How to Conduct a Capital Needs Analysis

When determining the life insurance need, it becomes critically important for advisors to avoid telling prospects what they “should” or “ought” to do. Rather, the role of the financial professional is simply to facilitate the process of helping the prospect identify what they would want to have happen if, God forbid, they did not make it home tonight.

To create buy-in and ownership, the amount of life insurance the prospect needs should ultimately be the prospect’s number, not the advisor’s. During the fact finding or discovery process, you will want to conduct a Capital Needs Analysis to determine the appropriate amount of life insurance for the prospect. You do this by saying the following:

“Most of my clients look at three things when determining their life insurance need:

  1. Typically, they are interested in eliminating any debt they have. They want to make sure the family is able to pay off the mortgage so they can live in the same neighborhood and the kids can attend the same school.
  2. If college education planning is something that is important to them, they want to provide enough capital to cover the cost of a college education.
  3. Assuming the debt is eliminated and college is take care of, they want to provide some type of stream of income so the family can continue to maintain their standard of living.”

At this point, you are referring to the three factors that most people take into consideration when determining their life insurance needs. Up to this point, you’re simply educating the prospect on how to specifically quantify their life insurance need. At this stage of the process your job is to simply review each of the three factors to facilitate the process of helping the prospect determine what they want the life insurance to do for their family. Remember, the final number is the prospect’s number, based on their capital needs. It’s based on what they want to have happen in the event of their premature death, not what you want.

Debt Reduction

At this point, you begin to specify each of the three factors to their specific situation. You do this by saying:

“As we look at your debt situation, would you want Lisa and the boys to be able to pay off the mortgage and remain in the same home?” Notice that at this point, I am using the names of the spouse and the children. This provides a stronger emotional connection between the prospect and the decision. Prospects are typically going to say yes to debt elimination. If they have any additional substantial debt, like a student loan, you will want to see if they want that debt eliminated as well.

College Planning

Next, if college education planning was important to them earlier in the fact finder, then you will want to bring this up to them. For example, you might say, “Earlier you said that providing a college education for the boys was something that’s important to you. Is this something you still want to provide for them if something were to happen to you?” Prospects will typically say “Yes”. Remember, it’s their number. So, if they so “No”, it’s not a big deal. You want them to own the number. However, if appropriate, you might challenge the prospect if college planning is something that is important to them if they are alive.

As a side note, here’s how you determine the college education need on the spot. College tuition inflation rates have been growing at an average of 6-7% per year for the past decade. If you were to reinvest the death proceeds from the life insurance to provide for a college education, you would have to expect a very conservative rate of return, since the proceeds are earmarked for the family’s financial security. Therefore, we could assume we would re-invest the death proceeds in a fixed income type investment earning 5-7% after tax. Therefore, the cost of college tuition inflation of 6-7% offsets the potential rate of return of 5-7%, so it’s a wash.

To determine the amount of life insurance needed to address college planning, you simply multiply the average annual tuition by the number of years you need to fund (typically four years), and do so for each child. For example, if they would like to send their two children to a state university with an average annual tuition of $30,000 per year, and they want to fund four years each . . . you would multiply $30,000 times 4, which is $120,000. Then you multiply $120,000 times two for both children. The total amount of capital – death benefit – it will take to fund college for two children in this scenario is $240,000.

Stream of Income

Now we have the amount of life insurance we need to eliminate debt and the amount needed to ensure the children receive a college education. Finally, we are going to calculate how much life insurance it will take to provide a specific stream of income to ensure the family can maintain some standard of living. At this stage in the process we simply say:

“Now that debt has been eliminated and college is funded, how much income would you want to provide for your family on a monthly basis to help them maintain a certain standard of living and how long would you want that income to continue?”

You want to begin by stating the fact that debt and college have been funded. This will help build your credibility and trust because you’re helping them identify a realistic number. The prospect might need some help from you to determine what they need based on their budget. Some prospects will want income coming to the spouse for the remainder of his or her life. Other prospects will want the income to continue until the children graduate from college while others will want no stream of income to continue. The important thing to remember is the final number needs to be the prospect’s number. I will tell you from experience, the number is always much larger when the spouse is present during the fact finder. Call it social pressure.

There are several methods for calculating the amount of life insurance needed to generate a stream of income. The most accurate would be the time value of money method using a financial calculator, which we will address in a later article. One approach used by advisors as a rule of thumb is to attribute $200,000 of life insurance for every $1,000 of monthly income needed. If a prospect wants to provide $4,000 of monthly income for his or her family, it will take approximately $800,000 of life insurance coverage (that’s $200,000 multiplied by 4). Again, it takes approximately $200,000 of coverage to generate $1,000 of monthly income.

Another rule of thumb used in the industry is to divide the annual stream of income needed by the after tax rate of return you would expect to receive after reinvesting the death proceeds. For example, if a prospect told you they would like a $50,000 stream of income coming to their family upon their death, then you would divide that number by 6% or .06, a reasonable after-tax rate of return. Remember, the expected rate of return on the death proceeds needs to be conservative since it is the final dollars the family has available for their financial security.

The question always comes up, “How long can you expect that income to last?” Using these two rules of thumb, you can expect the income to continue for approximately 20-25 years, but not forever.

The final step in the Capital Needs Analysis is to add up the total amount of insurance needed to address the debt, college education and a stream of income. Then, you subtract any existing life insurance (group and individual) from this number. This net amount provides you with an approximate amount of life insurance they need to make these things happen.

Creating Alignment

Once you have determined the amount of additional life insurance the prospect needs, you should ask them, “How do you feel about that amount or number?” You will want to pause after asking the prospect this question. Give them a moment to soak it in and respond. If the prospect says, “Seems like a lot of insurance” or “That’s a big number” or something to that effect, you will need to address this concern directly. Remember, ultimately the number is the prospect’s number, not your number.

If you receive this response, you should follow up by saying, “Well, as I said before, the amount of life insurance you own is not right or wrong until you compare it to what you would want to have happen if you didn’t make it home tonight. So based on that, let’s take a look at our analysis of the things you wanted your life insurance to do for you to determine what we should eliminate.” The power phrase here is “what do you want to eliminate?” Be sure to use the word “eliminate” specifically. They have to understand the amount can be smaller, but something has to be sacrificed.

After saying this, ask the prospect, “Do you not want to pay off the debt and mortgage? Do you not want to provide for college? Do you want to provide less income?” The majority of the time, the prospect will choose to provide less monthly income in this situation. The most important part of this process is to make sure the final amount of life insurance is the prospect’s number and that you come to agreement on the number before moving forward. Again, the stream of income desired is almost always higher if the spouse is present in that meeting.


The role of the advisor in the Capital Needs Analysis is one of simply facilitating the process of helping the prospect identify what’s most important to them. In particular, what they want to have happen financially if they don’t make it home tonight. The final amount of life insurance needed has to be the prospect’s number, not the advisors. To the extent a financial professional can do this, they are creating buy-in and ownership at the conclusion of the discovery phase. Then, the “closing” meeting just becomes the next, natural step in the sales process vs. the stereotypical hard sell

» By Joey Davenport for

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