Just finished lecture 6. Is the purchase of life insurance related in any way to the computation of present capital with regards to future earnings. If I make $100,00 per year and the interest rate is 10% then I would purchase $1,000,000 worth of life insurance. My wife owns the policy (and perhaps me), if I pass then she gets my future earnings???
Great question. Yes, the standard approach in is to compute the “human life value” of a person and then “fully insure.” So you’re right, other things equal, the lower the interest rate, the more death benefit someone would take out on the breadwinner of a household.
However your formula is too simple. If you make $100,000 in salary, then it would be overstating your “human life value” to say at a 10% interest rate that your future earnings are worth $1 million. This is because (a) you won’t generate that income forever and (b) you have to consume in order to stay in working condition.
So e.g. maybe you’d say that you contribute only $75,000 on net to the rest of the household, and that you could be expected to do that until age 70. So you might take out a life insurance policy discounting that future net income stream into a PDV using market interest rates.
(BTW I happen to do a lot of outside work on life insurance, so if this stuff interests you check out this website: http://Lara-Murphy.com )
Thank you very much, just finished this course yesterday. A few episodes were over my head, particularly that impossibility theory. I am going to start over with Part 1 and then part 2 again. Really enjoye Contra Krugman and I benefited greatly from your Lessons for the Young Economist book (although I’m in my 60’s). Hoping to meet you at the Soho Forum next year.