Determining an appropriate level of life cover is done by several methods that produce meaningfully different answers, because they answer slightly different questions.
This describes the methods. It is not advice, and life cover decisions involve individual circumstances that warrant regulated advice.
The income multiple method
The simplest and most commonly cited.
A multiple of annual income, with commonly quoted figures ranging widely.
Its virtue is simplicity, and its limitation is that it ignores actual obligations. Two people with identical incomes and completely different debts and dependants receive the same answer.
It functions as a rough starting point rather than a calculation.
The needs-based method
More work and more informative.
Adding together the specific obligations cover would need to meet.
Outstanding debts, including mortgage and other borrowing.
Income replacement for dependants, for a defined period, adjusted for other resources.
Future costs such as education.
Immediate costs including funeral expenses.
Less existing resources — savings, other cover, employer death-in-service benefits, and state provision where applicable.
The result is specific to circumstances and requires updating as they change.
The human life value approach
A method used more in professional contexts.
Estimating the present value of future earnings over a working lifetime, adjusted for what would have been consumed by the person themselves.
Which produces a figure representing economic loss rather than obligations to be met.
It generally produces higher figures than the needs-based method and is more theoretical.
What is commonly overlooked
Categories that the simple methods miss.
Non-earning contributions, particularly childcare and household work, which have a real replacement cost that is frequently substantial and is invisible in income-based calculations.
Existing employer cover, which is real and typically ends with employment, so relying on it creates a gap at exactly the moment of a job change.
Inflation over the cover period, since a fixed sum assured buys less over time.
And existing provision through other means, which if ignored produces over-insurance.
Term and structure
Which affects cost substantially.
Level term cover pays a fixed sum during a defined period.
Decreasing term cover reduces over time, and is commonly used alongside a repayment mortgage where the debt is also decreasing.
Whole of life cover pays whenever death occurs and costs considerably more, since a claim is certain rather than probable.
Which means the structure should follow the purpose, and cover intended to clear a decreasing debt does not need to be level.
The underwriting process
Worth knowing since it determines cost and availability.
Applications involve health and lifestyle questions, and sometimes medical examination.
Disclosure obligations are significant, and non-disclosure can result in a claim being declined, which is the outcome that defeats the entire purpose.
Which means answering fully, including things that seem irrelevant, is the practical protection.
Cost rises with age, which is why cover taken earlier is generally cheaper for the same term.
Where the cover sits
A structural point with tax and practical consequences in many jurisdictions.
Cover written into an appropriate trust arrangement, where available, can affect how quickly proceeds are paid and how they are treated for estate purposes.
The specifics vary enormously by jurisdiction and this is precisely the sort of thing where professional advice is appropriate.
Reviewing it
The step most often omitted.
Cover set at one point becomes inappropriate as circumstances change — debts reduce, dependants become independent, income changes, other provision begins or ends.
Which means a periodic review, and particularly a review after any significant life event, is what keeps the cover matched to the purpose.
Both over-insurance and under-insurance are costly, in different ways, and neither is discovered without looking.
Related cover worth distinguishing
Since the products are frequently confused.
Life cover pays on death.
Critical illness cover pays on diagnosis of a defined condition, and the definitions determine everything about whether a claim succeeds.
Income protection pays a regular amount if illness or injury prevents working, and is the cover most people are least likely to hold despite the risk being more probable than death during working years.
Which means an assessment of cover generally should consider all three rather than defaulting to the most familiar, and the relative priority depends on circumstances.
Reviewing after life events
When the calculation actually changes.
A new mortgage, a child, a change in income, a change in relationship status, or a dependant becoming independent all move the figure meaningfully.
Employer cover ending on leaving a job is the event most likely to create an unnoticed gap.
Which means a review at each of those points, rather than on a schedule, is what keeps cover matched to the need.
Beneficiary and trust arrangements should be reviewed at the same time, since those determine who receives the proceeds and are frequently set once and forgotten.
Cover through work and its limits
The provision most people have and least understand.
Death-in-service benefits are commonly a multiple of salary and are genuinely valuable, and they end with employment.
They are also frequently paid at the discretion of trustees rather than automatically to a named person, which means an expression of wishes should be recorded and kept current.
Checking what the multiple actually is, and whether it is included in any needs calculation, avoids both over-insuring and assuming cover that does not exist.