment fund. This can be
considered a postmortem expense. Some surviving spouses find it so difficult to
adjust to the death of their spouse that they cannot work for a time. Others may
find it necessary to spend money on themselves or others, and still others may try
to adjust by traveling. Each situation is unique, and the planner should carefully
investigate the possible need for an adjustment fund.

Estate Liquidity
One factor the planner must consider is whether insurance is needed to provide
estate liquidity at death. A number of variables cause the estate to shrink at death:
the decedent’s debt, probate and administrative costs, the federal and state estate

Chapter 1: How Client Data Affects the Life Insurance Selection Process  9
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tax, and any state inheritance tax. These costs must be paid in cash, usually
within nine months after death. Therefore, the estate must be sufficiently liquid to
meet these costs. Insurance can provide this needed cash if other assets are not
available. Given increasing life expectancies, estate liquidity is likely to be a very
long-term need. Generally, due to the long-term cost implications, permanent
insurance is the preferred method of dealing with such needs (and a term insurance
policy may not be renewable for a long enough term to be used for this purpose).

Risk Tolerance
Another factor the planner must consider in the life insurance selection process is
the client’s risk tolerance. A client may think of risk in at least a couple of ways.
First, risk can refer to the fluctuation of the cash value (if any) of the policy. If
the client has a low to moderate risk tolerance level, then whole life or universal
life could be appropriate. If the client has a moderate- to high-risk tolerance
level, then he or she may consider purchasing a product, such as variable or
variable universal life, with returns that fluctuate according to the performance of
specific underlying accounts.
On the other hand, a client’s risk tolerance may refer to his or her willingness to
retain risk (think in terms of personal risk management, as opposed to investment
risk). A client with a moderate to high-risk tolerance level may consider choosing
term insurance, since he or she would be willing to assume the risk of being
unable to pay increased future premiums. Clients with a high-risk tolerance also
may feel that covering an education fund, for instance, is not necessary.

Existing Insurance
Many people rely on their employers to cover insurance needs. If the client’s
insurance coverage is all group- and employer-provided, then it would be wise to
consider purchasing an individual policy. While a group policy may be converted
into an individual policy, this conversion normally must be to a permanent
product at the insured’s attained age. A client who has no individually owned
insurance, and who needs to maintain coverage, may be forced into an expensive
conversion situation in the event of a job termination.

10  The Life Insurance Selection Process

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Amount of Insurance Needed
Generally, the most important question is how much insurance is needed, rather
than what type of insurance is needed, and the answer to the first question (how
much) frequently provides an answer to the second (what type). The worksheet
described in Stage 5 (in Chapter 2 of this module) can be used to determine life
insurance needs.
If a large amount of insurance is needed, term insurance may be the only method
of completely covering the need. Permanent insurance may be too expensive,
resulting in less coverage, leaving a risk exposure. It is also appropriate to use
term insurance to cover temporary needs and permanent insurance to cover
permanent needs.

Changing Needs
Conventional wisdom sometimes states that no one needs life insurance after an
arbitrary age, such as age 65. The reality is that very few people ever reach a
point in their lives when no life insurance is needed. Young couples with small
children have obvious needs. When the children grow up and leave home, the
need to provide for them is over. However, at that point, a couple usually is
living on their joint income, and the death of either would severely affect the
lifestyle of the other. If they have been successful in building an estate separate
from their life insurance, they will often want that estate kept intact for their
children. In that case, life insurance can provide the liquidity needed to settle the
estate. The maximization of retirement plans, or even the augmentation of
retirement plans, can be achieved with permanent insurance purchased at a young
age. It is also becoming more common for adult children to have some responsibility
in providing financial assistance for aging parents. Insurance can be used to continue
providing for parents’ needs if the adult child dies prematurely.
Future needs in relative (inflated) terms may not be as large for an “empty-
nester” couple, but the absolute (number of dollars) need may remain the same.
Take this example: In 1980 a man age 45 with a $30,000 annual income and
$100,000 of personally owned life insurance might have seemed to have
adequate insurance. However, if he died in 2010, at age 75, the $100,000 of
insurance proceeds would not likely have provided more than a few year’s

Chapter 1: How Client Data Affects the Life Insurance Selection Process  11
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income for his surviving spouse. The absolute dollars, $100,000, didn’t change,
but those dollars no longer adequately provided the relative (inflated) income
need. Thirty years hence, the same dollar amount can be said to have lost
some of the purchasing power it once had! Thus, once again the necessity for
a thorough assessment of a client’s life needs at various points along the way
are clearly illustrated.

12  The Life Insurance Selection Process

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Chapter 2: The Life Insurance
Selection Process
Reading this chapter will enable you to:

6–2 Analyze a client’s financial situation and goals to calculate the

amount of life insurance needed under either the annuity or interest-
only method.

L
ife insurance selection is a multistage process that helps determine the
amount and type of insurance a client needs. At the end of this module, a
flow chart is provided that details the stages in the life insurance
selection process.
There are many methods and approaches to estimating life insurance needs. All
approaches lead to recommendations using assumptions that practically ensure
that the calculations ultimately will be incorrect. In other words, no one yet has
been able to accurately predict such long-range items as real rates of return,
actual inflation rates, college costs, and the like. So, the planner’s objective is not
to recommend a specific dollar amount of insurance that is “guaranteed” to take
care of all client needs. The objective is to help the client identify specific goals
based on clearly recognizable events, or specific periods of life, while still
keeping an eye on the bigger picture. This process is an art form unto itself.
It is often easier for a client to understand the big picture if he or she understands
the component parts. The decision about whether to purchase life insurance is
often an emotional one. The amount of insurance purchased, however, generally
is decided upon in a more rational way. The process presented here distinguishes
the periods of one’s life, identifies events that give rise to specific financial
needs, and then quantifies and qualifies those needs.
Having already identified the essential facts about a client, the process continues
with the identification and/or establishment of measurable goals. Next, available
resources are identified, followed by the identification of economic assumptions.
Then the client’s life insurance needs are determined to ascertain whether the

Chapter 2: The Life Insurance Selection Process  13

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client needs additional life insurance, or if he or she already has adequate assets
and insurance. If more insurance is needed, a determination is made concerning
appropriate types and products by identifying the facts affecting the choice of life
insurance products. Even if the client has an appropriate amount of life insurance,
the appropriate type and product must be determined by matching the unique
characteristics of the insurance with the client’s needs.
The life insurance selection process requires review at various intervals as
objectives are achieved or modified and as circumstances change. As you work
through the life insurance needs determination process, calculations are made as
of today (i.e., as if the client were to die tomorrow).

Stage 2: Establish Goals

To determine life insurance needs, the client first must establish goals and
quantify them in time frames and dollar amounts. For life insurance purposes,
goals might include
 providing liquidity at death for the estate,
 establishing an income fund for dependents,
 establishing an education fund,
 creating a preretirement income fund and a retirement income fund for the
surviving spouse,
 accounting for final expenses (e.g., funeral, unpaid medical, etc.), and
 providing an adequate emergency fund.
These objectives are outlined in Exhibit A, the life insurance needs determination
worksheet, which is discussed later in this chapter.

Stage 3: Identify Resources

The next stage involves identifying the client’s available resources (data
gathering), which can be determined by reviewing the client’s financial
statements. The cash flow statement indicates the client’s sources of funds
(inflows), including salaries, cash dividends, interest, and trust income. It also

14  The Life Insurance Selection Process

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includes the client’s allocation of funds (outflows). The statement of financial
position shows what is owned (assets), what is owed (liabilities), and the client’s
net worth as of a specific date. The assets are broken down into cash and cash
equivalents, invested assets, and use assets. From the inflows, cash and cash
equivalents, and invested assets, the financial planner can determine which
resources are available and which can be repositioned to purchase any needed
insurance. Resources already earmarked for other goals may not be available for
repositioning. Determinations also need to be made on such things as: whether to
pay off the mortgage on the house, should the remaining spouse plan to work or
stay at home with the children, and the like.

Stage 4: Identify Economic Assumptions

After the client’s available resources have been identified, some economic
assumptions must be made. For life insurance needs determination purposes, an
inflation rate and an after-tax return must be determined.
The assumed inflation rate should be based on an average rate over an extended
period, on which the financial planner and the client must decide together. The
after-tax return also is a long-term average and should not be based solely on
today’s economic scenario. The financial planner should help the client make
realistic assumptions by considering the level and direction of economic output,
interest rates, inflation, energy costs, financial market indices, and changes in
monetary and fiscal policy. Even though the inflation rate and rate of return used
are based on assumptions, the planner should attempt to make the assumptions as
realistic as possible. Unrealistic rates make the calculations less meaningful. It is
generally safest to assume that inflation will be higher than historical averages
and that investment returns will be lower. At the worst, this will help to ensure
available funds will be adequate to meet future needs.
It is imperative that the client selects or helps select the assumptions. This is the
client’s life insurance needs analysis, and if the client is to act on it, he or she
must believe it is reasonable. If the planner makes the assumptions, at the end of
all of the calculations, the client may have a harder time accepting the reality of
the identified need.

Chapter 2: The Life Insurance Selection Process  15

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Stage 5: Determine Life Insurance Needs
Replacing the earning power of a family income earner and assuring liquidity for
an estate to meet the surviving family’s cash needs when the estate is settled are
the primary functions of life insurance for most families. However, determining
the required amount of insurance is not an easy task. Needs and attitudes differ
widely, circumstances change, and information on this topic is rarely objective or
impartial and often is difficult to obtain. Ultimately, even the best answers are
something of an educated guess. These answers involve recognizing and
evaluating subjective goals; present and future needs and earnings; assets and
liabilities; Social Security and pension benefits; income, estate, and gift taxes;
and inflation prospects. Life insurance needs determination is the process of
evaluating these variables to determine what amount of insurance is needed.
Unfortunately, the word “needs” implies making a determination of the minimum
amount of insurance required. It is important that a client’s “wants” are also
included in these calculations. By asking a client “How much will your survivors
need to pay the bills?” you may get a much different answer than by asking
“How much will your survivors need to maintain their current lifestyle?” Be
careful not to assume a given client merely wants his or her survivors just to get
by. Many people want family lifestyles continued and dreams fulfilled, even if
they are unable to participate.
Many methods are used to determine life insurance needs. A few of the most
common methods include the “six, eight, or ten times salary” rules of thumb, the
income-replacement approach (human life value), the percentage of income
method (all somewhat arbitrary in process), and the personalized needs approach.
Through the determination process, resources presently available and those to be
acquired are coordinated into an integrated financial plan. The major steps in
determining a client’s life insurance needs in this stage are as follows:
1. Gather information about the client’s financial and social situation.
2. List liquid and nonliquid assets available to the client.
3. Determine liabilities and estimate postmortem expenses.

16  The Life Insurance Selection Process

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4. Compare liquid assets with the sum of liabilities and postmortem expenses to
determine insurance needed, if any, to meet estate liquidity needs.
5. If children are involved in the analysis, estimate the funds needed to provide
dependents with adequate income until the youngest child reaches the age of
18 (or another age that the client chooses).
6. Estimate the amount required to establish a higher education fund, if desired.
7. Estimate the funds required to provide an adequate preretirement income to
the spouse after the youngest child reaches the age of 18 (if children are
involved, and if such an income is desired).
8. Estimate the funds required to provide an adequate retirement income to the
surviving spouse (if such an income is desired).
9. Estimate the amount required to establish an emergency fund.
10. Compare available assets with total needs to determine the amount of
insurance needed, if any.
An individual’s personal situation and attitudes are taken into account when
determining life insurance needs. Differing circumstances determine the
importance of various considerations. For instance, a single person without
dependents may not need insurance if sufficient resources are available to pay his
or her final expenses, which include debts and postmortem expenses such as last
illness expenses, funeral expenses, and probate costs. However, if other persons
are economically dependent on the single person, insurance may be required.
Future needs should also be considered; the early purchase of insurance may help
avoid an insurability problem later.
In determining life insurance needs for a married individual without children,
certain special factors should be taken into consideration. Does the individual
have sufficient resources to avoid causing a financial hardship to the surviving
spouse at death? Will the surviving spouse be self-supporting at a level that will
permit a satisfactory standard of living? If a financial need does exist, for how
long will it exist? How long before Social Security or other benefits will become
available to the surviving spouse?

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The answers to these questions vary among individuals. Simplistic life insurance
needs determination methods (e.g., the six, eight, or ten times salary approaches)
do not recognize these differing needs. One of the simplest, the interest-only
approach, divides the income needed by an assumed interest rate (e.g., $36,000 ÷
.08 = $450,000). This approach does not take into consideration the effects of
inflation, nor does it provide for cash needed at death for final expenses and
estate tax payments. The life insurance needs determination worksheet, included
later in this chapter, enables you to adopt a personalized, step-by-step needs approach
that recognizes individual circumstances. Copy the worksheet, Exhibit A (which
starts on page 26), and follow along with the written explanation of each step.

Step 1
Gather information about the individual’s family. Determine ages, attitudes,
goals, and personal financial resources of family members. (Any comprehensive
data-gathering form would be appropriate for this purpose.)

Step 2
List the fair market value of those family assets that could be liquidated easily at
the death of the individual. The client should include the following as liquid
assets:
 the net death benefit value of any life insurance policies (except in the case
of a UL type 2 or type B policy, do not include both the cash value of a life
insurance policy and its death benefit)
 amounts held in savings accounts and certificates of deposit
 the fair market value of any stocks, bonds, money market mutual funds, or
other investments that the client feels could be liquidated easily and that are
not earmarked for specific needs
The following items may or may not be considered liquid:
 lump-sum pension benefits (payouts can take from 12 to 24 months to
process)
 IRAs (the surviving spouse may continue the account until retirement)

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 equity in real estate
 collectibles
Do not include the following items as either liquid or nonliquid assets:
 checking accounts (amounts in excess of current expenses can be included,
but exercise caution in doing so)
 funds earmarked for other purposes, like college educations
 automobiles and other use assets
 expected inheritances (not yet received)
 personal effects, like jewelry
Note: Any assets that have been held out of the liquid asset category and that are
intended to be used for specific needs in the future should be included as part of
the available resources at that time. For example, an IRA intended for use at
retirement would have its current value subtracted from the bottom line need
calculated in Step 8.

Step 3
List all liabilities and postmortem expenses.
 Include repayment of any debts owed. List any outstanding balances on credit
cards, charge account installment debts, student loans, bank loans, finance
company loans, and car loans. Disregard any residential mortgage note balance
that would not be liquidated, because this is an expense that would be
considered when annual income needs are determined in steps 5, 7, and 8.
However, if the client wants to pay off the mortgage at death, his or her
liabilities would increase, but annual income needs may decrease. Sometimes
the client does not want to have the mortgage paid off at death because making
timely mortgage payments establishes credit for the surviving spouse.
 Include estimated last illness expenses. Even if the individual is covered by
medical insurance, some medical expenses, such as deductibles and
coinsurance payments, may remain.
 Include estimated funeral expenses. Check with local mortuaries for the
average cost of burial or cremation in your area.

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 Include estimated probate costs. Probate is the procedure by which a court
validates wills and supervises the collection of assets, the payment of debts
and taxes, and the distribution of the estate according to the will’s
instructions. The major components of probate costs are attorney’s fees,
executor’s fees, appraisal fees, and court fees. Probate procedures vary from
state to state, and costs vary from one estate to another.
 Include estimated estate taxes. That portion of an estate that is passed on to
nonspousal heirs may be subject to a federal estate tax. If property going to
nonspousal heirs (including the death benefits of life insurance owned by the
deceased, and any taxable gifts made during the life of the decedent), is
below a certain threshold, no estate tax will apply. Further, property passing
to a surviving spouse qualifies for an unlimited marital deduction. The use of
trusts, titling of property, and other estate planning tools may also have an
impact on potential probate and estate tax expenses.
 Include an adjustment fund. When a loved one dies, survivors often take
some time to come to terms with the death. Each person deals with this type
of personal loss in his or her own way. In many cases, additional funds may
be needed to allow survivors to get through the period of time it takes to
adjust to life without the deceased.

Step 4
Subtract estimated liabilities and postmortem expenses from estimated liquid
assets available (computed in Step 2) to pay these items. If expenses exceed
liquid assets, additional insurance is needed for liquidity, and this need is carried
forward to Step 10d of the worksheet. Liquid assets that remain after this step are
brought forward to Step 10b of the worksheet.

Step 5
Estimate the size of the fund required to provide dependents with adequate
income until the youngest dependent reaches age 18. Step 5 can be bypassed if
there are no children to consider. Refer to the worksheet included later in this
chapter and proceed with the following substeps:

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Estimate desired monthly income. Throughout this worksheet, all amounts
should be expressed on an after-tax basis. For purposes of this exercise, we
have inserted numbers that typically would be obtained from the client. You
can use 75% of present expenses as a rule of thumb. However, while rules of
thumb are convenient, the client needs to supply the numbers in order for
him or her to be more comfortable with the resulting calculation. This
calculation begins with gross salaries minus all taxes, minus savings and
investments, divided by 12, and multiplied by 75%. In practice, the planner
should not use rules of thumb but should discuss with the client which
expenses would remain and which would be decreased or eliminated.
If a spouse who does not work outside the home provides child care services,
a dollar value needs to be determined for those services. Among other direct
economic losses to be considered are:
 the economic value of a homemaker
 the loss of the right to file a joint tax return
 the loss of the estate tax marital deduction
 the loss of the gift tax marital deduction
Determine the sum of the following:
 expected monthly after-tax earnings of the surviving spouse (taking into
account the new tax bracket)
 expected monthly Social Security benefits available to the survivors
(Some financial planners feel it is prudent to ignore or severely discount
Social Security benefits. They question the soundness of the system’s
structure and predict cuts in future benefits. This decision should rest
with the client.)
 any other expected monthly benefits the survivors will be entitled to
receive (trust benefits, proceeds from a buy-sell agreement, etc.)
Subtract the total expected monthly income of the survivors (amount determined
in substep b) from the desired monthly income (determined in substep a). It is
possible that income is enough to cover expenses, in which case this step ends, a
“-0-” or “N/A” is placed in the bottom line, and the planner moves on to Step 6.
Do not put in a negative number.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Multiply this amount by 12 to determine annual income needs.
If an insurance need exists, calculate the total amount needed to provide a series
of inflation-adjusted income payments.
Note: The technique that may be used to determine the total amount needed to
provide a series of inflation-adjusted income payments can be found in Module
3: Introduction to the Time Value of Money (present value of a serial payment).
All calculations used in the life insurance needs determination process are to be
done in the “beginning of period” (BEGIN) mode.

Step 6
Estimate the amount required to provide a higher education fund. The amount
projected for this fund should be based on an estimate of total higher education
costs. Refer to the worksheet in Exhibit A and proceed with the following
substeps:
 Step 6a. Determine the annual costs for college in today’s dollars. Include
tuition, room and board, and living expenses. A client may choose to provide
only partial coverage for education expenses. Use this alternate amount if
this is the case.
 Step 6b. Determine the number of years until the student begins college.
Estimate the inflation rate for college costs per year. Calculate the future
value of the income needed when serial payments begin.
 Step 6c. Determine the number of years the child will attend college, the
assumed inflation rate during those years, and the after-tax rate of return
earned on investments during those years. Calculate the present value of an
annuity due (PVAD) using an inflation-adjusted interest rate. Use the
following formula to determine the inflation-adjusted interest rate:

1 + after-tax return 
inflation-adjusted interest rate =  − 1 × 100
 1 + inflation rate 

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Step 6d. Determine the number of periods until the student begins college
and the after-tax rate of return during these periods. Calculate the present
value of the PVAD in Step 6c (i.e., using the after-tax rate of return as the
discount rate, discount back to “today” the amount determined in Step 6c).
Of all calculations in the worksheet, this one is the least accurate, regardless of
the method used. Costs vary so much from college to college, estimating the cost
of a minor child’s education can be quite difficult. The important purpose served
by this calculation is to create a target for the client’s education fund. As time
passes, and the client has a better idea of where a child actually might attend
college, he or she can make appropriate adjustments to the plan.

Step 7
Estimate the size of the fund required to provide the surviving spouse with a
series of income payments after the youngest child reaches the age of 18 and
until retirement benefits become available (known as the “blackout” period).
Note: Some planners prefer to use the cessation of the surviving spouse’s benefit
as the trigger point for blackout period calculations. This benefit, when available,
ends when the youngest child is age 16. More traditionally, the end of surviving
children’s benefits is used as the trigger point. These benefits normally stop when
the youngest child is age 18. For exam preparation purposes, please use the more
traditional age 18 as the blackout period trigger point.
Refer to the worksheet in Exhibit A and proceed with the following substeps:
 Step 7a. Estimate the surviving spouse’s desired annual income, based on
today’s dollars.
 Step 7b. Estimate the surviving spouse’s expected annual after-tax earnings,
again based on today’s dollars.
 Step 7c. Subtract Step 7b from Step 7a to determine annual payments needed
for the period beginning when the youngest child reaches age 18 and ending
when the surviving spouse’s retirement age is reached. It is possible that
expected income could equal or exceed annual income needs, in which case
Step 7 is complete, the planner places a
“-0-” or “N/A” on the bottom line, and moves on to Step 8.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Step 7d. Calculate the amount needed to provide a series of inflation-adjusted
“blackout period” income payments (beginning when the youngest child
reaches age 18 and continuing until the surviving spouse retires).
Graphically, this concept can be illustrated through the use of the following
time line. Always assume that payments will be made at the beginning of the
year. (Remember, your calculator must be in “BEGIN” mode.)

Annual Increases with

Payment inflation

Today Youngest Retirement Date

child
reaches
age 18

The three-step process (as a part of the calculation subset to this substep 7d)
is as follows:
1. Adjust annual income needs for inflation. Calculate the future value (FV)
of the needed income. The FV is based on the period of time between
today and the date when the youngest child reaches age 18. For example,
if the client’s child is now four, there are 14 more years until that child
reaches age 18. If the assumed annual inflation rate is 5% and the client
needs $10,000 annually today, he or she will need $19,799 in the 14th
year to maintain purchasing power equivalent to today.
2. Calculate the lump sum needed to provide periodic income payments.
The lump sum represents the present value, at the beginning of the
payment period, of the total number of annual payments made over the
period beginning with the youngest child’s 18th birthday and ending at
retirement. Annual payments will be increased for inflation while
simultaneously recognizing the effect of any investment yield. See
Module 3: Introduction to the Time Value of Money, for a further
analysis of the serial payment calculation. Remember to use the
following formula to determine the appropriate interest rate for this step:

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 1 + after-tax return 
inflation-adjusted interest rate =  − 1 × 100
 1 + inflation rate 
3. The lump sum calculated in Step 2 is now discounted back to today (in
our example, 14 years) by the expected after-tax yield.

Step 8
For retirement years, estimate required annual income and reduce this amount by
Social Security retirement benefits and other retirement benefits, again in today’s
dollars. Subtract any other expected earnings or benefits. Estimate the client’s
life expectancy at the time retirement benefits begin and use that term to
calculate the total retirement-income funding need. The result of this calculation
should provide an adequate lifetime income. If an insurance need exists, refer to
the process in Step 7 above to calculate the amount needed to provide a series of
inflation-adjusted payments for retirement income. If funds set aside for
retirement were not included in steps 2 and 4, subtract them now from the total
present need.

Step 9
Estimate the amount required to provide an emergency fund for the survivors.
For most clients, financial planners often suggest having three to six months of
fixed and variable expenses in reserve. Such a fund should also be available to
provide for emergency medical expenses and other contingencies.

Step 10
Determine the amount of insurance needed, if any. Add the amounts determined
in steps 5 through 9. From this amount, subtract the sum of the remaining liquid
assets (determined in Step 4). A positive number indicates an insurance need. If
there is an insurance need, this amount is added to the amount of insurance
needed to provide estate liquidity (i.e., if the total in Step 4 is negative) to
determine the total amount of insurance required by the client. If no insurance is
needed, a “-0-” or “N/A” is placed in the bottom line. Individual and family
needs and circumstances change over time, so plan to review all insurance
coverages annually.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Exhibit A
Life Insurance Needs Determination Worksheet for__________
Step 1. Gather information from the client.
Step 2. Estimate the fair market value of assets owned. Classify assets as “liquid”
or “nonliquid.”

Assets at Fair Market Value

Liquid

TOTAL LIQUID ASSETS $

Nonliquid

TOTAL NONLIQUID ASSETS $

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 3. Determine the liabilities to be paid off if client dies today.

Liabilities
$

TOTAL LIABILITIES $

Estimated Postmortem Expenses

TOTAL POSTMORTEM EXPENSES $

TOTAL OF STEP 3 $

Step 4. Determine the liquid assets remaining, if any, after subtracting estimated
liabilities and postmortem expenses.

Total liquid assets $

Subtract estimated liabilities and postmortem expenses (Step

3) $

TOTAL OF STEP 4 $

Chapter 2: The Life Insurance Selection Process  27

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
If the total in Step 4 is greater than zero, the amount represents liquid assets
remaining after total liabilities and postmortem expenses are paid. If the total is less
than zero, the amount represents the amount of insurance needed for estate liquidity.
Step 5 (For youngest child, age until age ). Estimate the funds needed
to provide all dependents with income until the youngest child reaches age 18.

a. Desired monthly income $

b. Expected monthly after-tax earnings of spouse

Expected monthly Social Security benefits* $

Other monthly benefits $

Total of Step b $

c. Step a minus Step b $

d. Multiply by 12 to arrive at annual total payment $

e. Serial payment calculation:

Number of periods

% inflation

% after-tax yield

Calculate the present value of annuity due $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 5 $

* This worksheet contains a number of references to Social Security benefits. In many

cases, this amount will include other benefits as well. Since this is a generic worksheet,
whenever a client wants to exclude Social Security benefits from a calculation, just ignore
references to Social Security and enter a “0.”

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Step 6. Estimate the amount required to provide higher-education funds for the
client’s children.

CHILD

a. Annual college costs $

b. Serial payment adjustment

Inflation Calculation:

Number of periods until student begins college

% inflation

Calculate the future value of the needed income when serial payments
begin $

c. Serial Payment Calculation:

Number of years child will attend college

% inflation

% after-tax return

Calculate the present value of the annuity due $

d. Discount Calculation:

Number of periods until student begins college

% after-tax return

Calculate the present value of the above PVAD $

Calculate needs for each child, then total the needs for
all children $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 6 $

Chapter 2: The Life Insurance Selection Process  29

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 7 (For age until age ). Estimate preretirement income fund for
spouse after youngest child reaches age 18.

a. Desired annual income for surviving spouse $

b. Expected annual after-tax earnings and benefits of

spouse $

c. Subtract Step b from Step a $

d. Serial payment adjustment

Inflation Calculation:
Number of periods until serial payments begin

% inflation

Calculate the future value of the needed income when

serial payments begin $

Serial Payment Calculation:

Number of periods between date when youngest child
reaches age 18 and retirement

% inflation

% after-tax yield

Calculate the present value of annuity due (PVAD) $

Discount Calculation:
Number of periods until serial payments begin

% after-tax return

Calculate the present value of the above PVAD $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 7 $

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 8 (For age until age ). Estimate the retirement income fund for a
spouse.

a. Desired annual income for surviving spouse at $

retirement

b. Expected Social Security, retirement, or other

benefits $

c. Subtract Step b from Step a $

d. Serial payment adjustment

Inflation Calculation:

Number of periods until retirement

% inflation

Calculate the future value of the needed income $

Serial Payment Calculation:

Number of periods of retirement income

% inflation

% after-tax yield

Calculate the present value of annuity due (PVAD) $

Discount Calculation:

Number of periods until retirement

% after-tax return

Calculate the present value of the above PVAD $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 8 $

Step 9

The amount needed for an emergency fund $

Chapter 2: The Life Insurance Selection Process  31

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 10. Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 $

Step 6 $

Step 7 $

Step 8 $

Step 9 $

Total financial needs $

b. Total resources available (remaining liquid assets

from Step 4) $

c. Subtract total resources available in Step b from the total financial

needs in Step a to determine insurance needed, if any. $

d. List insurance needed, if any, to provide estate liquidity. (This is the

case when the total in Step 4 is negative.) $

e. Add the amounts in Steps c and d to determine:

ADDITIONAL AMOUNT OF INSURANCE NEEDED, IF ANY $

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 3: Selecting an
Appropriate, Cost-Effective Policy
Reading this chapter will enable you to:

6–3 Evaluate the client’s life insurance selection facts to select the most
appropriate type of life insurance for the client.

Stage 6: Determine Appropriate Type and

Product

A
t this stage, facts identified in previous stages are weighed to determine the
appropriate type of insurance for the client. To illustrate the life insurance
selection process, the family scenario in Appendix A, at the end of this
module, provides an outstanding opportunity to apply the seven fact groups
relating to the life insurance selection process for Mirralee Delgado. They are
expressed as follows:

1. Client profile Age: 34

Annual salary: $45,000
Health: Excellent
Last year’s savings and investments: $5,640
2. Client goals and See survivors’ needs
objectives
3. Survivors’ needs: Income for dependents; education fund;
preretirement income fund and retirement
income fund for surviving spouse;
emergency fund
4. Estate liquidity: Estate is liquid
5. Risk tolerance: Moderate
6. Existing insurance: $100,000 annually renewable individual
term insurance policy; no group
7. Amount needed: $163,194 of additional insurance*
*See calculations in Appendix A at the end of this module

Chapter 3: Selecting an Appropriate, Cost-Effective Policy  33

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Selection Process
Following are some selection process considerations.
If a client can qualify for one type of life insurance, he or she generally can qualify
for any type of life insurance. The main exception to this rule is that term products
often are not offered to prospective insureds over the age of 65, whereas permanent
products may be available at age 70 or 80. Therefore, except when dealing with a
client of advanced age, age and health factors do not preclude the availability of
any particular product. On the other hand, age and health may influence product
selection by making a permanent product more expensive than the client’s
situation allows.

Original issue rates on any kind of insurance become higher with advancing age.
If the client is in poor enough health to require a rating, the insurance premium
will increase even further. Nevertheless, if the client can afford the premium, a
permanent product still may be quite attractive compared with a rated term
product. Since the details of the client’s situation will be the determining factor,
the planner may need to do some spreadsheet modeling to reach a final decision.

Pitfalls
Life insurance selection process pitfalls usually can be avoided. Most problems
result from making unwarranted assumptions. The planner must take care to
ensure the accuracy of the assumptions upon which conclusions are based.
Following are some common pitfalls.
Term insurance. The first pitfall is to recommend that the client buy term
insurance just because he or she is young. Conversion to permanent insurance
should occur in the future, when term becomes expensive and the client would
like to lock in a level premium. However, unless circumstances require such a
decision, it does not necessarily make economic sense.
A permanent product is composed of two parts. Such products have a decreasing
net amount at risk (the difference between the cash value and the death benefit,
which is provided through what amounts to term insurance). Permanent products
also have an increasing cash value that serves two purposes. First, the cash value
provides investment income for the insurance company that will assist in paying

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future term charges for the net amount at risk, thus keeping the premium level.
Second, most permanent products also must generate sufficient additional
investment income to endow the cash value (i.e., make it equal to the face
amount) at maturity (currently age 120).
As term insurance becomes expensive and the client finally is advised to
purchase the permanent product, the entire death benefit of the new policy is the
net amount at risk (since there is no cash value in the newly purchased policy).
Thus, the policyowner continues to pay the higher term charges for this net
amount at risk.
Further, the additional premium that was “saved” because a permanent contract
was not purchased is the amount that would have gone into the cash value of the
policy. This amount would have accumulated on a tax-deferred basis to assist in
paying future mortality costs and making the cash value endow at maturity. The
combination of time- and tax-deferral makes a significant difference over the life
of the contract.
To give an idea of the impact tax-deferred compounding can make, take the
example of A and B, both 30 years of age. A makes 15 deposits of $2,500, at the
beginning of each year, into an investment earning 8%, and then stops
contributing (but the investment continues earning 8%). B waits 10 years (to age
40) and then puts $2,500 a year into an investment at 8% for 25 years. At age 65,
A’s fund is $341,698 and B’s fund, with $25,000 more invested, is only
$197,386. To have the same sum as A at the end of the 25-year period, B would
have to make annual deposits of $4,328. Clearly, the cost of waiting can be high.
As noted previously, this does not mean that a recommendation to buy term and
convert it in the future never should be made. For example, the client may not
have enough money to pay for permanent insurance now. Perhaps his or her
needs are likely to decrease substantially in the near future so that substantially
less permanent insurance will be needed. Note that the ideal solution here would
be to cover the anticipated long-term need with permanent insurance and to cover
the short-term need with term insurance. Or, perhaps the client is a very good
investor and actually has achieved results that consistently beat insurance policy
returns on an after-tax basis.

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Even the most aggressive investor, if he or she has a diversified investment
program, will have some funds invested in vehicles with a risk and return that are
similar to those of life insurance. Examples would include money market funds,
high-grade corporate bonds, and even certificates of deposit. (Although most
states have state guarantee funds, insurance products lack the FDIC insurance of
a CD and therefore are not, strictly speaking, as safe as a CD.) If this is the case,
consider the possibility of having the life insurance serve as this portion of the
portfolio. Whatever the scenario, think the situation through, model alternate
approaches, and come to a solution that matches the client’s actual situation and
temperament and is in the client’s best long-term interest.
Variable vs. nonvariable. A second pitfall is to assume that a variable product
will perform better than a nonvariable (nonequity) product, or to ignore the
emotional implications of such products for the client. When making an
evaluation, get actual (net) investment results for the variable product. While
past results do not guarantee future returns, you should consider those results
when making projections. Also consider the short-term effects the policy would
suffer if there were a market drop in the early years, before the policy has a
chance to build up a sufficient amount to absorb such a loss and still maintain the
insurance. A possible solution might include selecting conservative investments
for the first few years, or starting the policy with a contribution that is larger than
is anticipated for future annual payments (but that is still within federal
guidelines). Further, consider possible client risk management concerns about the
performance of a variable life insurance product.
Investing through the insurance company. A third pitfall, related to the one
above, is to assume as a matter of course that a client can invest his or her own
money to get better returns than an insurance company. Many insurance
companies are multibillion-dollar businesses with full-time investment
departments. With much of their asset base in exceptionally conservative
investments, they still consistently earn returns well in excess of the typical
conservative investor’s average return.
Diversification concept applied to insurance. A final pitfall is to assume that a
client should “diversify” the types of insurance he or she purchases.
Diversification is a concept that applies to investments, not to the types of

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insurance a client owns. A client might want to spread the purchase of insurance
among more than one company to spread the risk of insolvency. Note, however,
that this is not the same as saying that since a client owns some whole life, he or
she should buy universal life to diversify the types of insurance he or she owns.
A client’s situation may require a mix of product types, but not because there is a
need for “diversification.”

Selection Process Example

Taking the prior considerations into account, the life insurance selection process
for the Delgado family (in Appendix A) could proceed as follows:
 Client profile. Mirralee’s age and health allow the selection of any type of
product. Further, her annual salary, savings, and investment rate are such that
she can afford any product she wants to purchase. However, her savings rate
and total income indicate another important consideration. Since the
Delgados currently have a substantial income and pay about $33,000 per year
in taxes, a product that could reduce their tax burden might be appropriate.
Note that current investments probably do not add substantially to their tax
burden. If there is no substantial turnover in their stock portfolio, there would
be taxation of only the $220 of dividends. The IRA and pension investments
are not currently taxable. The art collection would not be taxable unless sold,
and real estate rental income probably is offset to some extent by
depreciation and taxes. On the other hand, income from the family’s cash
equivalents is fully taxable and is earning a low rate of return. Except for
emergency fund use, the reason for maintaining the cash equivalents at this
level should be investigated.
 Client goals and objectives. In this case, Mirralee’s goals and objectives are to
meet the family’s needs. She does not appear to have any agenda other than
securing the financial well-being of her family in case of her premature death.
 Survivors’ needs. Mirralee’s shortest-term survivor need is for an education
fund. Since this need will not end for 20 years, it does not qualify as a short-
term need. While it would be wise to model a term/permanent comparison,
this kind of a time horizon is certain to show a substantial advantage for
permanent insurance over term insurance, assuming use of the same rates of

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 return for the cash equivalents in which Mirralee currently is invested. Since
we are replacing the cash equivalents in Mirralee’s current investment
program, we should replace them with a policy that closely matches the
category of cash equivalents. This would rule out variable products.
Mirralee’s insurance needs may decrease after the children are out of college
and the future may hold other unanticipated changes in her situation, so it
might be good to have the option of changing the policy’s face amount.
Universal life offers both premium and death benefit flexibility. For this reason,
universal life may be preferable to whole life as a recommendation. Remember
that while the relative need may decrease, the absolute need might not.
 Estate liquidity. Estate liquidity requirements are relatively minor and are
sufficiently covered with current liquid assets, so this consideration has little
effect on our selection.
 Risk tolerance. Mirralee has a moderate risk tolerance. Certain investment
options within a variable product may be appropriate for her. However, the
reasons previously given suggest the recommendation of a nonvariable
product. All other available products (such as UL or whole life) should fit
within her risk tolerance without a problem.
 Existing insurance. The existing insurance is individual term. The only
impact this consideration might have for Mirralee is that it leaves more funds
available to meet the new insurance need than would be available if a more
expensive alternative had been in place.
 Amount needed. Only $163,194 of additional insurance is needed. Because
of Mirralee’s age and current savings rate, cost should not be a factor for this
amount of insurance.
Given the considerations listed here, one acceptable recommendation is that
Mirralee purchase $163,194 of universal life insurance to fill her life insurance
need.
Note that there is no single best answer in this process. The unique characteristics
of available products should be compared with the unique needs of the client to
arrive at the most reasonable match possible.

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Stage 7: Evaluate Existing Type and Product
After the appropriate insurance type and product is determined for a client, the
financial planner must evaluate the client’s existing insurance. The client may or
may not have the most suitable type of insurance.
In addition to using facts about the client to evaluate the appropriateness of
existing insurance, another technique is to compare the cost of life insurance
policies. The most direct and effective way to evaluate an insurance company’s
policy is to compare the cost of one policy, on a cost-per-thousand basis, against
another similar policy. Many financial planners oversimplify this computation by
dividing the insurance protection of the policy by the annual premium and
comparing this cost with the costs of alternative policies. Other commonly used
methods include the traditional net cost method, which ignores the time value of
money (premiums paid minus dividends, minus cash value at the end of the
period, equals net cost); the surrender cost method (or interest-adjusted method);
and the net payment cost method. Generally, these latter methods are calculated
by actuaries (see the end of Chapter 4 of this module) rather than by agents,
consumers, or financial planning practitioners. The equal outlay method, cash
accumulation method, Linton yield method, Belth yearly yield and yearly price of
protection methods, and Baldwin method may also be used to evaluate policies.

Belth Method
One of the methods used by insurance agents and financial planners to evaluate
life insurance policy costs is the yearly price of protection method, which is
described below (Belth 1985, pp. 76-92).
The first step of the yearly price method involves gathering the following
information about a given year of the policy:
 Determine the death benefit payable at the end of the policy year. This is the
amount the insurance company would pay to a beneficiary if the insured
were to die at the end of the year. Generally, the face value of a policy is a
constant, regardless of the insured’s year of death. However, with some
policies (e.g., adjustable life policies), the death benefit may fluctuate over
time. The figure used should be the death benefit of the policy at the end of
the year. When determining the death benefit and cash value, disregard any
accidental death benefits or loans against the policy.

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 Determine the cash value of the policy payable on surrender at the end of the
policy year (for term insurance, the value will be zero).
 Determine the cash value at the end of the previous policy year.
 Determine the annual policy premium payable at the beginning of the policy
year (paid-up whole life policies will have a zero premium).
 Determine the annual dividend payable at the end of each policy year, based
on the company’s current dividend scale (UL and other nonparticipating
policies will have a zero dividend).
 Determine the insured’s current age.
This information may be obtained from an existing policy illustration (called an
in-force ledger), from current policy statements, or from the policy itself. As with
any comparison, when a financial planner compares an alternative policy to an
existing one, identical variables should be used to assure validity. Often, further
insight is gained by making the comparison for several different years of the
policy’s existence.
Reading the next part of this chapter will enable you to:

6–4 Calculate life insurance costs to determine the most cost-effective

policy.

The second step of the yearly price method is to determine the yearly price per
thousand using the following formula:

(P + CVP) (1 + i) − (CV + D)
Yearly price per thousand =
(DB − CV) (.001)
where
DB = Death benefit
CV = Cash value at end of policy year
CVP = Cash value at end of previous policy year
P = Annual premium
D = Annual dividend at end of the policy year
i = Rate of interest chosen by the client and the financial
planner

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From the information collected, all the variables have been determined except the
interest rate (i). This variable represents the tax-deferred rate of return that could
have been earned had the premium and the cash surrender value (P + CVP) been
invested in a different vehicle having similar investment risk characteristics. For
the analysis to be accurate, the financial planner and client should keep in mind
the tax consequences of the other investment vehicle.

As an example, evaluate the yearly price per thousand for the following policy
for a man, age 56:

where
DB = $200,000
CV = $54,000
CVP = $52,000
P = $2,200
D = $1,200
i = 5%
Therefore:
($2,200 + $52,000) (1 + .05) − ($54,000 + $1,200)
Yearly price per thousand =
($200,000 - $54,000) (.001)

$1,710
Yearly price per thousand = = $11.71
$146

The insured, at age 56, assuming an 5% after-tax return, is paying $11.71 per
$1,000 of insurance. This can be compared to another policy (set to an identical
time period and interest rate criterion) or to the applicable “benchmark” price per
thousand from the list below.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Table 1: Benchmarks
Age* Price per Thousand Front-End Load Multiple
Under 30 $1.50 10
30–34 2.00 9
35–39 3.00 8
40–44 4.00 7
45–49 6.50 6
50–54 10.00 5
55–59 15.00 4
60–64 25.00 3
65–69 35.00 3
70–74 50.00 3
75–79 80.00 2
80–84 125.00 2
*The insured’s current age is used.
Source: (Belth, 1985)

The benchmarks in Belth’s table were derived from certain U.S. population death
rates. The benchmark figure for each five-year bracket is slightly above the death
rate per 1,000 persons at the highest age in that bracket. In other words, if the
price of life insurance protection per $1,000 is in the vicinity of the “raw material
cost” (that is, the amount needed to pay death claims based on population death
rates), the life insurance protection is reasonably priced.

To compare the policy’s yearly price per thousand with the benchmark figure,
use the guidelines below.

If the yearly price per thousand of the policy is

 less than the benchmark figure, the yearly price is low and the policyowner
should not consider replacing the policy on the basis of price.
 more than, but not double, the benchmark figure, the yearly price is
moderate, and the policyowner probably should not consider replacing the
policy.
 more than double the benchmark figure, the yearly price is high, and the
policyowner should consider replacing the policy if adequate coverage is
available through other insurers at a lower price.

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In the previous numerical example, the yearly price per thousand of $11.71
compares favorably with the benchmark figure of $15. For cash surrender value
policies, this means that (1) the life insurance protection provided is cost-
effective, and (2) the investment return on the cash value compares favorably to
the return offered by other investment vehicles.
The yearly price per thousand for term policy protection is calculated similarly.
For example, the yearly price per thousand for a nonparticipating term life
insurance policy with a face value of $100,000, an annual premium of $1,600 is
calculated as follows:

($1,600 + 0) (1.06) − (0 )
Yearly price per thousand =
$100,000 × .001
$1,696
Yearly price per thousand =
$100
Yearly price per thousand = $16.96
The benchmark table also includes a column marked “Front-End Load Multiple,”
which can be used to measure a new policy’s front-end expenses. Many policies
charge higher prices in the first few years to cover marketing and administrative
costs. The multiple is derived by dividing the policy’s price as calculated
previously by the benchmark price. If the policy is heavily front-end loaded, its
multiple will be substantially higher than the table’s multiple.

Yearly price per thousand

Front-end load multiple =
Benchmark price per thousand

To compare the policy’s front-end load with the benchmark figure, use the
guidelines below.

If the front-end load of the actual policy is

 less than the benchmark figure, the front-end load is low.
 more than, but not double, the benchmark figure, the front-end load is
moderate.
 more than double the benchmark figure, the front-end load is high.

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For example, if the policy’s price is $42.13 and the benchmark price is $15, then
the multiple is 2.8. Compared to the benchmark multiple of 4, this policy is not
heavily front-end loaded, even though the price is more than double the
benchmark. Combine the multiples for the first two policy years when evaluating
the size of a front-end load.
This multiple is of particular value when the planner is evaluating universal or
variable life policies. Because of its nature, the front-end load multiple generally
is most effective as a measurement tool when used with a proposed policy
illustration or within the first year or two of a policy’s existence (after a policy
has been in effect for several years, the front-end load already has been paid, and
becomes irrelevant).
An individual insurance policy’s complexity makes a perfect evaluation method
impossible to find. Some caveats and conditions to consider when using the
yearly price method include the following:
 The yearly price method should not be used if the policy covers more than
one life.
 The year chosen for evaluation might not be representative of the policy as a
whole. Calculate and evaluate the policy for several different years to
alleviate this problem.
 The yearly price per thousand could be negative when using a conservative
interest rate or evaluating a very competitive permanent policy.
 When comparing policies, it is important to realize that all products are not
the same. Even when comparing the same type of policy (e.g., whole life
with whole life), the policies may differ in terms of the reliability of the
company, the services offered to policyholders, and many other variables.
 If the cash value (CV) of the policy is very high (i.e., little life insurance
protection remains), the financial planner might consider the return on the
investment as he or she would with any other investment and compare it to
the return on other comparable investments that are available.

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Linton Method
Another method of evaluating policies, derived from the work of M. Albert
Linton, was created to compare cash value life insurance with the “buy term and
invest the difference” approach. This method is based on subtracting the “cost of
protection” from each year’s policy premium, net of dividends, and treating the
remainder as a savings deposit. Many policy illustrations will include the Linton
Yield for the life of the policy.

Additional savings
Rate of return =
Beginning cash surrender value
First, the policy is divided into two parts. By subtracting the first part (the cash
surrender value) from the face amount, you arrive at the second part (the net
amount at risk, or the amount of life insurance protection). The amount at risk is
then “priced,” based on the insured’s age, gender, health, etc. (or what it would
cost if the policyowner purchased the net amount at risk “on the street”). The cost
of the protection is subtracted from the premium, and then dividends are
subtracted. The result is added to the savings deposit. The formula looks like this:

Annual premium - Dividends - Term cost = Addition to savings

The addition to savings is considered by Linton to be the “rate of return,” or

yield, for a particular policy year.
The drawbacks of this method are that the dividend assumptions and the term
cost assumptions, which the planner can vary according to source, will in turn
affect the amount being “added” to savings. The person doing the calculation
might choose to use very low term rates, resulting in a low-yield permanent
policy. If high term rates are used, the permanent policy may appear to be
unrealistically beneficial. Because this method is highly susceptible to
manipulation, it must be used carefully and selectively, but it can help to
compare yields of different life insurance policies.
Finally, under any of the above circumstances, the advice given is to consider
replacement. This is merely quantitative data. A definite answer cannot be given
in any circumstance without considering other variables such as the client’s

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
specific circumstances. Replacement may involve income tax consequences, high
initial replacement costs, and the surrender of valuable and hard-to-replace policy
provisions. The client’s total financial situation must be considered in order to
reach an optimal decision on replacement. The calculation for determining the
cost-effectiveness of a policy should not be viewed in isolation in deciding
whether to keep or replace a policy.

Stage 8: Appropriate Amount

If, in Stage 7, it is determined that the client possesses the type of insurance that
is most appropriate for his or her situation, the next question to ask is whether he or
she possesses the appropriate amount of insurance. This can be determined by
referring back to Stage 5, in which the client’s life insurance needs were determined.
If a client has the appropriate type of coverage as well as the appropriate amount
of coverage, then the life insurance needs determination process is ended.
However, the entire process should be repeated periodically to review changing
needs, goals, and circumstances. If, on the other hand, the client has the
appropriate type of insurance but an insufficient amount of insurance, it is
necessary to move on to Stage 9. If the client has too much insurance (which
seldom is the case), it might be appropriate to consider canceling the excess
coverage. However, there are a number of variables to be taken into account
before considering cancellation, and these variables will be discussed in Stage
11. Remember, no beneficiary ever complained that there was a little too
much life insurance.

Stage 9: Sufficient Resources

If it is determined in Stage 7 that the client has an inappropriate type of
insurance, the next question is whether the client has sufficient resources
available to purchase a more suitable form of insurance. For example, even
though a cash value form of insurance might be most appropriate for a given
client, the client’s income may force him or her to buy lower-premium term. If
the client has sufficient financial resources, cost becomes a less significant
consideration, and the most suitable form of insurance can be purchased.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
If it is evident in Stage 8 that, although the client’s existing type of insurance is
appropriate, there is an insufficient amount, it must be determined again whether
the client has sufficient resources to purchase more coverage. The client may
need to choose a form of insurance with a lower premium to meet total insurance
needs. If sufficient resources are available, the client can increase his or her
coverage (assuming he or she is insurable).

Stage 10: Purchase Appropriate Coverage

If sufficient resources are available, the next stage is to purchase additional
insurance coverage that was determined to be the most appropriate based on the
client’s facts (see Stage 1). This may be accomplished by adding new coverage to
the client’s existing plan, or it may be more appropriate to replace the existing
coverage. The life insurance selection process ends at Stage 10 if there is no need
to cancel coverage. If replacement is being considered, the financial planner
should continue on to Stage 11.

The client has two choices if insufficient resources prevent purchasing the type of
policy deemed most appropriate to meet his or her needs. Either the client’s
objectives will have to be modified (see Stage 12) or, using the least desirable
option, the client may choose to purchase the appropriate type of insurance, but
in a lesser amount (see Stage 13). The client’s goals and objectives (see Stage 1)
will generally dictate which of these choices takes precedence.

Additional Considerations
In some ways, the two life insurance modules (modules 6 and 7) of this program
have only scratched the surface on the uses of life insurance. Additional
information will be added in the Retirement Planning and Employee Benefits and
Estate Planning course, but there are two life insurance-related topics that are
appropriate to consider here:
 irrevocable life insurance trusts, and
 private split-dollar arrangements.
Either of these can impact decisions on what amount of coverage and what type
of product should be used.

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Irrevocable Life Insurance Trusts
Irrevocable life insurance trusts (ILITs) have many uses, including as a home for
multiple-life policies and in private split-dollar arrangements. In almost all cases,
the idea behind using a life insurance trust is to remove that asset from an
individual’s estate, thereby reducing potential estate tax liability. While the biggest
negative to an ILIT may be the loss of control over the life insurance policy (transfers
must be complete and permanent), it is offset by two big positives:
 Properly executed, assets in an ILIT escape estate taxation and stay out of
probate, thereby increasing the confidentiality of estate settlement. By
eliminating federal estate taxation, a substantially larger amount of money
can be passed to heirs; state death taxes may also be favorably impacted.
 Additionally, trust assets normally cannot be challenged by dissatisfied heirs
or creditors.
Both of these benefits are frequently desired by high net worth individuals.
Obviously this is only a cursory look at ILITs; further coverage is outside the
scope of this module.

Private Split-Dollar Arrangements

Private split-dollar arrangements are split-dollar agreements between private
parties (often family members as opposed to an employer and employee). In a
split-dollar arrangement, the money to pay premiums is provided by one entity
(business or individual) who probably also has the right to receive from the
policy an amount equal to premiums paid. The remainder of the cash value
and/or death benefit goes to the insured or the policy’s beneficiary. In its most
usual iteration, a business provides the money to pay the premiums on a key
employee’s permanent life policy as a benefit, in addition to encouraging that
employee to remain an employee. At termination of employment or death of the
employee, the business recovers the premiums paid for the policy, and the
employee’s beneficiary gets the remainder (note that this is a very brief
summary, and there are significant variations on the workings of this type of
split-dollar arrangement).

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When a split-dollar arrangement is between family members, it is known as a
family or private split-dollar arrangement. One party, often a parent, provides the
money to pay the premiums on a life insurance policy for another party, usually a
child or other family member. Done correctly, the money to pay premiums can
be considered a gift, and may be sheltered by the annual gift tax exclusion. The
private split-dollar policy may avoid estate taxes to the extent that there are no
incidents of ownership (which the use of an ILIT can help accomplish).
Survivorship policies are often used in these arrangements.
With most arrangements, there will come a time when the cost of insurance (e.g.,
the P.S. 58, Table 2001 or standard term cost) exceeds the amount of the annual
gift tax exclusion. At this time, many people want to end the arrangement and do
a rollout. The rollout may reimburse the person who made all the premium
payments (the grantor) by taking money out of the policy’s cash value (similar to
what happens in an employer/employee split-dollar arrangement). However, in
this case, the policy will probably require significant future premium payments,
which is not usually what the parties desire. Alternative rollouts include gifting
the policy’s cash value to the non-grantor in a lump sum or over a period of
years. Another option is for the grantor to receive an interest-bearing note from
the trust with the note payments being paid by additional gifts to the trust by the
grantor. A number of other rollout options are also used.

What does the IRS think of these plans?

The answer to this depends largely on the benefits to the grantor and other parties
in the arrangement. Split-dollar arrangements can be either
 equity-based (normally, where the insured receives the death benefit along
with a disproportionate share of the cash value); or
 non-equity based (where the insured gets the death benefit, but not the cash
value). Non-equity arrangements are essentially taxed only on the value of
the insurance protection.
Significant changes were made to some IRS regulations that largely impact new
equity plans or those materially modified after September 17, 2003. There are
two basic types of equity split-dollar arrangements:
 economic benefit regime

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 If the policyowner pays the premiums for the benefit of the insured (who is
not the policyowner), then the arrangement falls under the economic benefit
regime. In the case of private split-dollar arrangements, the most likely tax
treatment would be for the economic benefit of the life insurance to be
considered a gift to the insured from the owner (grantor).
 loan regime
With the loan regime equity split-dollar arrangement, all premium payments
made by the nonowner (grantor) are deemed to be loans to the owner/insured.
So, the owner is considered the borrower and the grantor is the lender. To
stay within new IRS regulations, the loans must be interest bearing. If the
interest is below market, the IRS will impute interest based on current rates
(and this loan interest will be taxable). (Note that loan regime arrangements
will work for private companies and families, but should not be used by
public companies due to the Sarbanes-Oxley Act of 2002, which prohibits
loans by public companies to executives.)
The preceding section has presented only a brief summary of private split-
dollar arrangements, and in no way covers all of the issues. It would be a
very good idea to consult a specialist before making use of these tools.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 4: Deciding to Keep or
Cancel a Policy
Reading this chapter will enable you to:

6–5 Evaluate factors that might influence the decision to keep or replace
a policy.

Stage 11: Cancel Inappropriate Coverage

M
any life insurance experts assert that rarely is it in the best interest of
the policyowner to replace a policy. Some reasons given are as
follows:
 The policyowner will have to pay new acquisition costs.
 An existing policy, for a variety of reasons and variables, tends to increase in
value with age.
 The new policy will have to pass through a contestable period and a suicide
clause period, through which the existing policy already may have passed.
 New participating policy dividends likely will be much less than those paid
by the existing policy.
 The new policy’s initial cash value will seldom equal the proceeds from
cashing in the old policy.
 If the replacement policy and the existing policy are of different types, but
the policyowner’s needs have remained constant, the replacement policy may
not meet all of the client’s insurance needs.
Most state insurance commissioners recognize that replacing an existing policy
often is not in the policyholder’s best interest. Insurance regulations frequently
require some form of agent disclosure when replacing an existing policy, to
discourage arbitrary replacement of policies.

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The policyowner’s changing circumstances, however, may require changes in his
or her insurance portfolio. Also, insurance companies have developed new
products that may be more appropriate for a client’s current needs. Thus, while
replacing policies may be costly and proposals of this nature require careful
examination, it is possible that the change will be warranted by the less costly or
more suitable coverage provided by the new policy. However, the planner must
be confident that the change is best for the client over the long term.

Nontaxable Policy Exchanges/Replacements

Section 1035(a) of the Internal Revenue Code dictates the circumstances under
which one policy may be exchanged for another without triggering a taxable
event. These circumstances are as follows:
 the exchange of one life insurance policy for another life insurance policy or
an annuity contract;
 the exchange of an endowment contract for a similar endowment or an
annuity contract; and
 the exchange of an annuity contract for another annuity contract.
If the exchange involves life policies, the policies must be on the life of the same
insured.
If no cash or other property is received in connection with the exchange, no gain
will be recognized. The cost basis of the new policy will be the same as the cost
basis of the old policy (plus any premiums paid and less any excludible dividends
received after the exchange).
If the new insurance policy carries the same outstanding indebtedness as the old
policy, the exchange will be considered tax-free.
There are four basic types of life insurance policy replacement. A term policy
may be replaced by another term policy or a cash value policy. Similarly, a cash
value policy may be replaced by another cash value policy or a term policy. The
methods of evaluating the cost of insurance (covered in Chapter 3 of this module)
are valuable when considering a replacement. Remember that the numbers are
but one of the issues to be considered.

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 Replacing one term policy with another is the least complex of the
alternatives. There is no concern with built-up cash values. Comparing policy
costs is relatively simple on a cost-per-thousand basis (see Stage 7). If the
alternative policy offers the same coverage at a lower cost than the existing
policy, a change should be considered, provided other criteria are satisfied.
Be sure to compare all benefits associated with each policy.
 Replacing a term policy with a cash value policy normally can be done
through the term policy’s conversion clause. However, exercising this option
is not always the best alternative. Companies issuing acceptable term policies
may not offer the most desirable cash value policy.
 Replacing a cash value policy with another cash value policy usually is not
advantageous. Payment of another front-end load may be required, and,
because the insured is older when the new policy is issued, the new
premium usually is higher. Still, if the existing policy is much more
expensive, and the alternative policy has equal or better coverage, a
replacement could be worthwhile.
 Replacing a cash value policy with a term policy usually is unwise. Once a
reasonably good cash value policy has been purchased, retaining it tends to
be more advantageous than exchanging it. Insurance companies amortize
certain costs during the early years of the policy’s life, and cash value and
dividend accumulation is not as rapid during this initial period. The
policyowner will have a substantial loss if a cash value policy is replaced
soon after purchase.
Exceptions to these generalized conditions do exist. For instance, the existing
cash value policy may have an extremely poor rate of return. Also, the
policyowner may not be able to afford premiums on a cash value policy. In any
event, the policyowner’s personal situation must be examined.
Before replacing any policy, one should
 compare costs (using the methods outlined in Chapter 3 of this module).
 never drop an existing policy until the new policy is issued and in force (to
avoid a lapse in coverage).

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 check the financial stability and ratings of all the insurance companies
involved before making a decision.
 compare the language of the two insurance contracts as to quality of
coverage and benefits.
 consider agent service.
 discuss the replacement with the existing and proposed agents.
At this point, assuming sufficient resources to purchase appropriate coverage, the
life insurance selection process ends until the next periodic review. Otherwise, it
is necessary to move on to Stage 12.

Stage 12: Modify Goals

The client may need to modify his or her goals if sufficient resources are not
available to purchase the appropriate type and/or amount of life insurance
coverage. For example, a client could plan to send his or her children to a less
expensive college. Alternately, the client could decide to only partially fund
college tuition (adding the expectation that the children would pay the difference).
In either case, required insurance amounts would be smaller.
The client must understand the potential consequences and decide changes to be
made. Planners who make these decisions for clients may find themselves in the
awkward position of having to explain to the survivors why the entire plan was not
funded (and having to deal with the potential of adverse legal consequences). If the
process reaches this stage, the goals and objectives initially identified in Stage 5
often will need to be clarified.

Stage 13: Purchase a Lesser Amount

If the client is unwilling or unable to modify his or her goals, the next solution is
to purchase a less expensive amount of insurance. This actually is a compromise
solution. It means insuring only essential risk exposures or choosing a less
expensive form of insurance, even though this may not be the most appropriate
choice for the client’s needs. In fact, the most important question in the life
insurance selection process is not what type of coverage the client needs, but how
much coverage the client needs. If the client needs a large amount of insurance

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and has limited resources, term insurance, with a lower premium, may be the
only possible solution, assuming the client’s primary goal is protection of his or
her family. When applying the client’s life insurance selection facts (Stage 1),
keep in mind that the amount of insurance needed is a factor. The major concern
is to cover the client’s risk exposures, which may require some compromise as to
the type of insurance.
This is a case where the planner must take some steps to protect his or her
reputation and practice. If the client will not change the goals and intentionally
under funds them, the planner should at least maintain complete notes as to the
recommendation made and the client’s choice. Even better, the planner should
get the client to sign a statement that he or she understands the planner’s
recommendation and chooses to purchase a lesser amount of protection.
Again, it is always important to review the client’s life insurance plan at periodic
intervals to be certain that the plan still meets the client’s needs and goals. The stages
in the evaluation process are outlined in Appendix B at the end of this module.
Note: The term “resources” has been used frequently in the description of this
process. Some will interpret this to be the same as income. However, this is not
always the case. Insurance policies create large amounts of capital. If the client is
using a cash value policy, it may be appropriate to use capital to purchase it.
Over time, the result will be seen as moving cash from one asset to another.

Other Approaches to Programming

There are as many approaches to determining the amount of insurance needed by
a client’s dependents as there are creative planners. Thorough familiarity with the
concepts of annuities, annuities due, and present and future values will assure
that the planner is able to adapt to any situation that might arise.

Human Life Value

One of the more common needs-determination approaches is to use the human
life value concept. Essentially, this concept is based on an individual’s ability to
earn an income. It also requires that someone be dependent on that income.
Stated in its simplest form, if an individual either has no income, or has nobody
who is dependent on any income, he or she (technically) has no human life value,

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and therefore needs no insurance (a rather arbitrary judgment, at best). This is not
to say that individuals without income are not valuable. Rather, this concept
attempts to determine insurance needs based on an individual’s economic impact.
Without going into much detail, human life value calculations subtract an
individual’s current living expenses from his or her earnings (this is done
because, after death, the individual will have no ongoing maintenance needs).
Once that number is determined, a number of years of expected/required income
is decided, along with assumed discount or interest rates. This information is then
used to determine the present value of the lost income stream. This approach has
a number of difficulties, which a more thorough needs analysis (described
previously) helps correct.
As one might expect, available methods for determining insurance needs share a
number of common elements. Each method must take into account the monetary
needs of dependents and the way those needs change as the client’s dependents
enter different stages of their lives. They must take into account the interest that
will be earned on funds set aside, tax brackets, rates of inflation, income the
survivors will earn, and anticipated inflation rates. An additional consideration is
whether the client wants his or her heirs to consume available assets in the
process of meeting these income needs. This is the “capital utilization” method or
the “annuity” approach. An alternate choice is to preserve funds using the
“interest only,” “capital preservation,” or “capital retention” approach so the
dependents receive an inheritance when the need for income ends. Note that with the
annuity approach, it is possible for the surviving spouse to outlive assets or income.
The annuity approach is most acceptable to those who have no heirs, feel they
have been able to assist their heirs sufficiently during their lifetime, or, for
whatever reason, do not wish to leave excess assets behind. The interest-only
approach is most acceptable for those clients who want to retain principal in
order to make a bequest following the death of both spouses. At the end of the
family income period, the entire principal is left intact as an inheritance for the
client’s heirs.
The longer the family income period and the higher the effective interest rate, the
smaller the difference between the two approaches. For example, assume a client’s
family needs $30,000 per year, starting immediately, for 30 years, and assume an

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8% after-tax return and no inflation. Using the annuity approach, the client needs a
lump sum of $364,752 today to provide the income stream. This is the present
value of an annuity due (PVAD) for the assumptions listed above. At the end of 30
years, the family would have had a level $30,000 per year and the entire principal
would have been used up. If we use interest only as the income stream (8% of the
principal), retaining all of the principal for the client’s heirs, the client needs
$375,000. This is a difference of only $10,248, or 2.8%. Therefore, for the
premiums on an additional $10,248 of insurance, the client can leave his or her
heirs $375,000 at the end of the family income period.
Note, however, that changes in the interest rate or income period can have a
dramatic effect. For example, if an assumption of 4% inflation is added to the
above calculation (reducing the effective after-tax and after-inflation rate of
return to 3.8462% [calculated using the inflation-adjusted rate of return
formula]), the need becomes $549,000 (rounded) for the annuity approach, and
$810,000 (rounded) for the interest-only approach. To calculate the need using
the interest-only approach, divide the desired income by the investment earnings
rate less the inflation rate, then add the first year’s income requirement.

$30,000
+ $30,000 = $810,000
.038462
This is a difference of $261,000, or 47.6%. Rather than changing the interest rate,
if the income period is changed to 10 years, the annuity approach requires
$217,407, while the interest-only approach still requires $375,000. The
difference, then, is $157,593, or 72.5%.
The annuity approach always will be the least expensive since it uses up principal
in addition to the interest earned on the principal. The interest-only approach will
be the most expensive as long as inflation is factored into the calculation.

Interest-Adjusted Cost Index Calculation

In general insurance textbooks, you can find the calculation for the interest-
adjusted cost index using a future value factor (value of premiums at interest,
minus value of dividends at interest, minus cash value at end of period, equals
interest adjusted cost).

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Interest Adjusted Cost Index
20 years’ premiums accumulated at 5% interest $ 8,333
Less 20 years’ dividends accumulated at 5% 2,256

Net premiums over 20-year period 6,077

Subtract year 20 cash surrender value 3,420

Insurance cost $2,657

Amount to which $1 deposited annually will accumulate

In 20 years at 5% $34.719

For interest-adjusted surrender cost index

Divide $2,657 by $34.719 $ 76.52

Interest-adjusted surrender cost index per $1,000 per

Year at the end of year 20 $ 7.65

The same result can be accomplished in fewer steps. Rather than calculating the
future value factor, calculate the total interest-adjusted cost as the “payment,”
with the same interest rate, number of years, and net premium cost as the future
value.
Perform the shortened version of the calculations in the following example.
With your calculator in the “begin” mode (this is an annuity due), enter the
following:
i = 5
n = 20
FV = $2,657
Calculate for PMT; this gives an answer of 76.53.
Divide this number by the number of thousands of insurance (in this case, 10),
and the final index of 7.65 is the same.

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Remember that these index numbers are not valid when comparing dissimilar
policies. They cannot be used to compare term with whole life, universal with
variable, or any other combination of policies.
While the interest-adjusted indices are very useful, for the most part, the
calculations should be left to actuaries. Nearly every computer-generated
illustration will include the interest-adjusted surrender cost index and the interest-
adjusted payments index.

Premarital (Prenuptial) Agreement

Potential divorce is one final consideration when looking at keeping or canceling
an insurance policy. A prenuptial (i.e., premarital) agreement may have
implications as to the policyowner’s ability to make changes to the policy.
However, many courts will override at least some of these considerations
when constructing a qualified domestic relations order (QDRO) pursuant to
divorce proceedings. This might especially be true when children from the
marriage are involved.
The typical marriage, particularly a first marriage, is not likely to involve much
premarital financial planning. However, in certain cases, a premarital agreement
does play a part in the marriage contract and, by implication, any divorce
proceeding that may occur. Such an agreement is somewhat more common in the
case of a second marriage between individuals with children from either or both
spouses’ prior marriages. The purpose of the premarital agreement is to limit the
presumed effect of the marriage on property acquired prior to, or during, the
marriage. Often property acquired by one spouse before marriage (or property
“brought to” the marriage) remains the separate property of that spouse and is not
subject to division upon dissolution of the marriage. In its most common form,
the premarital agreement involves a transfer of property from the more affluent
spouse to the other spouse in exchange for a release of all rights and claims the
other may have for support or may have against the transferor’s property.
Whether the premarital agreement will be enforceable in a court of law depends
upon a number of factors.

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Requirements
The first requirement that must be met for a premarital agreement to be
recognized is that it must be in writing and be signed by both parties affected. In
addition, some states have other formal requirements regarding the agreement,
such as having two witnesses, notarizing signatures, or executing the agreement
at least 10 days before the celebration of the marriage.
The second factor that must be present for a premarital agreement to be valid is
that a full and complete disclosure of each party’s net worth must be made.
Specifically, the provision for one spouse (normally the wife) cannot be clearly
disproportionate to the wealth of the other spouse, such that a presumption of
“designed concealment” arises. In such a case, the burden of proof is on the
wealthier party to show that the agreement is, in fact, fair and enforceable. As a
practical matter, this is not easily done.
Third, premarital agreements must not be intended to facilitate or promote the
procurement of a divorce. This results in the agreement being declared invalid as
contrary to public policy. For example, a premarital agreement that attempts to
regulate the disposition of property or an award of alimony on divorce would
probably be held invalid. This is in contrast to those agreements by which the
parties agree upon and fix the property rights that either spouse will have in the
case of the other’s death. Such contracts have been recognized as valid and not
contrary to public policy.
Fourth and finally, it must be shown that the agreement was executed willingly
by both parties without duress or coercion. Accordingly, if one party alleges
duress or coercion at the time of the agreement’s implementation, it is likely that
the agreement will not be binding.
Premarital agreements also have a variety of tax and insurance-related
implications that should be discussed thoroughly with the drafter. Primary among
these are gift and estate tax consequences that may occur. For our purposes,
planners should evaluate any prenuptial agreement when considering life
insurance ownership and beneficiary arrangements. This is especially true when
the planner is considering replacing an existing policy. Appropriate legal counsel
should be sought prior to making any changes.

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Summary

T
his module presented a process for analyzing and selecting a life
insurance policy. Time value of money concepts (presented in Module 3)
were applied in the life insurance needs analysis sections. You learned
what client data is essential in analyzing client needs. Practical steps for
calculating the amount of insurance needed also were presented. Finally, you
were given 13 stages to consider when selecting a life insurance policy for a
client, including information on how to evaluate possible replacement of an
existing policy.
Having read the material in this module, you should be able to:

6–1 Analyze client data to identify the facts affecting the selection of life
insurance policies.
6–2 Analyze a client’s financial situation and goals to calculate the
amount of life insurance needed under either the annuity or interest-
only method.
6–3 Evaluate the client’s life insurance selection facts to select the most
appropriate type of life insurance for the client.
6–4 Calculate life insurance costs to determine the most cost-effective
policy.
6–5 Evaluate factors that might influence the decision to keep or replace
a policy.

Before moving on to the next module, answer the Module Review

Questions that follow, and check your answers with those provided
(following the questions). Review the module text to help you master any
learning objective areas where you are not able to adequately answer
questions.

Summary  61
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Module Review
Questions
6–1 Analyze client data to identify the facts affecting the selection of life
insurance policies.

1. What are the life insurance selection fact categories used in the life insurance
selection process?

Go to answer.

2. Why are the life insurance selection facts used in the life insurance selection
process?

Go to answer.

3. Why is the use of the life insurance selection facts in the life insurance
selection process considered subjective?

Go to answer.

4. What personal financial information should the financial planner obtain

about the client to determine his or her life insurance needs?

Go to answer.

5. Identify the factors that affect the life insurance selection process for the
following types of clients.
a. a single person
Go to answer.
b. a married person without children

Go to answer.

c. a married person with children

Go to answer.

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Read the following information about the Winns, and use it to answer
questions 6, 7, and 8.
Rodney Winn is 38 years old and is married to Margaret, age 36. They have two
children, Jacob, age 17, and Susan, age 15. All are in good health. Both children
are planning to attend the state university located in their city. Assume each child
will begin college on his or her 18th birthday and end on his or her 22nd
birthday. Current costs are $6,000 a year per student.
Rodney’s take-home pay is $2,100 a month. Margaret works as a receptionist and
earns a net amount of $950 a month. Margaret and Rodney have a low risk
tolerance. The Winn family’s net worth is approximately $175,000. They own
$34,000 in liquid assets (which is well above the preferred amount of emergency
funds of three months of fixed and variable expenses) and $12,500 in nonliquid
assets, and have approximately $20,000 in liabilities. They put $6,500 into
savings annually. Margaret would most likely liquidate the majority of these
assets in the event of Rodney’s death.
Rodney has a $25,000 group term life insurance policy. The Winns have
adequate health and major medical coverage, which make a last-illness fund
unnecessary. They expect minimal estate transfer costs and funeral costs
(approximately $4,000). The Winns feel that Social Security will not be available
in the near future for their age category, and they would like Social Security,
death, and retirement benefits to be ignored. They feel they can obtain an after-
tax return of 7% on their investments and that inflation will average 5% over the
long run.
Margaret would like to maintain her current lifestyle through retirement if
something were to happen to Rodney, although her needs will be reduced
substantially after the children have completed college. The Winns expect that
after Jacob and Susan leave home, Margaret’s income needs will be half of the
Winns’ current income needs ($36,600 ÷ 2 = $18,300). Furthermore, half of this
amount will be provided by the retirement benefits under her pension plan at
work when Margaret turns 65. At that point (i.e., at retirement), Margaret would
like to be able to provide a guaranteed lifetime income for herself.

Module Review  63
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
6. Assume Rodney Winn is in good health and has a low risk tolerance level.
Use the information provided above to identify Rodney’s life insurance
selection facts.
Go to answer.

6–2 Analyze a client’s financial situation and goals to calculate the

amount of life insurance needed under either the annuity or interest-
only method.

7. Analyze the preceding client information (presented before question 6) to

calculate the amount of life insurance needed for Rodney Winn, using the life
insurance needs determination worksheet provided on the following pages.
Life Insurance Needs Determination Worksheet for Rodney Winn
Step 1
Gather information from the client.
Step 2
Estimate fair market value of assets owned. Classify assets as “liquid” or
“nonliquid.”

Assets at Fair Market Value

Liquid
Money market fund $ 2,500
Stock 3,000
Insurance proceeds 25,000
IRA (Rodney’s) 3,500
TOTAL LIQUID ASSETS $ 34,000

Nonliquid
Antique china collection $ 9,000
IRA (Margaret's) 3,500

TOTAL NONLIQUID ASSETS $ 12,500

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Step 3
Determine liabilities to be paid off if the client dies today.

Liabilities Amount
Credit cards $ 1,000
Auto note (Subaru) 7,450
Auto note (Volvo) 11,550

TOTAL LIABILITIES $ 20,000

Estimated Postmortem Expenses

Funeral expenses $ 2,000
Probate and estate expenses 2,000

TOTAL POSTMORTEM EXPENSES $ 4,000

TOTAL OF STEP 3 $ 24,000

Step 4
Determine liquid assets remaining, if any, after subtracting estimated
liabilities and postmortem expenses.

Total liquid assets (Step 2) $

Subtract estimated liabilities and

postmortem expenses (Step 3) $

TOTAL OF STEP 4 $

If the total is greater than zero, the amount represents remaining liquid assets
after total liabilities and postmortem expenses are paid. If the total is less
than zero, the amount represents the amount of insurance needed for estate
liquidity.

Module Review  65
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 Step 5 (For children age 15 until age 18)
Estimate funds needed to provide all dependents with income until the
youngest child reaches age 18. Use the following formula to determine the
interest rate for the serial payment calculation:

1 + after-tax return 
inflation-adjusted interest rate =  − 1 × 100
 1 + inflation rate 

a. Desired monthly income $ 3,050

b. Expected monthly after-tax earnings of spouse $ 950
Expected monthly Social Security benefits 0
Other monthly benefits 0
Total of Step b $ 950
c. Step a minus Step b $ 2,100
d. Multiply by 12 to arrive at annual total payment $ 25,200
e. Serial payment calculation:
Number of periods 3
% inflation 5%
% after-tax yield 7%
Calculate the present value of annuity due $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 5 $

Step 6
Estimate the amount required to provide higher-education funds for the
Winns’ children. *Use the following formula to determine the interest rate
for the serial payment calculation:

1 + after-tax return 
inflation-adjusted interest rate =  − 1 × 100
 1 + inflation rate 

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CHILD: Jacob
a. Annual college costs $
b. Serial payment adjustment
Inflation Calculation:
Number of periods until student begins college
% inflation
Calculate the future value of the needed income when
serial payments begin $
c. Serial Payment Calculation:
Number of years child will attend college
% inflation
% after-tax return
Calculate the present value of the annuity due $
d. Discount Calculation:
Number of periods until student begins college
% after-tax return
Calculate the present value of the above PVAD $

Module Review  67
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 CHILD: Susan

a. Annual college costs $

b. Serial payment adjustment

Inflation Calculation:

Number of periods until student begins college

% inflation

Calculate the future value of the needed income when

serial payments begin $

c. Serial Payment Calculation:

Number of years child will attend college

% inflation

% after-tax return

Calculate the present value of the annuity due $

d. Discount Calculation:

Number of periods until student begins college

% after-tax return

Calculate the present value of the above PVAD $

Calculate needs for each child, then total the needs for all children $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 6 $

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Step 7 (For age 39 until age 65)
Estimate preretirement income fund for spouse after youngest child reaches
age 18.

a. Desired annual income for surviving

spouse $ 18,300
b. Expected annual after-tax earnings
and benefits of spouse $ 11,400
c. Subtract Step b from Step a $ 6,900
d. Serial payment adjustment
Inflation Calculation:
Number of periods until serial payments
begin 3

% inflation 5%
Calculate the future value of the
needed income when serial payments
begin $
Serial Payment Calculation:
Number of periods between date when
youngest child reaches age 18 and
retirement 26
% inflation 5%
% after-tax yield 7%
Calculate the present value of annuity due (PVAD) $
Discount Calculation:
Number of periods until serial
payments begin 3
% after-tax return 7%

Calculate the present value of the above PVAD $

TOTAL AMOUNT NEEDED, IF ANY , IN STEP 7 $

Module Review  69
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 Step 8 (For age 65 until age 85)
Estimate retirement income fund for spouse.

a. Desired annual income for surviving spouse at

retirement $18,300
b. Expected Social Security, retirement, or other
benefits $9,150
c. Subtract Step b from Step a $9,150
d. Serial payment adjustment
Inflation Calculation:
Number of periods until retirement 29
% inflation 5%
Calculate the future value of the needed income $
Serial Payment Calculation:
Number of periods of retirement income 20
% inflation 5%
% after-tax yield 7%
Calculate the present value of annuity due (PVAD) $
Discount Calculation:
Number of periods until retirement 29
% after-tax return 7%
Calculate the present value of the above PVAD $
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 8 $

Step 9
The amount estimated for an emergency fund. $ 9,150

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 Step 10
Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 $
Step 6 $
Step 7 $
Step 8 $
Step 9 $
Total financial needs $
b. Total resources available (remaining
liquid assets from Step 4) $
c. Subtract total resources available in
Step b from the total financial needs
in Step a to determine insurance
needed, if any. $
d. List insurance needed, if any, to
provide estate liquidity. (This is the
case when the total in Step 4 is
negative.) $
e. Add the amounts in Steps c and d to
determine:
ADDITIONAL AMOUNT OF INSURANCE NEEDED, IF ANY $

Go to answer.

Module Review  71
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 6–3 Evaluate the client’s life insurance selection facts to select the most
appropriate type of life insurance for the client.

8. Based on your answers to Review Questions 6 and 7, select the most

appropriate type of life insurance for Rodney. Justify your selection by using
at least three of the six life insurance selection fact categories.

Go to answer.
9. Bill Mortensen is 48 years old, in excellent health, divorced, with two
children who live on their own. He owns a bakery and earns $68,000 a year.
His company provides him with $50,000 of group term insurance, but he has
no retirement plan. Bill has $450,000 in various investments (including the
value of the bakery, which is readily saleable to his daughter, Phyllis, under a
private annuity), but feels he needs another $150,000 for retirement, which
he plans to begin at age 65. Most of Bill’s investments outside of the
business are in CDs and yield currently taxable income.
Bill’s daughter, Phyllis, is involved in the day-to-day operation of the bakery,
while his son, Andrew, is happily engaged in his own auto repair business.
Bill wants Phyllis to be able to own and run the bakery, but he wants to
equalize the value of assets passing to Andrew at the same time.
To accomplish his objectives, Bill feels he needs another $300,000 of
insurance. Bill is a strong saver and is able to save $1,000 each month. He
has a low risk tolerance level. For purposes of this question, assume that
Bill’s estate is liquid. Using this information, identify the facts that affect
Bill’s selection of life insurance.

Go to answer.

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10. Based on your answer to Review Question 9, select the most appropriate type
of life insurance for Bill. Justify your selection by using at least three of the
six life insurance selection fact categories.

Go to answer.

11. Kelly Lyle is 28 years old and is in excellent health. She is divorced and has
one child, Jamie, age 5. She works as a legal secretary for a small law firm
and earns $18,000 a year. The company provides Kelly with $10,000 of
group term life insurance but has no retirement plan. Kelly has not started an
IRA, but she has $4,000 in a money market fund and $2,500 in municipal
bonds, and is able to save $150 each month. She has a low risk tolerance
level. Assume that Kelly’s estate is liquid and that she needs an additional
$100,000 of insurance. Using this information, identify the facts that affect
Kelly’s selection of life insurance.
Go to answer.

12. Based on your answer to Review Question 11, select the most appropriate
type of life insurance for Kelly. Justify your selection by using at least three
of the six life insurance selection fact categories.

Go to answer.

Module Review  73
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 6–4 Calculate life insurance costs to determine the most cost-effective
policy.

Use the table below to answer the following questions.

Benchmarks

Price per Front-End Load

Age* Thousand Multiple

Under 30 $1.50 10

30–34 2.00 9

35–39 3.00 8

40–44 4.00 7

45–49 6.50 6

50–54 10.00 5

55–59 15.00 4

60–64 25.00 3

65–69 35.00 3

70–74 50.00 3

75–79 80.00 2

80–84 125.00 2

*The insured’s current age is used.

Source: Belth, 1985

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 (P + CVP) (1 + i) − (CV + D)
Yearly price per thousand =
(DB − CV) (.001)
where
DB = Death benefit of policy
CV = Cash surrender value at end of current policy year
CVP = Cash surrender value at end of previous year
P = Annual premium
D = Dividend
i = Rate of interest chosen by the client and the financial
planner
.001 = Policy cost per thousand conversion

13. Ralph Pence is 42 years old. Fifteen years ago he purchased a participating
whole life policy with a face value of $100,000. His annual premium is $1,400.
The previous year’s cash surrender value was $29,500, and the cash value at
the end of this policy year will be $31,750. Ralph received a dividend of $400
last year. Ralph feels he can earn an after-tax yield of 6% on his investments of
comparable risk.
a. Using the yearly price method, compute the cost per thousand of Ralph’s
policy.
Go to answer.
b. How does Ralph’s policy compare to the yearly price method’s industry
benchmark?
Go to answer.
c. Is Ralph’s policy cost-effective?
Go to answer.
d. Is Ralph’s policy heavily front-end loaded?
Go to answer.

Module Review  75
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14. Sidney Smith is 52 years old and has a nonparticipating whole life policy
purchased several years ago. The face value is $85,000 with an annual
premium of $900. At the end of the previous year, the cash value was
$21,000. At the end of this year, the cash value will be $22,000. Sidney feels
he can obtain an after-tax yield of 5% on his investments of comparable risk.
a. Compute the cost per thousand of Sidney’s policy.
Go to answer.
b. How does Sidney’s policy compare to the industry benchmark?
Go to answer.
c. Is Sidney’s policy cost-effective?
Go to answer.
d. Is Sidney’s policy heavily front-end loaded?
Go to answer.

6–5 Evaluate factors that might influence the decision to keep or replace
a policy.

15. What factors should a policyowner consider in determining whether to

replace a policy?

Go to answer.

16. What is the traditional method of net cost comparisons, and why is it
misleading?

Go to answer.
17. What are the two forms of the interest-adjusted method of cost comparison?
Go to answer.

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18. George has been considering the purchase of a $100,000 life insurance policy
from several companies. The following cost data are given for each policy.

Surrender
Cost Net Payment
Company Policy type Index (10 yr.) Index (10 yr.)

XYZ Ins. Co. Universal Life $4.62 $10.65

PHLM Ins. Co. Whole Life $4.45 $11.41

FCP Life Term Insurance $3.22 $3.22

LODLICO Modified Whole Life $5.27 $8.22

What recommendation can be made based on this information?

Go to answer.
19. How is the Linton Yield derived?
Go to answer.

20. Explain the advantages and disadvantages of the four basic types of policy
replacement.
a. term with term
Go to answer.
b. term with cash value
Go to answer.
c. cash value with cash value
Go to answer.
d. cash value with term
Go to answer.

Module Review  77
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Answers
6–1 Analyze client data to identify the facts affecting the selection of life
insurance policies.

1. What are the life insurance selection fact categories used in the life insurance
selection process?
a. client profile

b. client goals and objectives

c. survivors’ needs

d. estate liquidity

e. risk tolerance

f. existing insurance

g. amount of insurance needed

Return to question.

2. Why are the life insurance selection facts used in the life insurance selection
process?
They define the client’s specific circumstances. These are then taken
into account in selecting an appropriate type and amount of life
insurance.
Return to question.

3. Why is the use of the life insurance selection facts in the life insurance
selection process considered subjective?
No single factor can be considered in isolation; all facts must be
weighed together.
Any weighing process is somewhat subjective.
Return to question.

78  The Life Insurance Selection Process

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4. What personal financial information should the financial planner obtain
about the client to determine his or her life insurance needs?
One category of personal information is about the individual’s family,
including ages, attitudes, goals, and personal resources.
Other information includes the fair market value of resources that
could be liquidated at the death of the insured.
Return to question.

5. Identify the factors that affect the life insurance selection process for the
following types of clients.
a. a single person
If the individual has no dependents, no insurance may be needed
if sufficient resources are available to pay final expenses.
If other persons are financially dependent on that individual, life
insurance may be needed to meet survivors’ needs.
Future insurance and insurability needs should be considered.
Return to question.
b. a married person without children

Are there sufficient financial resources available to avoid causing

a financial hardship to the surviving spouse?
Will the surviving spouse be self-supporting at a level that will
permit a satisfactory standard of living?
How long will it be before Social Security or other benefits will be
available?
Return to question.

Module Review  79
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 c. a married person with children
A planner would ask similar questions to those asked in 5b.
There must be sufficient funds to support children as well as the
surviving spouse.
There may be a need to provide a higher-education fund.
Return to question.

Read information about the Winns found preceding Question 6 in the Review
Questions section, and then use it to answer questions 6, 7, and 8.

6. Assume Rodney Winn is in good health and has a low risk tolerance level.
Use the information provided above to identify Rodney’s life insurance
selection facts.
Client profile:
Age: 38
Annual salary: $25,200 (net)
Health: Good
Last year’s savings and $6,500
investments:
Client goals and objectives: Same as survivors’ needs
Survivors’ needs: He needs a fund for income while
the children are under age 18, an
education fund, and a spousal
income fund for preretirement and
retirement years.
Estate liquidity: Liquid
Risk tolerance: Low
Existing insurance: $25,000 group term
Amount of insurance needed: $342, 586 (see question 7 for
calculations)

Return to question.

80  The Life Insurance Selection Process

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 6–2 Analyze a client’s financial situation and goals to calculate the
amount of life insurance needed under either the annuity or interest-
only method.

7. Analyze the preceding client information (presented before Question 6) to

calculate the amount of life insurance needed for Rodney Winn, using the life
insurance needs determination worksheet provided on the following pages.
Life Insurance Needs Determination Worksheet for Rodney Winn

Step 1
Gather information from the client.

Step 2
Estimate fair market value of assets owned. Classify assets as “liquid” or
“nonliquid.”

Assets at Fair Market Value

Liquid

Money market fund $ 2,500

Stock 3,000

Insurance proceeds 25,000

IRA (Rodney’s) 3,500

TOTAL LIQUID ASSETS $ 34,000

Nonliquid
Antique china collection $ 9,000
IRA (Margaret's) 3,500
TOTAL NONLIQUID ASSETS $ 12,500

Module Review  81
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 Step 3
Determine liabilities to be paid off if the client dies today.

Liabilities Amount
Credit cards $ 1,000
Auto note (Subaru) 7,450
Auto note (Volvo) 11,550
TOTAL LIABILITIES $ 20,000

Estimated Postmortem Expenses

Funeral expenses $ 2,000
Probate and estate expenses 2,000
TOTAL POSTMORTEM EXPENSES $ 4,000

TOTAL OF STEP 3 $ 24,000

Step 4
Determine liquid assets remaining, if any, after subtracting estimated
liabilities and postmortem expenses.

Total liquid assets (Step 2)

Subtract estimated liabilities and
postmortem expenses (Step 3)

TOTAL OF STEP 4

If the total is greater than zero, the amount represents remaining liquid assets
after total liabilities and postmortem expenses are paid. If the total is less
than zero, the amount represents the amount of insurance needed for estate
liquidity.

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 Step 5 (For children age 15 until age 18)
Estimate funds needed to provide all dependents with income until the
youngest child reaches age 18. *Use the following formula to determine the
interest rate for the serial payment calculation:

1 + after-tax return 
inflation-adjusted interest rate =  − 1 × 100
 1 + inflation rate 

a. Desired monthly income $ 3,050

b. Expected monthly after-tax earnings of spouse $ 950
Expected monthly Social Security benefits 0
Other monthly benefits 0
Total of Step b $ 950
c. Step a minus Step b $ 2,100
d. Multiply by 12 to arrive at annual total payment $ 25,200
e. Serial payment calculation*:
Number of periods 3
% inflation 5%
% after-tax yield 7%
Calculate the present value of annuity due $ 74,196
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 5 $ 74,196

Module Review  83
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Step 6
Estimate the amount required to provide higher-education funds for the
Winns’ children. *Use the following formula to determine the interest rate
for the serial payment calculation:

1 + after-tax return 
inflation-adjusted interest rate =  − 1 × 100
 1 + inflation rate 

CHILD: Jacob
a. Annual College Costs $ 6,000
b. Serial Payment Adjustment
Inflation Calculation:
Number of periods until student begins college 1
% inflation 5%
Calculate the future value of the needed
income when serial payments begin $ 6,300
c. Serial Payment Calculation:
Number of years child will attend college 4
% inflation 5%
% after-tax return 7%
Calculate the present value of the annuity due $ 24,502
d. Discount Calculation:
Number of periods until student begins college 1
% after-tax return 7%
Calculate the present value of the above PVAD $ 22,899

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
CHILD: Susan
a. Annual College Costs $ 6,000
b. Serial Payment Adjustment
Inflation Calculation:
Number of periods until student begins college 3
% inflation 5%

Calculate the future value of the needed

income when serial payments begin $ 6,946
c. Serial Payment Calculation:
Number of years child will attend college 4
% inflation 5%
% after-tax return 7%
Calculate the present value of the annuity due $ 27,014
d. Discount Calculation:
Number of periods until student begins college 3
% after-tax return 7%
Calculate the present value of the above PVAD $ 22,051
Calculate needs for each child, then total
the needs for all children

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 6 $ 44,950

Module Review  85
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Step 7 (For age 39 until age 65)
Estimate preretirement income fund for spouse after youngest child reaches
age 18.

Desired annual income for

a. surviving spouse $18,300

b. Expected annual after-tax

earnings and benefits of spouse $11,400

c. Subtract Step b from Step a $6,900

d. Serial payment adjustment

Inflation Calculation:
Number of periods until serial
payments begin 3

% inflation 5%

Calculate the future value of the needed

income when serial payments begin $7,988
Serial Payment Calculation:

Number of periods between date

when youngest child reaches
age 18 and retirement 26
% inflation 5%
% after-tax yield 7%
Calculate the present value of annuity due
(PVAD) $165,699
Discount Calculation:
Number of periods until serial
payments begin 3
% after-tax return 7%
Calculate the present value of the above PVAD $135,260

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 7 $135,260

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Step 8 (For age 65 until age 85)
Estimate retirement income fund for spouse.

Desired annual income for surviving

a.
spouse at retirement $18,300
Expected Social Security,
b.
retirement, or other benefits $9,150
c. Subtract Step b from Step a $9,150
d. Serial payment adjustment
Inflation Calculation:
Number of periods until retirement 29
% inflation 5%
Calculate the future value of the needed income $37,663
Serial Payment Calculation:
Number of periods of retirement
income 20
% inflation 5%

% after-tax yield 7%
Calculate the present value of annuity due (PVAD) $633,381
Discount Calculation:
Number of periods until retirement 29
% after-tax return 7%
Calculate the present value of the above PVAD $89,030
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 8 $89,030

Step 9
The amount estimated for an emergency fund. $ 9,150

Module Review  87
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Step 10
Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 $ 74,196
Step 6 $ 44,950
Step 7 $ 135,260
Step 8 $ 89,030
Step 9 $ 9,150
Total financial needs $ 352,586
b. Total resources available (remaining liquid assets
from Step 4) $ 10,000
c.
Subtract total resources available in Step b from the total financial needs in
Step a to determine insurance needed, if any. $ 342,586
d. List insurance needed, if any , to provide estate liquidity. (This is the case
when the total in Step 4 is negative.)
0
e. Add the amounts in Steps c and d to determine:

ADDITIONAL AMOUNT OF INSURANCE NEEDED, IF ANY $ 342,586

Return to question.

6–3 Evaluate the client’s life insurance selection facts to select the most
appropriate type of life insurance for the client.

8. Based on your answers to Review Questions 6 and 7, select the most

appropriate type of life insurance for Rodney. Justify your selection by using
at least three of the six life insurance selection fact categories.
 Client profile: Rodney’s age and health do not prevent the
selection of any type of insurance. The ratio of Rodney’s savings
to net income, without another explanation, indicates that he and
Margaret are excellent savers. Therefore, the client’s age, health,
or savings rate will not preclude the selection of any product.

88  The Life Insurance Selection Process

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 Client goals and objectives: There is nothing in the case
information that would cause the student to believe that Rodney
has any goals or objectives that would interfere with his survivors’
needs.
 Survivors’ needs: Rodney has some short-term needs: income
while the children are under age 18; and the college funding need,
which, while it will start in the short term, does stretch out for the
next seven years. Nevertheless, these shorter-term needs total
only $119,146 out of a total need for $342,586 of insurance.
Therefore, the duration of the bulk of Rodney’s survivors’ needs
would argue for a permanent form of insurance. However, it
should be noted that, although the Winns are able to save an
impressive $6,500 per year, they are facing substantial outlays in
only one more year—when Jacob starts college. These expenses
will increase significantly when Susan starts college in three
years. Therefore, while their profile may allow any product and the
duration of their needs indicates that they should choose a
permanent product, their college funding situation may actually
limit them to a minimal outlay for the next few years. This could be
one of those factors in a client situation that overrides the
economic reasons for buying permanent insurance as early as
possible. Here it makes sense to ignore the economics of buying a
permanent product due to the overriding client consideration of the
immediacy of college expenses. This same consideration also
justifies Rodney in maintaining his higher-than-usual $34,000 in
liquid assets.
For these reasons, it would not be advisable to consider using
what otherwise would be considered excess cash equivalents or
Rodney and Margaret’s demonstrated ability to save to pay for
permanent insurance. If an “annually renewable and convertible
term” product is recommended, Rodney can drop the face amount
by $75,000 when the college need has passed and convert the
balance to permanent insurance. This will allow Rodney to
purchase permanent insurance for his long-term needs in the not-

Module Review  89
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 too-distant future, when the college expenses suddenly disappear
and he has substantially more funds to pay for it. In the meantime,
the term insurance will protect his family’s future, leave him with
as much disposable income as possible to meet college
expenses, and guarantee his insurability for the next few years
due to its conversion feature. Note: Normally, if permanent
insurance is advisable, it should be recommended up front. Only
where there is an overriding consideration requiring term
insurance for the short term (as here) should a “buy term and then
convert” recommendation be made.

 Estate liquidity: Rodney’s estate liquidity needs are long-term

needs and should eventually be met with permanent insurance.
Due to the considerations listed above, it is recommended that
this be done through conversion of term insurance after college
expenses are met.
 Risk tolerance: The “annually renewable and convertible term” will
give Rodney a guaranteed premium (it does increase annually,
but a maximum increase is guaranteed in the contract) and a
guaranteed death benefit as long as he pays the premium. As the
name implies, it also will guarantee his insurability for the future,
when conversion will be recommended. An alternative might be a
convertible five- or ten-year level premium term. A careful cost
comparison should be made.

 Existing insurance and amount of insurance needed: Neither of

these considerations is relevant in this situation. Rodney can
afford the amount of insurance he needs now as term and easily
pay for it as permanent when the need for college funding has
passed.
Return to question.

90  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
9. Bill Mortensen is 48 years old, in excellent health, divorced, with two
children who live on their own. He owns a bakery and earns $68,000 a year.
His company provides him with $50,000 of group term insurance, but he has
no retirement plan. Bill has $450,000 in various investments (including the
value of the bakery, which is readily saleable to his daughter, Phyllis, under a
private annuity), but feels he needs another $150,000 for retirement, which
he plans to begin at age 65. Most of Bill’s investments outside of the
business are in CDs and yield currently taxable income.
Bill’s daughter, Phyllis, is involved in the day-to-day operation of the bakery,
while his son, Andrew, is happily engaged in his own auto repair business.
Bill wants Phyllis to be able to own and run the bakery, but he wants to
equalize the value of assets passing to Andrew at the same time.
To accomplish his objectives, Bill feels he needs another $300,000 of
insurance. Bill is a strong saver and is able to save $1,000 each month. He
has a low risk tolerance level. For purposes of this question, assume that
Bill’s estate is liquid. Using this information, identify the facts that affect
Bill’s selection of life insurance.

Client profile:
Age: 48
Annual salary: $68,000
Health: Excellent
Last year’s savings and $12,000
investments:
Client goals and objectives: Estate equalization
Survivors’ needs: None
Estate liquidity: Liquid
Risk tolerance: Low
Existing insurance: $50,000 group term
Amount of insurance needed: $300,000
Return to question.

Module Review  91
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
10. Based on your answer to Review Question 9, select the most appropriate type
of life insurance for Bill. Justify your selection by using at least three of the
six life insurance selection fact categories.
Note that this analysis will be rudimentary due to the lack of details
concerning the client.
 Client profile: Bill’s client profile is very important to product
selection. He is a strong saver with a substantial salary. His
substantial salary and single person tax-filing status tell you that
any currently taxable yield on his savings will be subject to a
substantial tax rate. These two factors combine to suggest a
permanent product. Universal life would provide permanent
protection (which Bill’s strong savings habit suggests he would
have the discipline to keep up through adequate premium
contributions), a tax-deferred accumulation on the cash values,
the ability to borrow or make withdrawals against the cash value at
retirement, and the flexibility to vary premium payments if he
needed to because of income fluctuations.
 Survivors’ needs: None. Bill intends to sell the business to Phyllis
using a private annuity. Neither child would require support upon
his death. In fact, Phyllis would be better off financially because
her annuity payments for the purchase of the business would
cease.

 Client goals and objectives: Bill’s only survivor needs come under
the heading of estate equalization, and this is something he
wants. Apparently the business is such a substantial portion of
Bill’s estate that bequeathing it to Phyllis would leave Andrew with
a smaller inheritance than Phyllis. Such a need will continue until
either retirement or death. That being the case, we know that the
need for insurance will continue for at least 17 years (to age 65) or
beyond. Universal life would allow Bill to continue the insurance
for as long as he wishes, with a premium that could be designed
to be level using conservative assumptions. At retirement Bill
would have several options, and the insurance would have the
flexibility to accommodate any of them.

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  Estate liquidity: This is not a consideration for Bill since it already
is adequate without the insurance.
 Risk tolerance: Universal life would be appropriate for Bill’s low
risk tolerance. It has a guaranteed maximum mortality cost and
guaranteed maximum administrative fees. It also has a
guaranteed minimum interest rate. All of these should combine to
make Bill comfortable with the product.
 Existing insurance: Bill’s existing insurance has no impact on our
considerations.
 Amount of insurance needed: Bill could afford $300,000 of any
type of insurance, so this is not a major consideration either.
Return to question.

11. Kelly Lyle is 28 years old and is in excellent health. She is divorced and has
one child, Jamie, age 5. She works as a legal secretary for a small law firm
and earns $18,000 a year. The company provides Kelly with $10,000 of
group term life insurance but has no retirement plan. Kelly has not started an
IRA, but she has $4,000 in a money market fund and $2,500 in municipal
bonds, and is able to save $150 each month. She has a low risk tolerance
level. Assume that Kelly’s estate is liquid and that she needs an additional
$100,000 of insurance. Using this information, identify the facts that affect
Kelly’s selection of life insurance.

Client profile:
Age: 28
Annual salary: $18,000
Health: Excellent
Last year’s savings and $1,800
investments:
Client goals and objectives: Same as survivors’ needs
Survivors’ needs: She will need an income
and education fund for
her child.
Estate liquidity: Liquid

Module Review  93
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 Risk tolerance: Low
Existing insurance: $10,000 group term
Amount of insurance needed: $100,000
Return to question.

12. Based on your answer to Review Question 11, select the most appropriate
type of life insurance for Kelly. Justify your selection by using at least three
of the six life insurance selection fact categories.
Note that this analysis will be rudimentary due to the lack of details
concerning the client.
 Client profile: Kelly’s client profile is very important to product
selection. She is young and has a very low income, yet has
substantial financial needs. While 10% of annual gross income
often is thought of as a guideline for annual savings, given her
income level and responsibilities, Kelly should be thought of as an
extraordinarily strong saver. Her savings ability, along with her
tight budget, could be used as an argument that term is
appropriate for her. With her budget so tight, she needs to
maximize her savings in the short term and keep as much money
available as possible. The higher front-end load on permanent
products makes their performance less attractive in a short time
frame. Term insurance would allow her to continue her strong
savings pattern outside an insurance product and allow her
access to her funds if she needs them in the next five years or so.
Further, since she is such a strong saver, she would not
particularly benefit from the “forced savings” feature of a
permanent product. Finally, with such a low income and low tax
bracket, the benefits to be derived from the tax deferral of income
on her investments would not be a major consideration.
 Client goals and objectives: These are the same as survivors’
needs.

 Survivors’ needs: Kelly’s child will have income or educational

needs for the next 17 years. While permanent products are

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 generally most appropriate for long-term needs like this, one could
argue that Kelly’s financial situation overrides this consideration.
Further, since she only has one child, each year that passes
reduces her need for life insurance. Thus, Kelly could periodically
reduce the face amount of her term product, if appropriate, to
partially offset the effect of the increasing premium. This periodic
reduction would allow her term policy to meet her changing needs
on a very inexpensive basis.

 Estate liquidity: This is not a consideration for Kelly, since the

liquidity of her estate is already adequate without the insurance.
 Risk tolerance: Term would be appropriate for Kelly’s low risk
tolerance. Since term has a guaranteed maximum premium
(although it increases every year, the policy contains a table
showing the maximum allowed in any given year) and a
guaranteed death benefit, she would be comfortable with it.
 Existing insurance: Her existing insurance has no impact on our
considerations.
 Amount of insurance needed: Kelly could afford $100,000 of any
type of insurance, so this is not a major consideration either.
Because she needs only $100,000 and because this need will
decrease in the future, the use of term is indicated here; there
currently does not appear to be any need to retain a substantial
amount of insurance in her old age (unless the cash buildup is
used to augment her retirement income).
Return to question.

Module Review  95
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 6–4 Calculate life insurance costs to determine the most cost-effective
policy.

Note: Refer to the table in the Questions section to answer questions 13 and 14.

13. Ralph Pence is 42 years old. Fifteen years ago he purchased a participating
whole life policy with a face value of $100,000. His annual premium is
$1,400. The previous year’s cash surrender value was $29,500, and the cash
value at the end of this policy year will be $31,750. Ralph received a
dividend of $400 last year. Ralph feels he can earn an after-tax yield of 6%
on his investments of comparable risk.
a. Using the yearly price method, compute the cost per thousand of Ralph’s
policy.

($1,400 + $29,500) (1.06) − ($31,750 + $400) $604

= = $8.85
($100,000 − $31,750) (.001) $68.25
Return to question.
b. How does Ralph’s policy compare to the yearly price method’s industry
benchmark?
benchmark = $4; $8.85 is more than double the benchmark
Return to question.
c. Is Ralph’s policy cost-effective?
No
Return to question.
d. Is Ralph’s policy heavily front-end loaded?
no; $8.85 ÷ $4 = 2.21, which is lower than the front-end load
multiple; loads are reasonable
Return to question.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
14. Sidney Smith is 52 years old and has a nonparticipating whole life policy
purchased several years ago. The face value is $85,000 with an annual
premium of $900. At the end of the previous year, the cash value was
$21,000. At the end of this year, the cash value will be $22,000. Sidney feels
he can obtain an after-tax yield of 5% on his investments of comparable risk.
a. Compute the cost per thousand of Sidney’s policy.

($900 + $21,000) (1.05) − ($22,000) $995

= = $15.79
( $85,000 − $22,000) (.001) $63
Return to question.

b. How does Sidney’s policy compare to the industry benchmark?

benchmark = $10; $15.79 is less than double the benchmark
Return to question.
c. Is Sidney’s policy cost-effective?
Yes
Return to question.
d. Is Sidney’s policy heavily front-end loaded?
no; $15.79 ÷ $10 = 1.579, which is lower than the front-end load
multiple; loads are reasonable
Return to question.

Module Review  97
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 6–5 Evaluate factors that might influence the decision to keep or replace
a policy.

15. What factors should a policyowner consider in determining whether to

replace a policy?
 cost-effectiveness of the current policy
 age and health of the insured
 new acquisition costs
 contestable period
 lower dividends
 lower cash value
 financial stability of the insurer
 quality of coverage
Return to question.
16. What is the traditional method of net cost comparisons, and why is it
misleading?
Under the traditional net cost method, the net cost equals the sum of
total premiums to be paid, less projected dividends, less cash value at
the end of the period. This method ignores the time value of money.
Return to question.

17. What are the two forms of the interest-adjusted method of cost comparison?
a. The “surrender cost index” equals the accumulation of premiums
less dividends accumulated at interest, less the cash value at the
end of the period. Using the end of the period as the future value,
the payment is calculated.
b. The “net payment index” is similar to the surrender cost index,
except that the cash value is not deducted.
In both instances, the lower the index, the better the policy.
Return to question.

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© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
18. George has been considering the purchase of a $100,000 life insurance policy
from several companies. The following cost data are given for each policy.

Surrender Cost Net Payment

Company Policy type Index (10 yr.) Index (10 yr.)
XYZ Ins. Co. Universal Life $4.62 $10.65
PHLM Ins. Co. Whole Life $4.45 $11.41
FCP Life Term Insurance $3.22 $3.22
LODLICO Modified Whole Life $5.27 $8.22

What recommendation can be made based on this information?

No recommendation may be made based on this information. Since
all four of the policies shown are dissimilar, the surrender cost and net
payment indices may not be used to compare them. Use of these
indices is acceptable only when comparing similar policies. Even
though whole life and modified whole life are somewhat similar, they
are different products. Modified whole life has low premiums for the
first few years, which gives it a distinct advantage over whole life in
the net payment index. It also has a very low cash value until the
premiums increase, which gives the edge to whole life in the surrender
cost index. The use of these indices requires the recognition that different
types of policies may not be compared using the indices.
Return to question.

19. How is the Linton Yield derived?

Annual premium - Dividends - Term cost = Addition to savings
Additional savings
Rate of return =
Beginning cash surrender value
The rate of return is then calculated over a period of time from 5 to 20
years.
Return to question.

Module Review  99
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
20. Explain the advantages and disadvantages of the four basic types of policy
replacement.
Policy Replacement Issues
Type of
Policy Advantages Disadvantages
a. Term least complex alternative; new contestable period and
with term no concern with built-up suicide clause period; some
cash values; if alternative term policies do pay
policy is more cost- dividends, and dividends
effective, consider from new policies would be
replacement lower
b. Term normally can be done replacing term with cash
with cash through term’s conversion value policy of equal
value
clause; tax deferral on coverage results in a large
savings; answers the need increase in premium; if not a
for forced savings; answers conversion, new contestable
the need for insurance past period and suicide clause
an age when term would period
become too expensive to
continue
c. Cash none, unless alternative may require payment of a
value with policy has better coverage new sizable front-end load;
cash value
or is less expensive because insured is older,
new premium could be
higher
d. Cash reduces outlay in the short once a reasonably good cash
value with term; may better answer value policy is purchased, it
term
policyowner’s needs is usually best to retain it; if
replaced soon after
purchase, a substantial loss
is inevitable for policyowner
Return to question.

100  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
References
Belth, Joseph M. Life Insurance, A Consumer’s Handbook, 2nd ed. Bloomington,
IN: Indiana University Press, 1985.
Black, Kenneth Jr., and Harold Skipper Jr. Life Insurance, 13th ed. Upper Saddle
River, NJ: Prentice-Hall, 2013.
Leimberg, Stephan R., and Robert J. Doyle. The Tools and Techniques of Life
Insurance Planning, 5th ed. Cincinnati: The National Underwriter Co., 2012.
Stanaland, Terence B., and Richard C. Baier. “The Impact of Final Split-Dollar
Regulations on Private Split-Dollar Arrangements.” Journal of Financial Service
Professionals, April 2004.

References  101
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Appendix A
Mr. and Mrs. Delgado: An Example
Your clients, John and Mirralee Delgado, both age 34 and in excellent health,
have come to you to discuss how much life insurance Mirralee should have. John
is a securities analyst with a major regional bank. He earns $40,000 annually,
receives health insurance and group term life insurance from the bank, and is
vested in the company pension fund. Mirralee, a CPA, began working for a small
computer software firm two years ago, where she earns $45,000 a year. Her
company does not offer a life insurance program, but Mrs. Delgado purchased an
annually renewable term life insurance policy two years ago on herself. The
policy has a face value of $100,000. John and Mirralee have two sons—Mike,
age 2, and Jim, age 5. You have prepared the Delgados’ statement of financial
position and cash flow statement from information on the client data survey form
they completed. At your most recent meeting with them, you agreed on the
following assumptions on which to base their life insurance program.
 The Delgados expect inflation to average 4% over the long run, and they
expect their investments to average an after-tax yield of 6%. They have a
moderate risk tolerance.
 Both Mike and Jim will attend college for four years. John and Mirralee
expect to pay $9,000 for each child per year (in today’s dollars) for their
education. Assume each child will begin on his 18th birthday and end on his
22nd birthday.
John expects the following if Mirralee dies:
 $500 for postmortem expenses (to meet the deductible on his major medical
policy), $5,000 for funeral costs, and $8,630 for probate and estate tax
expenses
 $325 in monthly Social Security benefits per child until each child reaches
the age of 18
 an annual income need of $36,000 in today’s dollars

102  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
John has current monthly after-tax earnings of $2,400. He anticipates that
between Social Security benefits and his company pension, his annual retirement
income will be $20,400.
John has indicated that, in the event of Mirralee’s death, he would not liquidate
the residence or the artwork that his brother gave to him and Mirralee. Based on
these assumptions and the information in the financial statements on the next two
pages, determine how much additional life insurance, if any, Mirralee Delgado
should buy.

Appendix A  103
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 John and Mirralee Delgado
Statement of Financial Position
As of December 31, 20XX

ASSETS LIABILITIES AND NET WORTH

Cash/Cash
Equivalents Liabilities
NOW Ac c ount $ 3,000 Credit c ard balanc e $ 300
Money market Residenc e home note balanc e
fund 21,530 43,330
Total Cash/Cash
Equivalents
$ 24,530 Rental house note balanc e 37,500

Auto note balanc e 5,740

Auto note balanc e 10,290
Invested Assets Total Liabilities $ 97,160
Stoc k investments $ 17,000
IRA investments 1 13,360
Vested pension
benefits 13,180
Art investments 3,500
Real estate limited
partnership 4,000
Rental house 2 100,000
Total Invested
Assets $ 151,040
Use Assets Net Worth $ 256,085
1997 auto $ 12,300
1996 auto 10,000
Household
furnishings 8,700
Clothing, jewelry,
etc . 11,800
Residenc e 134,875

Total Use Assets $ 177,675

TOTAL LIABILITIES AND
TOTAL ASSETS $ 353,245 NET WORTH $ 353,245

104  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 John and Mirralee Delgado
Cash Flow Statement
For the Year Ending December 31, 20XX
INFLOWS
Gross salaries $ 85,000
Rental income 6,980
Interest income 1,650
income 450
Dividend income 220
TOTAL INFLOWS $ 94,300

OUTFLOWS
Savings and investments $ 5,640
Fixed Outflows
1
payments $ 10,608
2
payments 5,010
3
Auto note payments 9,780
4
Taxes 33,180
Insurance premiums 2,540
Property taxes 2,500
Total Fixed Outflows $ 63,618
Variable Outflows
Food $ 6,500
Transportation 3,700
Clothing/personal care 3,460
Entertainment/vacations 3,780
Medical/dental care 730
Household furnishings 2,000
Utilities 2,372
Miscellaneous 2,500
Total Variable Outflows $ 25,042
TOTAL OUTFLOWS $ 94,300
1
Monthly payments of $884 include principal and interest.
2
Monthly payments of $417.50 include principal and interest.
3
Monthly payments of $815 include principal and interest.
4
FICA and federal and state income taxes.
Note: All calculations have been based on four decimal places.

Appendix A  105
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 1
Gather information from the client.

Step 2
Estimate fair market value of assets owned. Classify assets as “liquid” or
“nonliquid.”

Assets at Fair Market Value

Liquid
Money market fund $ 21,530
Stock 17,000
IRA (Miralee's) 11,300
Insurance proceeds 100,000
TOTAL LIQUID ASSETS $ 149,830

Nonliquid
Art investment $ 3,500
Real estate limited partnership 4,000
Rental home equity 62,500
IRA (John's) 2,060
Vested pension benefits (John's) $ 13,180
TOTAL NONLIQUID ASSETS $ 85,240

106  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 3
Determine liabilities to be paid off if client dies today.

Liabilities Amount
Credit cards $ 300
Auto note 5,740
Auto note 10,290
TOTAL LIABILITIES $ 16,330

Estimated Postmortem Expenses

Last illness 500
Funeral expenses $ 5,000
Probate and estate costs 8,630
TOTAL POSTMORTEM EXPENSES 14,130
TOTAL OF STEP 3 $ 30,460

Step 4
Determine liquid assets remaining, if any, after subtracting estimated liabilities
and postmortem expenses.

Total liquid assets $ 149,830

Subtract estimated liabilities
and postmortem expenses
(Step 3) $ -30,460

TOTAL OF STEP 4 $ 119,370

If the total is greater than zero, the amount represents remaining liquid assets
after total liabilities and postmortem expenses are paid. If the total is less than
zero, the amount represents the amount of insurance needed for estate liquidity.

Appendix A  107
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 5 (For children age 2 until age 18)
Estimate the funds needed to provide all dependents with income until youngest
child reaches age 18.

a. Desired monthly income* $

b. Expected monthly after-tax earnings of spouse $
Expected monthly Social Security benefits** 650
Other monthly benefits
Total of Step b $
c. Step a minus Step b $

d. Multiply by 12 to arrive at annual total payment $

e. Serial payment calculation:
Number of periods
% inflation %
% after-tax yield %
Calculate the present value of annuity due $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 5 $

* $36,000 ÷ 12 = $3,000
** The $650 amount is provided for this problem

108  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 6
Estimate the amount required to provide higher-education funds for the
Delgados’ children.

CHILD: Mike
a. Annual college costs $

b. Serial Payment Adjustment

Inflation Calculation:
Number of periods until student begins college
% inflation %
Calculate the future value of the needed
income when serial payments begin $

c. Serial Payment Calculation:

Number of years child will attend college
% inflation %
% after-tax return %
Calculate the present value of the annuity due $

d. Discount Calculation:
Number of periods until student begins college
% after-tax return %
Calculate the present value of the above PVAD $
Calculate needs for each child, then total the
needs for all children

Appendix A  109
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 CHILD: Jim
a. Annual college costs $
b. Serial Payment Adjustment
Inflation Calculation:
Number of periods until student begins college
% inflation %
Calculate the future value of the needed
income when serial payments begin $

c. Serial Payment Calculation:

Number of years child will attend college
% inflation %
% after-tax return %
Calculate the present value of the annuity due $
d. Discount Calculation:
Number of periods until the student begins
college
% after-tax return %
Calculate the present value of the above PVAD $
Calculate needs for each child, then total the
needs for all children
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 6 $

110  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 7 (For age 50 until age 65)
Estimate preretirement income fund for spouse after youngest child reaches age
18.

a. Desired annual income for surviving spouse $

Expected annual after-tax earnings and benefits
b.
of spouse $
c. Subtract Step b from Step a $

d. Serial payment adjustment

Inflation Calculation:
Number of periods until serial payments begin
% inflation %
Calculate the future value of the needed income
when serial payments begin $
Serial Payment Calculation:
Number of periods between date when youngest
child reaches age 18 and retirement
% inflation %
% after-tax yield %
Calculate the present value of annuity due (PVAD)* $
Discount Calculation:
Number of periods until serial payments begin
% after-tax return %
Calculate the present value of the above PVAD $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 7 $

*No rounding was done in these calculations. If you did any rounding, your answers may be a
few dollars off.

Appendix A  111
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 8 (For age 65 until age 85)
Estimate retirement income fund for spouse.

a. Desired annual income for surviving spouse at

retirement $
b. Expected Social Security, retirement, or other
benefits $

c. Subtract Step b from Step a $

d. Serial payment adjustment

Inflation Calculation:
Number of periods until retirement
% inflation %
Calculate the future value of the needed income $
Serial Payment Calculation:
Number of periods of retirement income
% inflation %
% after-tax yield %
Calculate the present value of annuity due (PVAD) $
Discount Calculation:
Number of periods until retirement
% after-tax return %
Calculate the present value of the above PVAD $
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 8 $

Step 9
The amount estimated for an emergency fund. $14,400

112  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 10
Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 $
Step 6 $
Step 7 $
Step 8 $
Step 9 $
Total financial needs $
b. Total resources available (remaining
liquid assets from Step 4)
$
c. Subtract total resources available in
Step b from the total financial needs
in Step a to determine insurance
needed, if any. $
d. List insurance needed, if any, to
provide estate liquidity. (This is the
case when the total in Step 4 is
negative.) 0
e. Add the amounts in Steps c and d to determine:

ADDITIONAL AMOUNT OF INSURANCE NEEDED, IF ANY $

Appendix A  113
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Life Insurance Needs Determination
Worksheet (Completed) for Mirralee Delgado
Step 1
Gather information from the client.

Step 2
Estimate fair market value of assets owned. Classify assets as “liquid” or
“nonliquid.”

Assets at Fair Market Value

Liquid
Money market fund $ 21,530
Stock 17,000
IRA (Miralee's) 11,300
Insurance proceeds 100,000
TOTAL LIQUID ASSETS $ 149,830

Nonliquid
Art investment $ 3,500
Real estate limited partnership 4,000
Rental home equity 62,500
IRA (John's) 2,060
Vested pension benefits (John's) $ 13,180
TOTAL NONLIQUID ASSETS $ 85,240

114  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 3
Determine liabilities to be paid off if client dies today.

Liabilities Amount
Credit cards $ 300
Auto note 5,740
Auto note 10,290
TOTAL LIABILITIES $ 16,330

Estimated Postmortem Expenses

Last illness $ 500
Funeral expenses 5,000
Probate and estate costs 8,630
TOTAL POSTMORTEM EXPENSES 14,130
TOTAL OF STEP 3 $ 30,460

Step 4
Determine liquid assets remaining, if any, after subtracting estimated liabilities
and postmortem expenses.

Total liquid assets $ 149,830

Subtract estimated liabilities and postmortem expenses (Step 3) $ -30,460
TOTAL OF STEP 4 $ 119,370

If the total is greater than zero, the amount represents remaining liquid assets
after total liabilities and postmortem expenses are paid. If the total is less than
zero, the amount represents the amount of insurance needed for estate liquidity.

Appendix A  115
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 5 (For children age 2 until age 18)
Estimate the funds needed to provide all dependents with income until youngest
child reaches age 18.

a. Desired monthly income* 3000*

b. Expected monthly after-tax earnings of spouse $2400
Expected monthly Social Security benefits** 650
Other monthly benefits 0
Total of Step b $3,050
c. Step a minus Step b (50)
d. Multiply by 12 to arrive at annual total payment NA
e. Serial payment calculation:
Number of periods 16
% inflation 4%
% after-tax yield 6%
Calculate the present value of annuity due NA

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 5 NA

* $36,000 ÷ 12 = $3,000
**The $650 amount is provided for this problem.

116  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 6
Estimate the amount required to provide higher-education funds for the
Delgados’ children.

CHILD: Mike
a. Annual college costs $ 9,000

b. Serial Payment Adjustment

Inflation Calculation:
Number of periods until student begins college 16
% inflation 4%
Calculate the future value of the needed income
when serial payments begin $ 16,857

c. Serial Payment Calculation:

Number of years child will attend college 4
% inflation 4%
% after-tax return 6%
Calculate the present value of the annuity due $ 65,543

d. Discount Calculation:
Number of periods until student begins college 16
% after-tax return 6%
Calculate the present value of the above PVAD $ 25,801
Calculate needs for each child, then total the
needs for all children

Appendix A  117
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
 CHILD: Jim
a. Annual college costs $ 9,000

b. Serial Payment Adjustment

Inflation Calculation:
Number of periods until student begins college 13
% inflation 4%
Calculate the future value of the needed income
when serial payments begin $ 14,986
c. Serial Payment Calculation:
Number of years child will attend college 4
% inflation 4%
% after-tax return 6%
Calculate the present value of the annuity due $ 58,269
d. Discount Calculation:
Number of periods until the student begins
college 13
% after-tax return 6%
Calculate the present value of the above PVAD $ 27,319
Calculate needs for each child, then total the
needs for all children
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 6 $ 53,120

118  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 7 (For age 50 until age 65)
Estimate preretirement income fund for spouse after youngest child reaches age
18.

a. Desired annual income for surviving spouse $ 36,000

Expected annual after-tax earnings and
b.
benefits of spouse $ 28,800
c. Subtract Step b from Step a $ 7,200
d. Serial payment adjustment
Inflation Calculation:
Number of periods until serial payments begin 16
% inflation 4%

Calculate the future value of the needed

income when serial payments begin $ 13,485
Serial Payment Calculation:

Number of periods between date when

youngest child reaches age 18 and retirement 15
% inflation 4%
% after-tax yield 6%
Calculate the present value of annuity due (PVAD)* $ 177,625
Discount Calculation:
Number of periods until serial payments begin 16
% after-tax return 6%
Calculate the present value of the above PVAD $ 69,921

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 7 $ 69,921

*No rounding was done in these calculations. If you did any rounding, your answers may be a
few dollars off.

Appendix A  119
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 8 (For age 65 until age 85)
Estimate retirement income fund for spouse.

a. Desired annual income for surviving

spouse at retirement
$ 36,000
b. Expected Social Security, retirement, or
other benefits $ 20,400
c. Subtract Step b from Step a $ 15,600
d. Serial payment adjustment
Inflation Calculation:
Number of periods until retirement 31
% inflation 4%
Calculate the future value of the needed income $ 52,621
Serial Payment Calculation:
Number of periods of retirement income 20
% inflation 4%
% after-tax yield 6%
Calculate the present value of annuity due (PVAD) $ 883,521
Discount Calculation:
Number of periods until retirement 31
% after-tax return 6%
Calculate the present value of the above PVAD $ 145,123
TOTAL AMOUNT NEEDED, IF ANY, IN STEP 8 $ 145,123

Step 9
The amount estimated for an emergency fund. $14,400
(This number is being provided.)

120  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 10
Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 0
Step 6 $ 53,120
Step 7 $ 69,921
Step 8 $ 145,123
Step 9 $ 14,400
Total financial needs $ 282,564
b. Total resources available (remaining
liquid assets from Step 4)
$ 119,370
c. Subtract total resources available in
Step b from the total financial needs
in Step a to determine insurance
needed, if any. $ 163,194
d. List insurance needed, if any, to
provide estate liquidity. (This is the
case when the total in Step 4 is
negative.)
0
e. Add the amounts in Steps c and d to determine:
ADDITIONAL AMOUNT OF INSURANCE NEEDED, IF ANY $ 163,194

Appendix A  121
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Appendix B
The Life Insurance Selection Process
Figure 1: The Life Insurance Selection Process

STAGE 1
Identify client’s life insurance selectio n facts

STAGE 2
Establish goals
STAGE 3
Identify resources
STAGE 4
Identify economic assumptions

STAGE 5
Determine life insurance needs

STAGE 6
Determine appropriate type and product

STAGE 9 STAGE 7
NO YES STAGE 8
Suffic ient Existing type
available and product Appropriate
resources ? appropriate? amount?
NO YES
NO YES
STAGE 10
Purchase Go to Time
appropriate Stage 9 interval
STAGE 12 coverage
Modify goals? STAGE 11
Cancel Return
NO YES inappropria te to Stage 1
coverage
Time
STAGE 13 Return interval
Purchase
lesser amount to Stage 6 Replacement
Return NO considered?
Time to Stage 1
YES
interval

Return
to Stage 1

122  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Appendix C
Life Insurance Needs Determination Sample
Worksheet
Life Insurance Needs Determination Worksheet for__________
Step 1. Gather information from the client.
Step 2. Estimate the fair market value of assets owned. Classify assets as “liquid”
or “nonliquid.”

Assets at Fair Market Value

Liquid

TOTAL LIQUID ASSETS $

Nonliquid

TOTAL NONLIQUID ASSETS $

Appendix C  123
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 3. Determine the liabilities to be paid off if client dies today.

Liabilities
$

TOTAL LIABILITIES $

Estimated Postmortem Expenses

TOTAL POSTMORTEM EXPENSES $

TOTAL OF STEP 3 $

Step 4. Determine the liquid assets remaining, if any, after subtracting estimated
liabilities and postmortem expenses.

Total liquid assets $

Subtract estimated liabilities and postmortem

expenses (Step 3) $

TOTAL OF STEP 4 $

124  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
If the total is greater than zero, the amount represents liquid assets remaining
after total liabilities and postmortem expenses are paid. If the total is less than
zero, the amount represents the amount of insurance needed for estate liquidity.
Step 5 (For youngest child, age until age ). Estimate the funds needed
to provide all dependents with income until the youngest child reaches age 18.

a. Desired monthly income $

b. Expected monthly after-tax earnings of

spouse

Expected monthly Social Security benefits* $

Other monthly benefits $

Total of Step b $

c. Step a minus Step b $

d. Multiply by 12 to arrive at annual total $

payment

e. Serial payment calculation:

Number of periods

% inflation

% after-tax yield

Calculate the present value of annuity due $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 5 $

* This worksheet contains a number of references to Social Security benefits. In many cases,
this amount will include other benefits as well. Since this is a generic worksheet, whenever a
client wants to exclude Social Security benefits from a calculation, just ignore references to
Social Security and enter a “0.”

Appendix C  125
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 6. Estimate the amount required to provide higher-education funds for the
client’s children.

CHILD

a. Annual college costs $

b. Serial payment adjustment

Inflation Calculation:

Number of periods until student begins

college

% inflation

Calculate the future value of the needed

income when serial payments begin $

c. Serial Payment Calculation:

Number of years child will attend college

% inflation

% after-tax return

Calculate the present value of the annuity

due $

d. Discount Calculation:

Number of periods until student begins

college

% after-tax return

Calculate the present value of the above $

PVAD

Calculate needs for each child, then total

the needs for all children

TOTAL AMOUNT NEEDED, IF ANY, IN STEP $

6

126  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 7 (For age until age ). Estimate preretirement income fund for
spouse after youngest child reaches age 18.

a. Desired annual income for surviving spouse $

b. Expected annual after-tax earnings and

benefits of spouse $

c. Subtract Step b from Step a $

d. Serial payment adjustment

Inflation Calculation:

Number of periods until serial payments begin

% inflation

Calculate the future value of the needed income

when serial payments begin $

Serial Payment Calculation:

Number of periods between date when

youngest child reaches age 18 and retirement

% inflation

% after-tax yield

Calculate the present value of annuity due

(PVAD) $

Discount Calculation:

Number of periods until serial payments begin

% after-tax return

Calculate the present value of the above PVAD $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP 7 $

Appendix C  127
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 8 (For age until age ). Estimate the retirement income fund for a
spouse.

a. Desired annual income for surviving

spouse at retirement $
b. Expected Social Security, retirement, or
other benefits $
c. Subtract Step b from Step a $

d. Serial payment adjustment

Inflation Calculation:

Number of periods until retirement

% inflation

Calculate the future value of the needed

income $

Serial Payment Calculation:

Number of periods of retirement income

% inflation

% after-tax yield

Calculate the present value of annuity due

(PVAD) $

Discount Calculation:

Number of periods until retirement

% after-tax return

Calculate the present value of the above

PVAD $

TOTAL AMOUNT NEEDED, IF ANY, IN STEP $

8

128  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 9

The amount needed for an emergency fund $

Step 10. Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 $

Step 6 $

Step 7 $

Step 8 $

Step 9 $

Total financial needs $

b. Total resources available (remaining

liquid assets from Step 4) $

c. Subtract total resources available in Step

b from the total financial needs in Step a
to determine insurance needed, if any. $

d. List insurance needed, if any, to provide

estate liquidity. (This is the case when the
total in Step 4 is negative.) $

e. Add the amounts in Steps c and d to

determine:

ADDITIONAL AMOUNT OF INSURANCE NEEDED, IF ANY $

Appendix C  129
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
About the Author
David Mannaioni, CFP®, CLU, ChFC, CPCU is an associate
professor at the College for Financial Planning. Utilizing his 30+
years of experience in the financial services industry, David also
maintains a financial planning practice where he works with his
clients in all areas of financial planning. In addition to his
certifications, David holds Life and Health insurance licenses in
several states, as well as the Series 6, Series 7, Series 63, and Series 24
registrations with FINRA. You can contact David at [Link]@[Link].

130  The Life Insurance Selection Process

© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Index
A master index covering all modules of this course can be found in the Self-Study
Examination book.

Belth method, 39 Life insurance selection process, 34

Canceling life insurance, 1, 51 additional considerations, 47
Human life value, 55 ILITs, 48
Interest-adjusted cost index calculation, private split-dollar arrangements,
57 48
Irrevocable life insurance trusts (ILITs), appropriate amount, 46
48 evaluate existing type and product,
Life insurance evaluation 39
Belth method, 39 example, 37
Linton method, 45 pitfalls, 34
Life insurance needs analysis, 9, 16 diversification process applied to
amount of insurance needed, 11 insurance, 36
changing needs, 11 investing through insurance
company, 36
client goals and objectives, 8
term insurance, 34
client profile, 6
variable vs. nonvariable, 36
determine appropriate type and
product, 33 purchase appropriate coverage, 47
determine life insurance needs, 16 sufficient resources, 46
establishing goals, 14 Linton yield calculation, 45
estate liquidity, 9 Prenuptial agreement, 59
existing insurance, 10 requirements, 60
human life value, 55 Section 1035(a) exchange, 52
identifying economic assumptions, Split-dollar arrangements, 48
15 Yearly price method, 39
identifying resources, 14 benchmark, 41
risk tolerance, 10 front-end load multiple, 43
selection process, 34 yearly price per thousand, 43
survivors’ needs, 9

Index  131
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.