L—Human Life Value
In determining how much life insurance should be carried for family income purposes, two basic methods are used. Theneeds approachinvolves a determination of the family’s income requirements. Thehuman life value approachinvolves a capitalization of that part of the breadearner’s income devoted to the support of his family.
Calculating an individual’s human life value involves first determining the amount of his income allocated to family support. This is done by deducting income taxes, personal life and health insurance premiums, and the cost of self-maintenance from the breadearner’s annual income from personal efforts. Assume that the result is $10,000 per year.
The next step involves determining the number of working years to retirement. Our example assumes the figure of 5 years. A reasonable discount rate is then applied to arrive at the present value of these anticipated future earnings. For example, 5 percent might be used as representing a conservative after-tax rate of return for the surviving family.
NO GROWTH.The present value of future earnings after the first year can then be calculated by multiplying them by the appropriate discount factors (e.g., multiplying the $10,000 expected to be earned for the family in the second year by a factor of .9524, we find that its present value is $9,524). When this amount is added to the present values of anticipated earnings in the other years, we determine a human life value of $45,459 (for the limited five-year period).
8% GROWTH.However, it is important to anticipate that in future years the income devoted to the breadearner’s family will likelyincrease. If we assume an annual increase of 8 percent, earnings are projected to be $10,800 in the second year. The present value of these earnings is $10,286 ($10,800 x .9524). Adding this amount to the present values of the anticipated earnings in the other years, we determine a human life value of $52,941,16 percent morethan if “no growth” had been projected.
The more years to retirement, the greater is the contrast between “no growth” and “growth.” An accurate estimate of human life values requires not only projections of anticipated growth but periodic reviews and updates of insurance needs.