Do the Madigans Need Life Insurance?

The economics of the decision

John and Kelsey Madigan live in Miami and love the tropical lifestyle. They share experiences like snorkeling, tennis, and the occasional trip to Biscayne National Park that give them so much happiness they often wonder why it took them so long to move from Youngstown in the 2010s. After all, the Stoops brothers left the area for football coaching fame. Maybe it was their turn for a better life.

One day, amid an Ohio winter, Kelsey told John, “Let’s go build a new life somewhere. I want a fresh start.” They moved to South Florida in January 2014. Miami was their choice because it is warm and sunny, and the Madigans’ felt “our money will go further.” John had management experience and took the lead in finding a job. Today, John is the general manager of a popular seafood restaurant, and Kelsey is a librarian in the Miami-Dade public library system.

The Madigans received a call from a life insurance agent referred to them by a friend from their Zumba class, another athletic endeavor that keeps their sparks’ lit. John and Kelsey never overthought about life insurance. However, they read the News in the Wall Street Journal that reported an uptick in life insurance product sales among younger adults attributed to a pandemic response. Nightly reports of death and dying will do that.

Because of the agent’s initiative, the financial planning question for the Madigans became whether life insurance should be front and center in their economic life.

“Why have it?

We don’t have kids.”

“Will the agent be pushy?”

“We can find 500 other things to spend money on rather than life insurance premiums.”

Personal Finance Economics speaks precisely to their concerns. Indeed, they have relevant generalities common to many couples: The Madigans are without children today, don’t plan on having a child in the future, but otherwise live a lifestyle afforded by a dual income and the economics of shared living.

A Very Short History Lesson

Life insurance products and the institutions that offer them have been around for a very long time, beginning about 275 years ago and before the founding of the U.S.   Silicon Valley wordsmiths so adept at single word, brand names might not like the name of the first life insurer, “The Corporation for Relief of Poor and Distressed Presbyterian Ministers and of the Poor and Distressed Widows and Children of Presbyterian Ministers.”¹ Put that in a URL. There wouldn’t be much space left on the title screen of the mobile app. Today’s well-recognized brand names are moving toward their 200th year. New York Life (1845), Mass Mutual (1851), MetLife (1868), and the list goes on.   Fewer words. But talk about a mature industry!

Why do these institutions exist? It is better to ask why households demand life insurance, which has been a question asked by academicians for years. Leibenberg, Carson, and Dumm (2012) have interesting empirical findings based on the Survey of Consumer Finances for a range of years from the 1980s. The researchers found life insurance demand increases among new parents and households with new jobs and decreases through the cancellation of existing whole life policies among families who experience unemployment and a reduction in existing term life policies among the newly widowed or separated.² Affordability and rational motivation help to understand demand. Price needs to be reasonable (which it is for term life insurance), and demand is linked to need. The payoff from life insurance is a death benefit payable to a beneficiary, not the insured. Widows, widowers, and singles don’t need to buy life insurance, but those partnered, married, or with children and dependents may.

The Link to Human Capital

Who depends on your ability to produce an income? You do, of course, but we are considering the risk of you dying too soon. After that, who suffers economically? A spouse, partner, children, some other dependent family member, or a charitable organization that has come to rely on your generosity?   If the answer is “none of those apply to me,” then you don’t need life insurance or the affiliated products that can be inaccurately promoted as investment vehicles. 

Life insurance is intended to handle the risk of premature death. Nothing more, nothing less.   Some life insurers, unfortunately, paint their products with speculative risk, tying future premium costs to investment performance. If you are confused that a conversation about life insurance turns into a discussion with a life insurance agent about how a life insurance product can be an investment, then you should be skeptical. If you ever start talking to a sales representative or advisor about the need for life insurance, and the conversation turns to a product discussion about asset classes, cash values, and guaranteed rates of return, wonder, “What just happened?” This isn’t uncommon. Masking a product intended to handle a pure risk and obscuring it with speculative risk is a company strategy to help sell a simple product that is otherwise a tough sell. After all, a sale requires a conversation about futures without loved ones.

Pause on the curveball and let your confusion lock your wallet.

Find another agent.

One that will take you through a life insurance needs analysis. The Madigans’ example illustrates the proper approach.  

The Madigans’ Life Insurance Question

The Madigans live together. The economics of shared living is important when determining life insurance needs. The essence is that two adults living together can live more cheaply than two adults living apart because many non-discretionary household expenses are not additive. Two adults living together don’t double the mortgage, the light bill, or the streaming subscription. The result is that a higher living standard is conveyed to two, four, or six adults living together relative to the same count living apart.

Moreover, the per adult household living standard may heavily depend on the higher income earner. The lower-earning spouse lives at a higher standard than attainable alone. Throw non-income-producing children into the mix, and the living standards of all household members adjust to new levels based on the prospective earnings of the providers. A substantial expected living standard forsaken because of the premature death of a breadwinner signals a life insurance need back to the beach.

The Madigans have a two-income household. Their lifestyle is built around a household income of $130,000. John earns $85,000 per year, Kelsey earns $45,000 per year, and both expect to work up to age 70. Family and personal health histories suggest planning to a maximum age of 95. Because John and Kelsey are 40 years old, they have an implied work life of 30 years to fund living for more than 50 years. Inflation-indexed social security retirement benefits will be critical to their financial future. Their long-run living standard will be higher because they choose not to have children, but savings will likely be prescribed due to the balance of work years and living years.

Beyond earnings, the Madigans own assets and have minor debts. The Madigans’ home is valued at $800,000, which they purchased eight years ago for $340,000. Their monthly mortgage runs about $1,305, and annual property taxes and housing maintenance total $10,000. Both have a modest amount of money in regular individual retirement accounts (IRAs) and $30,000 in joint bank checking and savings accounts. Unfortunately, neither has an employer-sponsored retirement plan such as a 401(k). Both intend to contribute $1,000 annually to their IRAs and adjust this contribution for salary increases.

The Madigans’ optimal spending for the current year after housing costs, retirement contributions, and taxes is $67,586. How did I know that? I built their baseline financial plan using the optimization techniques built into MaxiFi Planner software.

What about the living standard per adult? Economists approximate that two adults living together can live as cheaply as 1.6 adults. John and Kelsey have total optimal discretionary spending for the current year of $67,586, but that doesn’t mean they each have a living standard of half that amount, $33,793. Because they live together, the annual living standard for each is approximately $42,241. This number is critical for any life insurance consideration because it is the standard of living each person has grown accustomed to.

If Kelsey dies, then it appears John’s higher salary ($85k) may be able to help John attain this living standard without Kelsey. If John dies, then there is no way Kelsey’s living standard, based on her pre-tax income alone ($45k), could reach that number. Mortality risk odds are slightly in Kelsey’s favor, but the outcome of John’s mortality could be severe to her future living standard.

John benefits financially from Kelsey’s income, and his living standard would likely be disrupted, although less so, should Kelsey die during her working years. In general, the proper life insurance policy death benefit can be viewed as an asset injection to a beneficiary to supplement their other assets and income.

Optimal Life insurance Amounts for John and Kelsey

How much life insurance is needed in the Madigans’ household? The prescribed economic solution is drawn in the chart below. If John were to die this year, Kelsey would need $1.291 million of life insurance death benefits to maintain her per-adult living standard for the rest of her life. This cash infusion, in large part, is the replacement of the impact of John’s human life value on Kelsey’s living standard. By contrast, if Kelsey were to die this year, John would need about $191k of life insurance death benefits to keep him at the same living standard as if Kelsey were alive and working. If Kelsey maintains her life for another 20 years, John will no longer need to own life insurance. According to current assumptions, John will need to keep life insurance until age 69. Still, Kelsey’s economic happiness on the life insurance dimension only requires John to maintain less than $500k of coverage once he reaches age 61.

How Investments Change the Need for Life Insurance

What if the Madigans’ had been aggressive savers and, to date, had put away $1 million into a brokerage account rather than have only $30,000 of bank assets? How would that alter life insurance needs?

Extra cash raises their living standard while both are alive. I turned the modeling crank and found their optimal level of household discretionary spending for the current year rose to $83,304, conveying an optimal living standard for each of $52,065. In terms of their overall life span, the additional million dollars increased their annual living standard in the first year by 23%. This becomes the new target for determining life insurance needs.

As seen in the chart below, the only life insurance to be purchased will be on John’s life for Kelsey’s benefit should John die prematurely. If Kelsey dies prematurely, John’s average earning capacity plus his large cash reserves make Kelsey’s lost income to John inconsequential to his standard of living. But, the opposite is not true. The magnitude of Kelsey’s $45k income plus annual returns on the $1 million of assets cannot get her to the living standard when John is alive and working. Initially, John’s life should be insured for $954k, then it gradually declines. By age 60, Kelsey needs only $300k of life insurance on John’s life, and by age 68, the life insurance required on John’s life vanishes.

Periodic Life Insurance Needs Analysis

It is important to review life insurance needs periodically. Swings in salaries, revaluation of assets, and changing family makeup will alter the optimal living standard while alive. These changes will drift into the solution to any life insurance question.

Who knows about the Madigans future family status? The effect of an afternoon Zumba class after a morning of snorkeling may change their calculus.

1. From the Historical Society of Pennsylvania, 2008.

2. Liebenberg, A.P., Carson, J.M. and Dumm, R.E. (2012), A Dynamic Analysis of the Demand for Life Insurance. Journal of Risk and Insurance, 79: 619-644. https://doi.org/10.1111/j.1539-6975.2011.01454.x