Discounting rate for HLV

Human Life Value asks a simple question. How much money, invested today, would replace a person's future income for their family?

To answer it, an adviser cannot just use the return the money will earn. Income itself grows every year with inflation. So the workbook blends the two rates into one. That blended rate is the discounting rate.

It feeds into Excel's PV function as the "Rate" argument. Get the discounting rate wrong, and the whole insurance need is wrong.

The formula, straight from the workbook:

Discounting rate = ((1 + rate of return) / (1 + inflation rate)) - 1

A special case worth remembering. If the assumed rate of return equals the assumed inflation rate, the discounting rate becomes exactly 0%. When that happens, the Human Life Value collapses to a simple thumb rule: current annual income multiplied by the number of years left to retirement. This is also why the workbook says HLV is naturally higher for younger people — more years remain, and a higher income growth assumption is often used for them too.

The discounting rate is then entered as the Rate argument of the PV function in Excel, alongside Nper (years remaining) and PMT (the income to be replaced), to compute the lump sum required today.

Anil earns Rs 1,50,000 a month. He pays an insurance premium of Rs 25,000, an EMI of Rs 32,000, and spends Rs 10,000 on himself. None of that money supports his wife if he dies, so it is excluded from the income to be replaced.

Income to be replaced = 1,50,000 - (10,000 + 32,000 + 25,000)
                       = Rs 83,000 a month = Rs 9,96,000 a year

Assume inflation of 6% and an expected return of 8%:

Discounting rate = ((1.08) / (1.06)) - 1 = 1.89%

His wife is 49 and expected to live to 80 — 31 years of income to provide for. Using the PV function with Rate 1.89%, Nper 31, and PMT Rs 9,96,000, the corpus required works out to Rs 2,36,43,984.

Add his outstanding home loan of Rs 40,00,000, then subtract his existing life cover of Rs 1,00,00,000 and other investments of Rs 50,00,000:

Additional insurance cover required = 2,36,43,984 + 40,00,000 - 1,00,00,000 - 50,00,000
                                     = Rs 1,26,43,984

Chapter 2 (Features of Life Insurance Products), section 2.2, works through both the simple Human Life Value method and the needs-based, income-replacement method, using this discounting rate in the PV formula each time. Expect a numerical question that asks you to compute the discounting rate first, then plug it into a PV calculation, and a conceptual True/False question built around the special case where the rate of return equals inflation.

• It is not the return rate, and not the inflation rate. It is a blend of both, and using either alone gives the wrong PV.
• When return equals inflation, the discounting rate is 0%, not undefined. HLV then equals income multiplied by years to retirement — a pure thumb rule.
• HLV falls as a person ages, even with income rising as planned. The discounting rate stays the same, but Nper (years left) shrinks, so the PV falls.
• The needs-based method will never exceed the HLV method. Overall expenditure cannot exceed income, so the needs-based corpus is always lower or equal.
• Always net out existing insurance cover and investments before quoting the final number — quoting the gross corpus overstates the need.