Human Life Value

Your life is priceless, and it cannot be valued. Life is subject to risks of disability and death due to accidental and natural causes. If this worst-case scenario happens to you, there is a loss of income to the household. The financial damage to the family is even more if you are the only breadwinner. This is where HLV comes into the picture.

You may not want your loved ones to suffer emotionally and financially in any situation. Hence, you must know your life's value and plan your investment accordingly.

By understanding a HLV of a person, can ensure that the standard of living of the family member is not affected even if the earning member is not there. In simple words it is based on simple reasoning that the value of one’s life is equal to his earning capacity.

In essence, it is the sum of money your loved ones would need to exist while maintaining their standard of living and pursuing their ambitions, after your death.

There are different ways to calculate human life value. The two popular ways are need-based and income replacement methods.

1. Income Replacement Method:

 In this method, your life value is calculated based on your annual income. The HLV is determined as:

Your Annual Income * Years Left for Retirement

For example, if your income is Rs20 Lakhs per year and you are currently 30 years and plan to retire at 50, your HLV is at least 20,00,000 * 20 = Rs 4 crore.

It's a simple method that gives you a close idea of the required sum Assured, but a significant drawback is that it does not factor in the inflation, income rise, and the major expenses on the way.

2. Need-Based Method:

 The calculation is done based on day-to-day expenses till the life expectancy of the youngest member in the family. The factors considered for assessment are the number of dependents and their needs, loans, children's education and marriage, your lifestyle, etc. This method considers inflation and discounting factor too. 

This method is generally based on assumptions such as (a) it provides benefits in the period immediately following the death of the insured to offset additional expenses; (b) it supports the normal living expenses of the dependents; (c) it provides long-term income for the retired surviving spouse.

Based on the analysis, this method estimates the total coverage your family may need to live a comfortable life in your absence.

Let’s assume current net disposable income(Income minus Personal Expenses along with tax liability) of A is Rs. 10 lakhs per annum and salary increases by 6% every year. He is 33 years of age and retires at 60. Suppose a family can earn 10% return on investment per annum and rate of inflation is 6%. He has a total liability of 10 lakhs and assets of Rs 5 lakhs.

So in Year 1 (age 33) he earns Rs. 10 lakhs which increases to Rs. 10.6 lakhs (Rs. 10 lakh + 6% of Rs. 10 lakh) in Year 2 (age 34) and so on.

In his retirement year he would be earning Rs. 48.22 lakhs per annum. So, he would earn Rs. 6.75 crores in his remaining 27 years to retirement, 

We need to calculate the discounting rate. If the return is 10% and inflation 6%, the discounting rate is about 4%, 3.77% to be precise. It is calculated as 1.1 / 1.06 -1 (1+return divided by 1+inflation minus 1).

Now we have a discounting rate (Rate) of 3.77%, years to retirement (N) of 27 and annual income (Pmt) of Rs. 10 lakhs. Human Life Value (HLV) is the present value of all future income that you could expect to earn for your family.

We will have to use the Present Value (PV) function in excel to calculate this amount. This will be PV(Discounting rate, Years to Retirement, Annual Income) or PV(Rate, Nper,Pmt). This comes to Rs. 1.67 crore as shown below.

So, the insurance needed as per human life value comes to Rs. 1.72 crore (Rs.1.67 crore plus Rs. 10 lakhs liability minus Rs. 5 lakhs assets)  and a person should take a life cover of at least this amount.

For financial planning purposes, the needs-based method is helpful because it takes a holistic approach and considers things like interest rates and inflation. 

Conclusion

It is important to note that HLV is a dynamic number and it changes with time as one vital component to calculate is your age. Additionally, any kind of changes in the economy or your earning will change the HLV. So, it is beneficial to calculate your HLV every year. This will further enable you in providing the right and sufficient cover for your family.