design-insurance-coverage-plan

Design Insurance Coverage Plan

Identify coverage needs across all risk categories, size each policy correctly, and eliminate gaps that could wipe out accumulated wealth.

Why This Is Best Practice

Adopted by: Insurance planning is a mandatory module in CFP Board certification. Every fee-only financial planner (NAPFA members) runs a coverage audit before any investment planning. Major insurers (Northwestern Mutual, New York Life) publish structured need-analysis frameworks used industry-wide. Impact: LIMRA "Life Insurance Barometer" (2023) found 40% of American households would face financial hardship within 6 months if a primary earner died — the coverage gap is $12 trillion. Disability is the leading cause of home foreclosure in the US (Council for Disability Awareness), exceeding both death and job loss combined. Why best: Insurance solves a specific problem: protecting against low-probability, catastrophic-magnitude events that would otherwise wipe out savings. The structured approach prevents the two most common failures — underbuying critical coverage (life, disability) and overbuying low-leverage coverage (extended warranties, whole life as investment).

Steps

1. Audit current coverage — List all active policies: carrier, coverage amount, premium, beneficiaries, expiry. Include employer-sponsored coverage (group life, STD/LTD, health).
2. Size life insurance need — Use DIME method: Debt (all liabilities) + Income replacement (10–12× gross income for dependents) + Mortgage payoff + Education costs for children. Compare to current coverage; gap = additional term life needed.
3. Size disability insurance need — Target 60–70% of gross income in benefit. Check employer LTD: most cap at 60% and exclude bonuses. Fill the gap with individual own-occupation DI policy. Elimination period: 90 days if 3+ month emergency fund exists, else 30 days.
4. Verify health insurance adequacy — Know your MOOP (maximum out-of-pocket): $9,100 individual / $18,200 family in 2024. Ensure HSA-eligible HDHP if healthy with savings capacity; PPO if managing chronic conditions with predictable costs.
5. Assess property and casualty — Homeowner/renter: insure replacement cost (not market value). Auto: liability limits should equal or exceed net worth. Umbrella policy needed if net worth > $300k or risk exposure is high (pool, teenage drivers, rental property).
6. Eliminate low-value coverage — Cancel extended warranties (manufacturers maintain quality incentives without them), credit life insurance (overpriced, term life does the job), mortgage life insurance (decreasing benefit at flat premium — term is better).
7. Review beneficiaries and ownership — Confirm beneficiary designations match estate intent; outdated designations override wills. Life insurance owned by the insured is estate-taxable above exemption — consider ILIT for large policies.
8. Set annual review trigger — Reassess after any: marriage, divorce, child birth, income change >20%, home purchase, business start.

Rules

• Term life > whole life for most people under 50 — buy coverage, not investment products bundled with coverage.
• Own-occupation disability definition is non-negotiable for professionals — "any-occupation" definition pays only if you can't work any job.
• Umbrella liability policy is the highest-ROI insurance purchase for anyone with net worth above $300k — $1M coverage costs ~$200/year.
• Never cancel health insurance for any reason — one hospitalization without coverage can cost more than 10 years of premiums.

Examples

35-year-old, $120k income, married, two children, $400k net worth, owns home: Life insurance need: $120k × 11 = $1.32M income replacement + $290k mortgage + $200k education = $1.81M. Has $500k group life. Gap: $1.31M → buy 20-year term at ~$60/month. Disability: employer LTD covers $6,000/month (60% of $120k). Supplement with individual own-occ DI to bring total to $8,000/month (70%). Individual policy ~$150/month. Umbrella: $1M umbrella over existing auto/home liability. ~$18/month.

Common Mistakes

• Relying solely on employer group life — Group coverage ends at termination; no individual underwriting means it can't follow you. Always own a personal policy.
• Skipping disability insurance because "it won't happen to me" — 1 in 4 workers will experience a disability lasting 90+ days during their career (Social Security Administration).
• Insuring the house at market value instead of replacement cost — If the land is worth $100k, the structure worth $250k, and market value is $400k — insure $250k (rebuild cost), not $400k.

Finance disclaimer: This skill encodes professional best practices for educational purposes. It is not financial advice. Consult a licensed financial advisor before making investment decisions.