The human-life approach is a method of calculating the amount of life insurance a family will need that is based on the financial loss the family would incur if the insured person were to pass away today. The human life value concept is a universally adopted approach utilized by underwriters as well as courts when establishing the economic value of a human life.
The main contention behind the concept that values human life is that in the event the member of the family which provides regular income dies an untimely death, the earnings lost must be replaced in order for the family to continue on living their lives with as little financial difficulty as possible.
This value is usually calculated by taking into account a number of factors, including, but not limited to, the insured individual’s age, gender, planned retirement age, occupation, annual salary, other employment benefits, as well as the personal and financial information of the spouse and/or dependent children.
HLV therefore represents the amount that ensures a family’s standard of living does not get affected if the one who earns for the family dies or is unable to continue earning.
Since the value of a human life has economic value only in its relation to other lives, such as a spouse or dependent children, this method is typically only used for families with working family members.
Method to get HLV
Every year the value of your money erodes as inflation nibbles quietly. So, what you could buy today for Rs100 will cost you, say, Rs105 the next year. Apply this logic to all your future incomes and assess their present worth. You do this by discounting all future earnings to the present value of money. For example, HLV of a 30-year-old earning Rs10 lakh per year today would be Rs2.9 crore when he turns 60, assuming his salary increases at 10% each year and the inflation is at 6%. This means that this person’s life is worth Rs2.9 crore today, if we consider his earning potential for the next 30 years.
If you are mathematically oriented, you may choose to do the following
1. Get an estimate of the person’s average yearly earnings by using current income (also take into consideration future increases in salary)
2. Deduct from the estimated amount in step 1 all living expenses, payments for insurance, and taxes to get the amount that is enough to financially support the family. Generally, that amount is about 70 percent of the pre-death earnings of the insured person. This amount will largely depend on the financial circumstances surrounding a family.
3. Determine the needed replacement period. That period may be up until the children will have finished college or until retirement of the family’s breadwinner
4. Take into account the rate of return that will be paid on the interest-bearing account in which the insurance company will leave the death benefit – for example, a fixed deposit with a bank.
5. Calculate future income by multiplying the estimated net salary by the number of years. After that use the rate of return from the previous step to get an estimate of the current value of the family’s earnings for the desired replacement period.
The process of computing the HLV is not complete without accounting for your outstanding loans/liabilities (like your housing loan or car loan, for instance) in present value terms. This needs to be taken into account because it will aid your dependants in paying off debts/liabilities in your absence. This will ensure that they don’t have to sacrifice any amenities provided by you during your lifetime. Besides, the amount that you wish to set aside for medical expenditure also needs to be added to the present value.
Some people, instead of this formal calculation use a simple back of envelope calculation, typically multiplying the annual salary by 10 to arrive at minimum sum assured. A younger than 40 person may multiply this by 15 – the rationale is that the amount of insurance will cover, if all the money is invested into a fixed deposit, the living expenses of the family if the deposit yields between 8% – 10% per annum.
While not a foolproof method, this method gives a logical near true approximation barring the changes in economic circumstances or lifestyles which cannot be incorporated into mathematical models, at least the simple ones. And the best way to get insurance against this, once you have understood your own value to your family , is via term insurance- the cheapest and best form of insurance available for such needs!