What Is the Human-Life Approach?
Let me explain the human-life approach to you directly: it's a straightforward method for figuring out how much life insurance a family needs, based on the financial hit they'd take if the insured person dies today.
Key Takeaways
You should know that the human-life approach calculates life insurance needs for a family by focusing on the financial loss when the insured dies. It accounts for various factors like the insured's age, gender, planned retirement age, annual wages, and benefits. This approach applies mainly to families with working members and differs from the needs approach. Remember, you must replace all lost income from an employed family member's death using this method. When setting up a policy, consider expected future earnings and how long the money is needed to avoid leaving the family in financial trouble.
Understanding the Human-Life Approach
I'll walk you through how the human-life approach works: it involves considering factors such as the insured's age, gender, planned retirement age, occupation, annual wage, employment benefits, and details about the spouse or dependent children.
Since a human life's economic value relates only to others like a spouse or kids, this method is typically for families with working members. It stands in contrast to the needs approach.
With this approach, you need to replace all income lost when an employed family member dies. That means after-tax pay, adjusted for expenses like a second car tied to earning that income, plus the value of health insurance or other benefits.
The Human-Life Approach Calculation
When you're determining life insurance for a family, take time to assess all variables so they won't face financial distress if someone dies. Here are the five key steps I recommend for calculating it.
Steps for Calculation
- Step One: Estimate the insured’s remaining lifetime earnings, including average annual salary and potential future increases, as this greatly affects insurance needs.
- Step Two: Subtract estimates of annual income taxes and living expenses for the insured to get the actual salary needed for family support, typically around 70% of pre-death income, though it varies by budget.
- Step Three: Determine how long earnings need replacement, such as until dependents are grown or until the insured's retirement age.
- Step Four: Choose a discount rate for future earnings, like the conservative rate on U.S. Treasury bills, since the insurance company holds the death benefit in an interest-bearing account.
- Step Five: Multiply the net salary by the time period to find future earnings, then calculate the present value using the discount rate.
Example of the Human-Life Approach
Consider this example: a 40-year-old earning $65,000 per year. After the steps, the family needs $48,500 annually if they pass away, until age 65, which is 25 years away. At a 5% discount rate, the present value of that future net salary over 25 years comes to $683,556.
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