What is the Needs Approach
BREAKING DOWN Needs Approach
The needs approach is a function of two variables:
- How much will be needed at death to meet obligations
- How much future income is needed to sustain the household
When calculating your expenses, it is best to overestimate your needs a little. If you underestimate, you might realize your mistake until it's too late.
The needs approach contrasts with the human-life approach. The human-life approach calculates the amount of life insurance a family will need, based on the financial loss the family would incur if the insured person were to pass away today. The human life approach usually takes into account factors such as the insured individual's age, gender, planned retirement age, occupation, annual wage, employment benefits, as well as the personal and financial information of the spouse and/or dependent children.
Needs Approach and a Primer on Life Insurance
Life insurance provides financial protection to surviving dependents in case of or after the death of an insured. As with other forms of insurance, life insurance is a contract between an insurer and a policyholder. In life insurance, the insurer guarantees payment of a death benefit to named beneficiaries. Various types of life insurance approaches exist, including the needs approach and human life approach. Whole life, term life, universal life, and variable universal life (VUL) policies are separate types of plans available to individuals and their families. Whole life (also known as traditional or permanent life) covers the full duration of the life of the insured.
In addition to providing a death benefit, whole life also contains a savings component where cash value may accumulate. Term life guarantees payment of a death benefit during a specified term. Unlike whole life, after the term expires, the policyholder can renew for another term, convert to permanent (whole life) coverage, or let the policy to terminate.
Universal life is similar to whole life insurance yet it provides an additional investment savings element and low premiums like term life insurance. Most universal life insurance policies contain a flexible premium option although some require a single premium (single lump-sum premium) or fixed premiums (scheduled fixed premiums). Finally, variable universal life or VUL is a permanent life policy with a built-in savings component, which allows for the investment of the cash value. Like standard universal life, the VUL premium is flexible.