Two follow-up points on last week’s topic.
First, the Human Life Value formula is used for determining the economic value of a life; it is not saying that one life is more valuable than another, per se. In the West, all human life is considered equally valuable from a philosophic perspective, but that is not the same as saying that they are all equal economically; they are not. The earning power of a surgeon is many times that of a laborer, and thus it is economically more valuable.
Second, it has been pointed out that my example of the capitalization of earnings method produced more insurance than was needed, because a) it didn’t deplete principal, and b) it didn’t consider the fact that social security could be available. Both points are true, so they require an explanation.
The general explanation is that, as previously mentioned, it was an overly simplistic method, just meant to give an overview, but since each point is a valid criticism, each will be addressed.
The capitalization of earnings example calculated an insurance amount using 4, 5 & 6% hypothetical interest rates with an assumption of $5,000 per month in household expenses. The amount of insurance needed at those hypothetical interest rates would be $1.5, $1.25 and $1.0 million, respectively, but those amounts would produce the $5,000 per month indefinitely.
There are two reasons (other than for the sake of simplicity, as already mentioned) for that. The first is inflation. There is no provision for increases in the $5,000 per month, and yet we all know that expenses will certainly increase over time. The second reason is if depletion of principal is factored into the equation, what time frame should be used? And what happens if the beneficiary outlives the estimated time frame? Can you see the problem with planning to spend down the principal?
Given the financial state of the US government, the social security issue really doesn’t have to be addressed, does it? If your planning is dependent on assistance from Uncle Sam, well, all I can say is that there is probably a problem with your planning.
Remember, there is no need for life insurance if love isn’t present. And if it is, skimping is not the way to go.