i try to remember it the opposite way since it makes more sense to me… lower human capital volatility (meaning less upside/savings, think of the teacher example) will lead to HIGHER demand for life insurance since if they kicked the bucket early there would be no savings left for the family… so they want the insurance.
then, the opposite must be true since CFAI is black and white.
hope that helps….
HC is the PV of all future expected earnings. Life insurance is a substitute for HC.
The more volatile the HC the higher the discount rate (as for any risky asset). More discount leads to lower PV. Lower PV leads to less life insurance.
mwvt9 Wrote:
——————————————————-
> HC is the PV of all future expected earnings.
> Life insurance is a substitute for HC.
>
> The more volatile the HC the higher the discount
> rate (as for any risky asset). More discount
> leads to lower PV. Lower PV leads to less life
> insurance.
Straight up, dis G right here be spitten mad knowledge..ya dig?
If someone didn’t have life insurance and died, his family would miss him greatly from an economically, so that is why he went to get himself a life insurance if he knew his HC is about to run out, no?
phBOOM
mwvt said it correctly - you get life insurance to REPLACE income you are currently generating and the family is depend on.
if your hc is volatile that means that your family does not depend on a daily basis on your income- so there is less need to replace that inflow.
The way I remember is : Higher HC volatility, so I will invest my FC in safe low volatility intruments. Thats why I dont need life insurance , because I ensure that I will have enough money for bequest when I die
I think most of you are equating volatile human capital as higher human capital (which makes sense because of usual risk return relationship). I am not sure it has to apply here.
Remember this is just crappy theory.
Imagine a shoe shiner. Each day he tries to shine some shoes, some days he makes $50 bucks, some days none.
In the human capital equation the total value of his expected future income is NOT high at all in the first place and the fact that it is volatile further decreases its PV.
Help?
Edit: crossed with amit and pimp.
My understanding – higher human capital volatility would imply it being equity like. If it is equity like, there is a lower need for life insurance as there is a greater ability to reach a higher retirement base with the equity like human capital.
I can give the textbook explanation.
1. Lower volatility (meaning bondlike) in Human Capital means that financial capital will be invested in equity. “Apparently this increases demand for Life Insurance”.
2. You can off course confuse this with another point mentioning that higher wealth leads to lower demand for life insurance (I know I mixed up). But do not get confused because having more wealth and more % of Financial capital as equity are separate concepts.
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