A young married client had done some mental math and decided that the total of his life insurance premiums if he held the policy for the full term was a princely sum. He felt reluctant to part with that money and told me so. For the moment we can leave aside the truism that you get what you pay for. Suffice to say that life insurance with equal benefits and provisions are competitively priced. If you find a cheaper product it may be because something is missing. (I have countless horror stories of people failing to receive life insurance payouts because of fancy clauses.)
But the bigger concept arising from his question is this. Why do I need life insurance? The average person does not pay enough attention to life insurance issues which can lead to tragic consequences as life insurance is an essential part of financial planning.
The reason is that none of us know the future (everyone has a bad story about someone who bucked life insurance only to leave a struggling family behind.)
Most of you who have spent any time with me can explain the reasons why life insurance is important at certain stages of your financial life. But the important idea behind that answer is called human capital.
Human capital is part of your wealth and can be your largest asset. Yet it is not often considered or discussed. What is human capital? It is a fancy name for beautiful you with all your skills, talent, and knowledge. It is your capability to produce financial capital. When you are young you have a great deal of human capital. You have energy, enthusiasm, and education. As you progress in life your human capital allows you to create financial capital. When you decide to stop using human capital to create financial capital you retire. Your amount of human capital is not as important then.
During the years you have a great deal of human capital you need to protect its potential loss. This is the role of life insurance. It is you realizing in one of your altruistic moods that you want to create a financial legacy for whoever is important in your life.
Much has been written about investing versus spending or accumulating to become financially independent. But little has been said about the foundation of those acts: human capital. Which when you think about it is surprising, given the uncertainty of careers and the increase in self employment.
So what advice did I give the 28 year old business owner? I told him if he was wise in his decision making there was a good possibility that he would not need life insurance for the entire term and would not be paying that princely sum. Obviously it takes a level of maturity to be one of these clients.
Human capital also plays a role in diversifying your long term investments. Much depends on whether your human capital is highly correlated to the stock market. One past example were the employees of Nortel Networks. Not only was the fate of their company highly correlated to market fortunes, they also had retirement plans in the company’s stock. This lack of diversification resulted in negative long term financial consequences