How do you calculate your value? This is not an easy question to answer. There are so many variables to be taken into consideration. It is therefore not a surprise that most Americans follow the simpler Multiple of Earnings method.
In this method, an American with an annual earning of $ 50,000 decides that he needs a policy that is eight times his annual earnings. This calculation may look quite simple, but it also has its disadvantages. For instance, the non-wage value goes un-measured and the potential increase in earnings is not taken into account.
The right way to calculate coverage value is called Human Life Value. It is almost similar to the method used by the courts to award judgments in wrongful death law suits. The human life value method requires you to takes into consideration: -- The present value of all the income your expect to earn in the future; -- Any other value that you expect to contribute; After this, you are required to deduct taxes and expenses on personal consumption. The period that is to be taken into consideration is till your retirement date. The human life value concept can be understood better by taking an example. Let’s say Jack is 35 years old today and plans to work till 55. His current annual income is $60,000. Of this, he spends 20 per cent on himself and the remaining 80 per cent on his family. The non-wage value of the contributions he makes to the family’s kitty is $10,000.
In other words, Jack’s expenditure on his family today is $48,000 (80% of the $ 60000) plus $10,000 (non wage value). Jack now needs to calculate the inflation over the next 20 years and the likely increase in his earnings over the next 20 years. Let’s presume Jack’s income grows at an annual rate of 3 per cent. In this case Jack’s value at age 55 will be $1,07,897. Jack also needs to apply a ‘discount rate’ to account for the time value of money. Once he does so, he will arrive at his real value – that is his value to his family translated in monetary terms. This is the amount of life insurance protection that Jack must buy. Jack can also take the help of an insurance agent to do these calculations for him. This will give him considerable peace of mind because he will know that his policy will ensure that his family is comfortably off even if he is not there.