A critical concept in Life Insurance is the “Human Life Value”. It’s a method of calculating the amount of life insurance a family would need based on the financial loss they would incur if the sole bread winner of a family is no more.
There are a number of factors taken into consideration when calculating the human-life approach, such as
- Age of the insured, lesser the age more the HLV and lower the premium
- Gender, typically higher the income, higher the HLV
- Planned retirement age,
- Annual Earnings,
- Any other benefits
- The human-life approach is primarily applicable to families with working individuals and stands in contrast to the needs approach.
- It is important to replace all of the income lost when an employed family member dies when using the human-life approach.
- When calculating a life insurance policy for the human-life approach, there are many factors to consider and to ensure that a family will not be left in financial distress, such as expected future earnings and length of time the money is needed.
- HLV typically helps a family maintain the same level of lifestyle when the deceased was alive and had provided for the family.
As 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. Typical steps in calculating HLV are as under:
Step One
Estimate the life assured’s remaining lifetime income; consider both the “average” annual salary and possible hikes in the earnings in the future. This will have a significant impact on deciding the sum assured.
Step Two
Deduct suitable and mandatory payables and living expenses spent on the insured. This provides the actual salary needed to provide for family needs..
Step Three
Decide on the period for which insured’s income needs to be replaced. This period could be until the insured’s dependents are fully grown, and no longer require financial support, or until the insured’s assumed retirement age.
Step Four
Factor in the time value of money. A person may feel INR 50,000 pm would suffice after a few years. However money loses value over time. This crucial concept is to be considered while determining HLV.
Step Five
Multiply the net salary needed by the length of time needed to determine the future earnings. Then, using the assumed rate of return, figure out the present value of future earnings.