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Needs Analysis Approaches
There are two basic approaches that may be pursued in determining "life insurance needs" -- an inclusive approach, where future cash flow needs are individually enumerated, and an exclusive approach, where specific future flows are assumed to be derived from a combination of future earnings and current investments.

Inclusive Approach

  1. Final expenses such as Funeral Expenses, probate costs, legal fees and other administrative fees
  2. Taxes owing including tax on gain on property that is taxable in the year of death. This property could include your investments, a cottage, other real estate that is not a principal residence, an RRSP (if you don't have a spouse or dependent children to leave it to).
  3. Monthly Housing Expenses (if you rent)
  4. Total mortgages owing (house, condo, cottage, etc.)
  5. Total credit card and line of credit debts, car loans
  6. Other debts such as furniture loans; payment plans; money owing to friends and family
  7. Children's Education Fund for each child. Project for inflation.
  8. Monthly Living Expenses such as childcare, food, household supplies, health-care expenses and supplies, clothing, dry-cleaning, car insurance, car repairs, parking and gas, other transportation, entertainment (books, movies, restaurants, vacations), charitable donations, spousal RRSP contributions, etc. Project for inflation.
  9. Deduct any existing Life Insurance Coverage.
  10. Deduct any Investments and Savings
  11. Deduct spouse's income (after taxes), as well as any other sources of household income.

Exclusive Approach

  1. Final expenses such as Funeral Expenses, probate costs, legal fees and other administrative fees
  2. Taxes owing including tax on gain on property that is taxable in the year of death. This property could include your investments, a cottage, other real estate that is not a principal residence, an RRSP (if you don't have a spouse or dependent children to leave it to).
  3. Present value of projected income (including inflation) of life to be insured, after tax. Reduce income by multiplying by a factor such as 80 to 90% to reflect the income that would have been marginally consumed by the life insured.
  4. Deduct any existing Life Insurance Coverage.

Our Recommendation

If the proposed life insured survives to past retirement age, then all expenses must be met from a combination of earnings and current investments. This is the Exclusive Approach for determining needs.

Since both approaches should yield approximately the same result, the principle of parsimony dictates that the simpler technique is preferable. In particular, the fewer number of estimates that are required, the better the quality of the result. In the Exclusive Approach, using the future estimated earnings stream (with some basic adjustments, like food and clothing for the deceased and perhaps replacement supplemental medical coverage for dependants) is a better technique than using future estimated requirements, since there are fewer estimates required.

Actual Course of Action

The method used for needs assessment does not necessarily have to follow the course of action that would be undertaken upon death. For example, Just because you used present value of future mortgage payments (as part of your income in the exclusive method) to assess the need does not mean that you must continue to make periodic mortgage payments following death. There is no reason not to retire the mortgage. The math is distinct from the real world activities.


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