It is difficult to put a price tag/value on anyone’s life. However to buy insurance you have to first answer the question of how much insurance should one have. So to put a price to your life, it is important to know your Human Life Value (HLV).
Huebner (1964) postulated that the optimal sum assured for a working individual should be equal to the displacement cost of his life to his family/dependents. The HLV of a working individual is therefore measured by the discounted present value of expected future earnings over the residual working life minus his own consumption needs.
There is a vast literature that discusses, refines and prescribes it.
The advantages of the HLV concept
Firstly, the idea is borrowed from property insurance and is based on the principle of indemnity. It therefore seems consistent with insurance precepts.
Secondly, it gives a more or less objective and precise yardstick to quantify the sum assured.
Thirdly, it protects the standard of living of survivors, something that every insured is concerned about.
Having said this, it is possible to raise a number of issues on which the HLV approach provides no guidance.
The critics of the HLV concept
- Firstly, any individual’s earning and consumption profile would fluctuate from year to year unless he is in a job like government employment where predictability is high. Should the individual change the amount of insurance as the earning/self maintenance undergo a change? For example if he falls ill and his medical hospital expenses increase should he reduce the sum assured as the HLV equation above predicts? Surely no one would do that! On the contrary, he may be induced to increase his insurance!
- Secondly, as his life progresses and his residual working life diminishes so would his human life value. Should he then go on reducing the amount of life insurance in such a way that on retirement he has no life insurance whatsoever because his HLV is zero? Most customers simply don’t do this.
- Thirdly, even granting that a customer’s HLV should equal sum assured, the HLV approach gives no guidance with respect to which life insurance policies should the customer buy; term, endowment, money back? We may tacitly suppose that HLV prescribes the pure term assurance plan, it being the cheapest. Yet the fact is that in most countries this plan does a miniscule proportion of business.
- Fourthly, the HLV approach seems entirely to ignore the fact that customers view life insurance as a vehicle of saving for the future in addition to providing protection. In other words, they attach an opportunity cost to the premiums that they pay. Yet formula (1) considers only the opportunity cost associated with the net income stream of the individual, not the premiums that he pays and the benefits that he receives under the life insurance policies.
To put it in the words of Borch (1977), “ the idea of Huebner has its origin in property insurance, the real problem in this field is not to evaluate property but to decide if the owner should carry some of the risk himself. Clearly this decision will depend on the cost of the insurance cover and calls for an economic analysis. As life insurance is a form of saving it will have to compete with other forms of saving. The growing interest in portfolio theory over the last two decades has brought much attention to insurance. Life insurance policies obviously should have a place in the optimal portfolio. How prominent this place should be will depend on the nature of alternative investments”.
- Fifthly, and this point is closely related to the point just made, the HLV approach does not consider the payment capacity of the individual. Can he really afford policies whose sum assured equals HLV after meeting other needs? Will insurance companies be willing to write these policies? Although not strictly criticisms of the HLV approach questions like these help to draw attention to the fact that in most societies the actual sum assureds that are bought and sold are much lesser than the human life values.
Therefore, HLV concept must be suitably adjusted :
- To account for notable changes in income & consumption levels
- To sync with reducing working life span.
- To match type of product to specific needs.
- To take into account that buyers often view insurance as an investment product also.
- To suit the payment capacity of the individual
See the examples of calculating HLV
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