How to calculate your HLV
Every individual wishes to provide for his family/dependants, in the event of him meeting with an eventuality. Despite that, not many indulge in the exercise of determining their Human Life Value (HLV). If providing for your dependants is a priority, then calculating the HLV is an exercise that you must indulge in.
Although the concept of HLV is something that you must have heard on multiple occasions and from various sources (especially from insurance agents), how it is calculated remains a largely lesser-known topic. Secondly, given that there are multiple methods for calculating the HLV only adds to the confusion.
The most common and widely accepted method involves taking into account the total income that the individual is expected to earn over the remainder of his working life, expressed in 'present' Rupee terms. In other words, calculations are made to figure out, what is the present value of the total monies that the individual would have earnt over the rest of his working days.
Our view on how HLV should be calculated, however, is quite different. We define HLV as the sum total of the monetary values of all future needs an individual's spouse and dependents have of him, along with the values of all outstanding liabilities. In short, while the conventional way of calculating HLV is by accounting for the 'income', we choose to follow the 'expense and financial commitment' route, which in our view is more objective and realistic.
But only understanding the concept of HLV is not enough. The next step is to understand how the same is calculated. In this article, we outline a 6-step strategy, which will help you in determining your HLV.
Step 1: Determine the tenure over which you wish to provide for your dependants
The first step is to decide the horizon over which you wish to provide for your dependants. For married individuals, the horizon ideally should be the remaining lifespan of his/ her spouse. For this, you will need to assume the life expectancy of the spouse and then deduct it from the current age. The resultant figure is the time frame over which you will have to provide for your spouse. For instance, if the current age of your spouse is 30 years and you expect him/her to survive until the age of 70 years, then you have to provide for another 40 years (70 less 30).
Step 2: Account for your dependants' life stage events
In the process of determining the HLV, you will have to make certain estimates. One of them is to determine your dependants and the amounts that you wish to set aside for them. If you are married, the dependants will typically comprise your children and your spouse. You will need to determine, what percentage of the monthly household expenditure your children account for and till what age they will remain dependent on you. This is important since once the children start earning, they are unlikely to be dependant on you. Beyond that, you will only have to provide for your spouse (in case you have no other dependents).
Also, you have to account for other expenses, for example a) Money you wish to set aside for children's education , b) Money you wish to set aside for children's marriage. This is important because these are typically the kind of events that you would like to ensure that your children don't miss out on, even in your absence.
Step 3: Account for your current household expenditure
Calculate your current household expenditure; more importantly find out, of that, how much you spend on yourself. For example, let's assume that your monthly expenditure is Rs 25,000, of which, you spend Rs 5,000 on yourself. Now, in case you were to meet with an eventuality, your dependants' monthly household expenditure would be the balance i.e. Rs 20,000 (Rs 25,000 less Rs 5,000) per month or Rs 240,000 per annum. This figure (after adjusting for inflation) will be your dependants' future household expenditure i.e. the sum that you wish to provide for.
Step 4: Factor in the impact of inflation on expenditure
The next step is to determine the future household expenditure. For the same, you will have to factor in the impact of inflation on household expenditure. It must be noted that adjusting expenditure for inflation is an essential part in the process of calculating HLV. Inflation is a situation wherein too much money chases a limited number of goods. This leads to a fall in the value of money. Inflation is also expressed as a rise in the price level. As a result, a higher amount needs to be spent to buy the same objects/goods. So over longer time periods, it becomes pertinent to factor in the impact of inflation on expenditure.
Step 5: Determine the present value of the expenditure
After arriving at the future expenditure, the next step is to determine its present value (a Rupee spend in the future, is worth less than a Rupee today; this is the impact of inflation). In other words, you need to compute how much your total future expenditure works out to in present monetary terms. For doing the same, you have to discount future expenses, using an assumed rate of return; generally the rate of return on low risk securities/deposits is considered as the discounting factor. This will give you an idea as to how much amount you will have to keep aside, to provide for your spouse/dependants in your absence.
Step 6: Consider the present value of outstanding liabilities and medical expenditure
The process of computing the HLV is not complete without accounting for your outstanding loans/liabilities (like your housing loan or car loan, for instance) in present value terms. This needs to be taken into account because it will aid your dependants in paying off debts/liabilities in your absence. This will ensure that they don't have to sacrifice any amenities provided by you during your lifetime. Besides, the amount that you wish to set aside for medical expenditure also needs to be added to the present value.
The amount arrived at the end of this process is your Human Life Value.
Finally, calculating the HLV is not a one-time event. While calculating HLV, you have to make few crucial assumptions such as the inflation figure and the low risk rate of return, which are not fixed and are bound to change. Furthermore, changing lifestyle could also necessitate a change in the expenditure. This makes the HLV a moving figure. Hence, it is important that you revisit your HLV calculation every year, preferably with the help of a financial planner to ensure that your dependants are adequately provided for at all times.
Comments