Human-Life Approach

Human-Life Approach

Definition
The human-life approach estimates how much life insurance a family needs by calculating the present value of the income the deceased would have earned and provided to dependents. It focuses on replacing lost future earnings and related benefits so the family can maintain its standard of living.

Why it matters
– Helps families with wage-earning members determine a coverage amount tied to financial loss rather than a single lump-sum guess.
– Emphasizes income replacement and considers factors such as taxes, living expenses, and employer benefits.
– Best suited for families where one or more members earn a significant portion of household income. It contrasts with the needs approach, which totals specific expenses (debts, future college costs, final expenses) rather than projecting lost earnings.

Key factors to consider
– Insured’s current salary and expected future salary growth
– Age and planned retirement age (time horizon for replacement)
– Income taxes and living expenses attributable to the insured
– Employer-provided benefits (health insurance, pension contributions)
– Discount rate (rate used to convert future earnings to present value)
– Number and dependency status of spouse/children and other household income sources

Calculation steps
1. Estimate remaining lifetime earnings: project the insured’s average annual wage and realistic future increases until the chosen end date (e.g., retirement).
2. Adjust for taxes and expenses: subtract estimated income taxes and the portion of living expenses the insured would have covered to produce the net annual amount that must be replaced (a common rule of thumb is roughly 70% of pre-death income, but this varies by household).
3. Determine the replacement period: decide how many years earnings must be replaced (until dependents are financially independent or until the insured’s retirement age).
4. Choose a discount rate: select a conservative rate to reflect the expected return if the death benefit were invested (commonly a short-term government bond rate or another low-risk rate).
5. Calculate present value: multiply the annual net amount by the present value factor for an annuity using the chosen discount rate and replacement period.

Present value formula (annuity):
PV = Net annual amount × [(1 − (1 + r)^−n) / r]
where r = discount rate, n = number of years.

Example
A 40-year-old earns $65,000 per year. After adjusting for taxes and expenses, the family would need $48,500 per year to replace the insured’s contribution. If replacement is required for 25 years (until age 65) and a 5% discount rate is used, the present value of those future net earnings is about $683,556. That figure represents the life insurance amount needed under the human-life approach.

Limitations and practical considerations
– Excludes non-economic values (emotional support, household services) and may undervalue contributions like childcare or homemaking unless explicitly converted into monetary terms.
– Sensitive to assumptions about salary growth, discount rate, inflation, and the replacement period—small changes can materially affect the result.
– Should be combined with an assessment of existing assets, other income sources (Social Security, pension), outstanding debts, and specific future obligations (college, mortgage) to produce a comprehensive coverage recommendation.
– Not ideal for households where the insured’s economic value to dependents is minimal (e.g., retirees with low earned income) or where needs-based expenses dominate.

Conclusion
The human-life approach provides a structured, income-focused method to estimate life insurance needs by determining the present value of lost future earnings. It is particularly useful for families that rely on a working member’s income, but results depend heavily on the assumptions chosen and should be validated alongside other methods and a household’s full financial picture.