How is Human Life Valued in Insurance?
One has heard of the famous saying “Human life is beyond comprehension”. It is futile to attach any value to it. One needs to determine what his life is worth in monetary terms and sad as it might seem this is a necessary task .One’s insurance needs depend on his monetary worth and in order to avoid being underinsured or over insured his human life value needs to be found out. Life is full of uncertainty and no matter how much one earns there is no guarantee he would be there to provide for his family when they need his support the most. Insurance fills up this all important role. Remember “You don’t need to pray to God any more when there are storms in the sky, but you do need to be insured.
What is human life value in insurance?
Human life value attempts to attach a value to one’s life so that one is able to establish for how much he needs to get himself insured. This saves one from insuring himself for too high an amount and needlessly paying the premiums. In simple words it is the present value of one’s future earnings.
- One’s main aim while taking up an insurance policy is to provide for his dependents particularly his spouse. If one’s spouse is 30 years and is expected to live for 75 years monetary support needs to be provided from the insurance policy especially if one is the sole breadwinner.
- One’s current income, how much one is expected to earn as well as his average future earnings determine human life value.
- Human life value calculations are not complete without expenses. Current expenses are repetitive monthly expenses as well as children’s education expenses which are currently present and continue to be incurred in the foreseeable future. Expenses include major liabilities such as a home loan a personal loan or an educational loan. One also needs to set aside a corpus for emergency medical expenses.
- One also needs to factor the effects of inflation while calculating human life value.
How is human life value calculated?
Let us understand human life value through a simple example. Mr Raju is 35 years of age and plans to retire at 60 years of age. Mr Raju earns INR 30000 per month. His monthly expenses are INR 12000 on personal expenses. His taxes and insurance premiums are INR 100000 per annum. The rate of inflation is 5% which reduces the value of his earnings. Mr Ramesh after paying up his liabilities spends the rest of the money on his family. This amount is assumed to be invested at a rate of 8%.So how is Mr Raju’s human life value calculated?
- Mr Raju’s age is 35 years and he plans to retire at 60 years of age. The time to retirement is 25 years.
- Mr Raju’s annual earnings are INR 360000.
- Mr Raju’s expenditure is INR 100000 on tax and insurance premiums. His annual personal expenses are INR 144000. Total expenses are INR 244000.
- Rate of inflation is 5% and assumed rate of investments has a notional value of 8%.
HLV can be calculated as follows
- Mr Raju’s annual income is INR 360000 from which his total expenses of INR 244000 are subtracted to get INR 116000.
- The time period is the time to retirement of Mr Raju which is 25 years.
- Rate is (1+ 0.08) / (1+0.05) - 1 where 8% is the rate of investment and 5% is the inflation rate.
- Rate = 2.86%.
- The Human life value of Mr Raju is calculated as INR 21 Lakhs as the present value of Mr Raju’s future earnings.
Why is human life value necessary in taking up a life insurance policy?
To answer this question one has to know why life insurance is taken? Life insurance is taken mainly to replace financial loss in case of a loss of life of one’s beloved. The emotional loss one suffers is huge and irreplaceable but the financial loss can be made up. This is the essence of insurance.
- The main purpose insurance exists is for risk transfer. Transferring the financial liability of a loss as the burden of the insurance Company is the main reason why one takes up a life insurance policy. This is achieved by paying a premium to the insurance Company to bear the risk.
- But what happens if one is underinsured? One would have to bear the financial loss himself to the extent of which he is underinsured. The very purpose of taking up an insurance policy is lost.
- But what happens if one is over insured? This mainly is the result if one insures himself or takes up a policy which does not match his needs .If one has no dependents and takes up a term insurance policy instead of health insurance the value of the premiums paid is lost.
- Insurance is all about risk protection. Separate insurance from investments. Adequate death benefit is a must for one from his life insurance policy. Think term insurance.
One has heard the famous saying “Something is better than nothing”. Sure insurance cannot replace the loved one and the emotional loss one suffers on this loss .Insurance takes care of the financial loss suffered due to one’s loss especially if he is the breadwinner. Insurance gives one a chance to play with uncertainty and has the power to protect ones finances from the hand of fate. Surely a life insurance policy which matches ones needs is a must.