In: Accounting
Darrell and Lena Jennings are a two-income couple in their early
30s. They have two children, ages 6 and 3. Darrell's monthly
take-home pay is $3,600, and Lena's is $4,200. The Jennings feel
that, because they're a two-income family, they both should have
adequate life insurance coverage. Accordingly, they are now trying
to decide how much life insurance each one of themneeds.
To begin with, they'd like to set up an education fund for their
children in the amount of $120,000 to provide college funds of
$15,000 a year - in today's dollars - for four years for each
child. Moreover, if either spouse should die, they want the
surviving spouse to have the funds to pay off all outstanding
debts, including the $210,000 mortgage on their house. They
estimate that they have $25,000 in consumer installment loans and
credit cards. They also project that if either of them dies, the
other probably will be left with about $10,000 in final estate and
burial expenses.
Regarding their annual income needs, Darrell and Lena both feel
strongly that each should have enough insurance to replace her or
his respective current income level until the youngest child turns
18 (a period of 15 years). Although neither Darrell nor Lena would
be eligible for Social Security survivor's benefits because they
both intend to continue working, both children would qualify in the
(combined) amount of around $1,800 a month. The Jennings have
accumulated about $75,000 in investments, and they have a
decreasing term life policy on each other in the amount of
$100,000, which could be used to partially pay off the mortgage.
Darrell also has an $80,000 group policy at work and Lena a
$100,000 group policy.
Assume that Darrell's gross annual income is $60,000 and Lena's
is $67,000. Their insurance agent has given them a multiple
earnings table showing that the earnings multiple to replace 75
percent of their lost earnings is 8.9 for Darrell and 7.9 for Lena.
Use this approach to find the amount of life insurance each should
have if they want to replace 75 percent of their lost
earnings.
Life insurance needed by
Darrell: $
Life insurance needed by Lena: $
Use Worksheet 8.1 to find the additional
insurance needed on both Darrell's and Lena's lives. (Because
Darrell and Lena hold secure, well-paying jobs, both agree that
they won't need any additional help once the kids are grown; both
also agree that they'll have plenty of income from Social Security
and company pension benefits to take care of themselves in
retirement. Thus, when preparing the worksheet, assume "funding
needs" of zero in Periods 2 and 3.)
Additional insurance needed by
Darrell $
Additional insurance needed by
Lena $
Is there a difference in your answers to Questions 1 and 2? If
so, why? Which number do you think is more indicative of the
Jennings' life insurance needs? Using the amounts computed in
Question 2 (employing the needs approach), what kind of life
insurance policy would you recommend for Darrell? For Lena? Briefly
explain your answers.
here is the solution
Answer a)
Using the earnings multiple calculation, the Jennings’ insurance needs are:
Darrell: ($3,600 * 12 = $43,200) * 8.2 = $354240
Lens: $(4,200 * 12 = $50,400) * 7.3 = $367920
Answer b)
Life Insurance Needs Analysis Method
Insured Name :- Lena Jennings Dated 5/5/2016
Step 1 Financial Resources needed after Death | |||||
1 | Annual Living Expenses and other needs | Period 1 | Period 2 | Period 3 | |
a | Monthly living exp | $ 7800 | |||
b | Net Yearly Income need ( a * 12) | $ 93600 | $ | $ | |
c | Number of Years in Time period | 15 | |||
d | Total living need per time (b * c) | 1404000 | - | - | |
Total Living Expenses | 1404000 | ||||
2 Special Needs | |||||
a | Spouse Education Fund | ||||
b | Childrens College Fund | 120000 | |||
c | Other needs | ||||
3 Final Expenses | Funeral,estate costs | 10000 | |||
4 Debt Liquidation | |||||
a | House Mortgage | 210000 | |||
b | Other Loans | 25000 | |||
c | Total Debt | 235000 | |||
5 | Other Fianncial Needs | ||||
Total Financial Resources Needed | 1769000 | ||||
Step 2 | Financial Resources available after death | ||||
1 Income | Period 1 | Period 2 | Period 3 | ||
a | Annual Social Security Survivors | 21600 | |||
b | Surviving Spouse Annual Income | 43200 | |||
c | Other Annual Pensions | ||||
d | Annual Income | 64800 | |||
e | No of yrs | 15 | |||
f | Total Period Income | 972000 | |||
g | Total Income | 972000 | |||
2 | Savings and Investments | 75000 | |||
3 | Other life Insurance | 100000 | |||
4 | Other Resources | 100000 | |||
Total Financial Resources Available | 1247000 | ||||
Total Financial Resources Needed | 1769000 | ||||
Total Financial Resources Available | 1247000 | ||||
Additional Life Insurance Needed | 522000 | ||||
Life Insurance Needed Analysis Method
Darrell Jennings
Total Financial Resources Needed as calculated above are same :- $1769000
Step 2 | Financial Resources available after death | ||||
1 Income | Period 1 | Period 2 | Period 3 | ||
a | Annual Social Security Survivors | 21600 | |||
b | Surviving Spouse Annual Income | 50400 | |||
c | Other Annual Pensions | ||||
d | Annual Income | 72000 | |||
e | No of yrs | 15 | |||
f | Total Period Income | 1080000 | |||
g | Total Income | 1080000 | |||
2 | Savings and Investments | 75000 | |||
3 | Other life Insurance | 100000 | |||
4 | Other Resources | 80000 | |||
Total Financial Resources Available | 1335000 | ||||
Total Financial Resources Needed | 1769000 | ||||
Total Financial Resources Available | 1335000 | ||||
Additional Life Insurance Needed | 434000 | ||||
The worksheets are above. One assumption is that the decreasing term that they each have pays $100,000 at the death of the insured. Since it is decreasing term that is most likely overstating the amount of insurance that will be received by the survivor.
The worksheet results suggest that Darrell needs to have insurance on his life of $434,000, which because of the decreasing term, should be rounded to $500,000.
The worksheet results suggest that Lena needs to have insurance on his life of $522,000, which because of the decreasing term, should be rounded to $600,000.
c) One difference is that the earnings multiple calculation is designed to replace 75% of the lost income. In the Worksheet analysis, the assumption is that 100% of the income is needed. Also, the worksheet is a more specific needs analysis than the general earnings multiple calculation. The more specific analysis provided by the worksheet is the better measure of their insurance needs.
The insurance needs are for a specific period of 15 years, until the children completes college. After that time, they believe that their income and retirement income will be sufficient and they will need no additional insurance. This is a case for term insurance. The best insurance for the premium dollar is level premium term for their time of need (15 years). So I would recommend term insurance for both Darrell and Lena.
Answer 2)
Financial Resources needed after Death
Period 1 Period 2 Period 3
Monthly living Exp 1650 3500
Net yearly Income 19800 42000
No of years 3 10
Total living need 59400 420000 =479400
Other needs 35000
Final exp 13000
House mortgage 64000
Other Loans 3900 67900
Total financial resources needed 595300
Period 1 Period 2
Annual Social Security (600 x12) 7200 7200
No of years 3 10
Total Income 21600 72000 = 93600
Savings & Investments (65000+5500 ) =70500
Other =110000
Total Financial resources available 274100
Needed 595300
Available 274100
additional 321200
Laurie is concerned that she should die and leave her mother not able to get the care she needs. While it is difficult to estimate lives, Laurie believes that her mother will live no more than 13 additional years. At Laurie’s death, Katie [Mother] will only have her social security which does not cover her expenses now. The needs analysis, Worksheet 8.1 below, indicates that Laurie will need $321200 of additional life insurance to provide for her mother’s care for the rest of her life. Laurie is 40 now.
Given Laurie’s middle age and the need for insurance of only an additional 13 years, Laurie should purchase 15 year term life insurance. After her mother dies, she will no longer have need for life insurance. With 15 year term, the premiums will be fixed for 15 years.