When considering the "right amount" of life insurance a client requires, it's important think and plan beyond covering the mortgage, debts and a basic heuristic multiple of income. A proper needs analysis incorporates a vital component in linking one's HUMAN CAPITAL to their FINANCIAL CAPITAL. What is Human Capital? Simply, it is the sum of all the income that you would earn over your working years multiplied by multiplying your take home by the number of years you plan to work. For example, let's take Maxine, a 30 year old Professional Engineer earning $90,000 after tax and planning to work to age 65. Using the Human Capital formula, she would have a Human Capital of $3.1 million. You may be surprised by the value of your own Human Capital, however this is your greatest asset and makes it important to protect!
Over time, the value of your Human Capital diminishes as it transitions to growth of Financial Capital. In other words, we spend our working years to save and invest, thereby contributing to growing Financial Capital into the future. Using Maxine as our example, she would ideally devote 30% of her after tax income to growing assets (including a house, retirement savings, TFSAs and other investments). These assets return a rate of 5% and at age 65, Maxine will have grown a Financial Capital of over $2.5 million!
Typically, many younger individuals (husbands, wives, young parents, singles) don't think about the future value they can build with the money they will earn and that is why having a conversation about Human Capital is so important in getting clients to think about the long term!
Once the basic needs and Human Capital are determined, we can then move forward in designing a life insurance policy to protect it all. At younger ages, Term Insurance is an excellent fit for a number of reasons. First, with higher insurance amounts, the unit costs (i.e. cost per $1000 of insurance) are less. Yes, buying in bulk also applies to Life Insurance! This means that protecting immediate needs, covering debt and insuring Human Capital can all be incorporated into the one amount for the best value. This is even more compelling if you have Bank Owned Mortgage Life insurance. By rolling that into one personally owned term insurance policy, you will save a significant amount of money (as creditor insurance is more expensive than personally held) and have more planning flexibility.
In fact, for Maxine, a 30 year term policy for $3 million can be more than 40% cheaper on a unit rate per $1000 of coverage than a policy for $250,000! Second, purchasing the right amount of term insurance as early as possible is always less expensive than waiting. Third, by locking in your insurability, you will have peace of mind in knowing that you have the right amount now rather than procrastinating and potentially jeopardizing your insurability status due to unforeseen health changes or by taking on new and dangerous avocations. Finally, the Term Insurance products that we broker are fully convertible to Permanent insurance in the future without any proof of good health. (My next article will discuss the value of Permanent Life Insurance as an asset class to your net worth enhancement).
In the meantime, ask yourself if you have considered the value of your Human Capital? I can help you plan in order to protect this most valuable asset by way of tailored insurance strategies in the event of dying too soon, or in the event of a sickness, injury or a serious health crisis.
Martin Maretzki, CHS, CLU
