Human Life Value

How much life insurance does a person need? The Human Life Value approach answers it by valuing the earner rather than the expenses.

The workbook's definition: the amount of life insurance cover required depends on the economic value that can be attached to human life. HLV is the value insurance needs to compensate for if there is a loss to life, or a disability that reduces the ability to generate income. Technically, it is the present value of the expected income over the working life of the individual that is available for the dependents.

It is deliberately the generous number. Its companion, the needs-based approach, asks a narrower question — what do the dependents actually need? — and the workbook states the relationship between them plainly: the HLV figure will always be higher than or equal to the needs-based figure, as overall expenditure cannot exceed income.

Only two assumptions. The workbook stresses how few inputs HLV needs: (i) by how much the current income increases — an inflation rate — and (ii) the post-tax return on the sum assured. In its illustration those are 6% and 8%.

The mechanism. The two assumptions are collapsed into one discounting rate:

Adjusted rate = ((1 + post-tax return) / (1 + income growth)) - 1

The income is then discounted over the remaining working years using the PV function, with payments taken at the beginning of each period.

Two results the workbook derives and then tests.

If income growth equals the post-tax return, the discounting rate is zero. Then HLV is simply current income x years left to retirement. The workbook calls this an easy thumb rule to remember, and notes it is the origin of the broader rule that the HLV of younger people is higher — both because more working years remain and because income tends to grow faster early on.

HLV falls as a person ages, other things being equal, because the discount rate stays put while nper falls.

What HLV also covers. The same calculation is prescribed for permanent total disability due to accident and for critical illness cover. The workbook notes both are routinely under-insured because nobody performs the calculation for them.

The workbook's own test case. A person aged 33, retiring at 60 — 27 years left — earning Rs 10,00,000 a year, with income assumed to grow 8% a year and the post-tax return on the sum assured also 8%.

Adjusted rate = (1 + 8%) / (1 + 8%) - 1 = 0
nper          = 27
PMT           = Rs 10,00,000
HLV           = 27 x 10,00,000 = Rs 2,70,00,000

This is the workbook's answer to a true/false question, and its point is counter-intuitive: raising the assumed income growth from 6% to 8% makes HLV go up, not down, because the discounting rate collapses to zero.

Now age the same person. At 45, with 15 years left and everything else unchanged, HLV is 15 x 10,00,000 = Rs 1,50,00,000. Twelve years have removed Rs 1.2 crore of insurable value. Nothing about him changed except the number of earning years in front of him.

Against the needs-based figure. Take the workbook's other example — Anil, who needs to replace Rs 9,96,000 a year for 31 years, plus a Rs 40,00,000 loan, less Rs 1.5 crore of existing cover and investments, giving Rs 1,26,43,984 of additional cover. His gross income is Rs 18,00,000 a year, so his HLV is far higher than that Rs 1.26 crore. The gap is exactly what he consumes himself and pays in EMI and premium — money the dependents never see. Hence the rule: HLV >= needs-based, always.

Chapter 2 (Features of Life Insurance Products), section 2.2 and 2.2.1, with Table 2.1 and two worked true/false questions that are reproduced almost verbatim in the exam. Expect both of them: whether HLV falls when assumed income growth rises (it does not), and whether HLV falls as a person ages (it does). Expect also the comparison question — HLV versus needs-based — whose answer is that HLV is always higher or equal.

• Higher assumed income growth raises HLV. It lowers the discounting rate. The intuitive answer is wrong and the workbook tests it directly.
• HLV falls with age, because nper falls while the discount rate does not.
• HLV >= needs-based cover, always. Expenditure cannot exceed income, so the needs figure cannot exceed the income figure.
• The needs-based figure falls when the client holds more investments; HLV does not — HLV never deducts existing assets or existing cover.
• Only two assumptions drive it — income growth and post-tax return — which is both its strength and its fragility.
• HLV is not only for death cover. The same calculation is prescribed for permanent total disability and for critical illness, and both are habitually under-insured.
• The discounting rate in the workbook's tables is shown to two decimals while the underlying formula runs to more, so small differences in the final rupee figure are expected.