Two Policies, One Life: Insurable Interest and a Budget That Won't Stretch
Nate, 41, is a healthy nonsmoker in Cedar Rapids. He earns $82,000; his wife Priya earns $28,000. They owe $164,000 on the mortgage plus $11,000 on a truck, and hold $30,000 in savings. Their children are 9 and 12. Nate's only life insurance is group term equal to one times salary, and the group plan is not portable if he changes jobs. Nate co-owns Precision Tool 50/50 with Owen; a funded buy-sell agreement values Nate's share at $400,000. Owen wants to own and be the beneficiary of a $750,000 policy on Nate's life. Separately, Nate can commit about $1,900 a year to personally owned coverage and wants it in force within 30 days.
1. Does Owen have an insurable interest in Nate's life, and is $750,000 an appropriate amount? Explain the reasoning and the practical consequence of getting the amount wrong.
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Interest exists; the amount is the problem.
- Insurable interest is tested at policy inception, not at death. Owen has a concrete, quantifiable economic loss if Nate dies: he must fund the purchase of Nate's 50% share under the buy-sell.
- But insurable interest has a quantity dimension. Owen's measurable exposure is the $400,000 buyout obligation. A $750,000 policy exceeds that by $350,000, which begins to look like a wager on Nate's life rather than indemnity for a loss.
- If the business also wants key-person coverage for lost revenue, that exposure must be separately documented and separately owned - it is not automatically part of the buy-sell.
Consequences of over-insuring:
- The extra $350,000 invites a challenge at claim time, creates moral-hazard optics, and may draw scrutiny as a stranger-originated arrangement if ownership is ever transferred.
- The buy-sell agreement only requires $400,000; paying for $750,000 wastes premium the business could use elsewhere.
Recommendation: a $400,000 policy, with Owen as owner, beneficiary, and premium payor, and the buy-sell stating that the policy funds the cross-purchase. Also flag that if Owen owns the policy, Nate's family has no claim on the proceeds - that is the point of a cross-purchase, but it should be documented so no one is surprised.
2. Estimate Nate's coverage need with a needs (DIME-style) analysis, showing components, assumptions, and the net figure.
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Components (capital needs at death):
| Item | Amount |
|---|---|
| Debt (mortgage $164,000 + truck $11,000) | $175,000 |
| Income replacement (10 x $82,000) | $820,000 |
| Education (2 children x 4 years x $28,000) | $224,000 |
| Final expenses | $15,000 |
| Gross need | $1,234,000 |
Offsets:
- Group term already in force: $82,000
- Savings: $30,000, but keep roughly $10,000 as an emergency reserve, so count $20,000
- Priya's $28,000 income is a continuing stream, not a lump sum; it roughly offsets the family's reduced living costs once the mortgage is retired, so it is treated as neutral rather than as a dollar offset
Net need: $1,234,000 - $82,000 - $20,000 = about $1,132,000.
Reasoning notes: the income-replacement multiple should run to the end of the dependency period (youngest child is 9; roughly 15-20 years). Ten times income is a conservative, easy-to-defend proxy; a capital-needs calculation (70% x $82,000 = $57,400 per year, discounted) produces a similar order of magnitude. The education figure assumes four-year public in-state costs escalated modestly.
Conclusion: roughly $1.0-1.1 million of death benefit is needed during the dependency window. Note this is a separate need from Owen's $400,000 buy-sell policy - do not let one policy be used to argue the other away.
3. Given the $1,900 annual budget, what coverage would you recommend and why? Name the trade-off you are accepting.
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What the budget buys:
- $1,000,000 of 20-year term for a 41-year-old preferred nonsmoker typically runs roughly $700-$950 per year - it fits, with room for a rider.
- A $1,000,000 whole life policy would run on the order of $12,000+ per year, roughly six times the available budget.
Recommendation - a term ladder:
- $750,000 of 20-year term (covers the years when both children are at home and the mortgage balance is highest)
- $250,000 of 30-year term (covers Priya's later working years and the tail of the mortgage)
- Add a conversion privilege - ideally convertible to permanent coverage without new evidence of insurability - so Nate locks in his current health status
The ladder tracks the declining need: the family's capital requirement drops when the children launch and the mortgage is retired, so paying for level $1.1 million for 30 years would over-insure the later years.
Trade-off accepted: no cash value and the coverage expires. The budget is being spent on the largest possible death benefit during the only period when people are financially dependent on Nate. Permanent coverage can be layered in later as cash flow improves, and the conversion rider preserves that option.
Two cautions: (1) do not count the non-portable group term as the foundation of the plan; (2) the buy-sell premium is a business expense paid by Precision Tool, not part of Nate's $1,900 personal budget.