How Much Cover Do You Need?

Life cover – put simply – concerns liquidity. It is about providing cash for the unavoidable expenses associated with wrapping up an estate and replacing the net income a family stands to lose over the longer term.

When calculating your life cover requirements, you will need to take three things into account: Your assets, your liabilities and your estate costs. The sections that follow may seem a little complicated, but if you follow the instructions precisely, you will have a fair estimate of what your current life insurance needs are.

Element #1: Assets

Assets are all the plusses on your balance sheet: property, vehicles, savings and investments, amongst others.

There are two rules that you need to apply when making your calculations.

1. Only base your calculations on those assets you want to liquidate after your death. The assets that will not be sold, i.e. furniture, property etc. will not be converted into cash and can subsequently not be used in your calculations.

2. Even if you are still paying your home and cars, you should treat these assets as unencumbered. The reason for this is that your bank will have compelled you to take life cover to protect these debts anyway.

The assets to include in your calculations are:

a) Property and other fixed assets (only applicable if these are to be sold)

b) Vehicles and other movable assets (only applicable if these are to be sold)

c) Savings (such as cash, investments, unit trusts)

d) Stocks and Shares

Once you have listed all your assets, accord a value to each of these.

Element #2: Liabilities

Liabilities are the minuses on your balance sheet. The rule you need to apply here is that those debts already covered by life insurance, such as your mortgage, should not be treated as liabilities when calculating your life insurance requirements.

The liabilities to consider are:

a) All your debts that are not covered by a life policy (lines of credit, credit cards, personal loans etc.)

b) Household expenses over a period of 20 years (i.e. rates and taxes, utilities, food, maintenance, child care, holidays etc.) less your partner’s after-tax income for the same period. If your partner’s income can comfortably cover these expenses, you can ignore this point.

c) Expenses related to your children’s educational needs (school, college, university)

Once you have listed all your liabilities, accord a value to each of these.

Element #3: Estate Expenses

Estate expenses are those expenses that require cash, and that are directly related to your death and the winding up of your estate after your death. These include:

a) Capital Gains Tax (CGT)

b) Income Tax

c) Estate Duty

d) Funeral Costs

e) Executor Fees

f) Master of the High Court Fees

g) Newspaper adverts

h) Bank charges

i) Asset Valuation fees

j) Mortgage cancellation fees

k) Property transfer fees

Once you have listed all your estate expenses, accord a value to each of these.

Pulling the Information Together

First the expenses

1. First we are going to calculate your once-off expenses. To do this, add the Estate Expenses – Element 3: Estate Expenses a) to k) – to those debts that are not covered by a life insurance policy – Element 2: Liabilities a). The result is the immediate cash that your family will need to meet the expenses associated with the wrapping up of your estate. Call this Subtotal 1.
2. Record the children’s education related expenses – Element 2: Liabilities c). Call this Subtotal 2.
3. Jot down the total household expenses that your family will need to foot over a 20 year period – Element 2: Liabilities b). Call this Subtotal 3.
4. Jot down the total income your family will need to sustain them for a 2 year period. (Subtotal 3 divided by 20 and then multiplied by 2.) Call this Subtotal 4.

Then the assets

5. The yield from the assets will not be available to your family for quite a long time. Call the total value of all your assets, Subtotal 5. Element 1: Assets a) – d)

Calculating the numbers

6. Add Subtotals 1 and 4. The sum you arrive at is the total amount of money that your family will need while your estate is being wrapped up.
7. Next, add Subtotals 2 and 3. The sum you arrive at is the total amount of money your family will need to maintain their lifestyle and to provide educational opportunities to your children.

Wrapping it up

You will need to deduct the sum of Subtotals 2 and 3 from Subtotal 5, to establish whether you have sufficient assets to support your family after the estate has been wound up. If the result is a plus, you do. If the result is a minus, you don’t.

Add this deficit (if applicable) to Subtotals 1 and 4. The result is the estimated amount of insurance cover you require right now.

Final Thoughts

Insurance cover is not static. Your changing personal circumstances, as well as external factors like tax rate adjustments, property price growth and fluctuating inflation rates will impact the sufficiency of your cover. For this reason it is advisable to revisit your life insurance needs analysis at least every two years and to select an insurance policy that will afford you the flexibility to amend your cover as and when you need to.