The human-capital section put an asset on the client's balance sheet that no custodian statement shows. This section takes the next step, which is the one most plans skip: an asset that large has risks attached to it, and two of those risks are insurable at a price you can compute.
What is an economic balance sheet?
Start by drawing the balance sheet properly. The economic balance sheet is the ordinary one extended on both sides.
| Assets | Liabilities and claims | |
|---|---|---|
| Conventional | Financial capital: portfolio, deposits, property, retirement wrappers | Mortgage, loans, tax payable on unrealised gains |
| Extended | Human capital: the present value of future earnings, net of the client's own consumption | Consumption liability: the present value of the household's spending plan, including a bequest if one is intended |
Net worth on this sheet is total assets less total claims, and it is the only version of net worth that answers a planning question. Two clients with identical portfolios and identical incomes can have opposite risk positions once the extended rows are filled in, because one has thirty years of earnings ahead of a modest spending plan and the other has three years ahead of a large one.
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Which two risks does the balance sheet show?
Two risks follow directly, and they are mirror images.
Human capital can stop early. Death or disability removes the largest asset on a young client's sheet while the consumption liability continues, and life and disability insurance transfer that risk.
Financial capital can run out late. Living longer than the plan assumed means the consumption liability outlasts the assets, and a life annuity transfers that risk.
Which risk dominates depends entirely on where the client sits in the life cycle, which is why the same client needs opposite products at different ages. Take a US client whose earnings, net of tax and of their own consumption, contribute $75,000 a year in real terms to the household, discounted at a 2% real rate, and follow the sheet across three ages:
| Age | Years to 67 | Human capital | Financial capital | Total | Human capital share |
|---|---|---|---|---|---|
| 35 | 32 | $1,760,125 | $250,000 | $2,010,125 | 87.6% |
| 50 | 17 | $1,071,890 | $900,000 | $1,971,890 | 54.4% |
| 67 | 0 | $0 | $1,900,000 | $1,900,000 | 0.0% |
Total wealth barely moves across the three rows. What changes completely is its composition, and with it the risk worth insuring. At 35 the client is 87.6% exposed to an asset that pays nothing if they die, so the insurance need is at its maximum and the annuity question is meaningless. At 67 there is no human capital left to protect and the entire question is whether the financial capital lasts. The plan that gets this backwards, and plenty do, sells a large annuity to a 35-year-old and lets a 67-year-old carry a life policy they no longer need.
How much life insurance, by two methods that disagree on purpose
Two standard methods answer the "how much" question, and a good adviser runs both, because the gap between them is itself informative.
The human-life-value method capitalises the client's own economic contribution. Take their gross earnings, subtract taxes and the client's own consumption, and discount the remaining stream over the working years at a rate reflecting the certainty of the income.
Worked on an Indian client aged 40, earning ₹36,00,000 gross with an effective 30% tax burden, consuming ₹6,00,000 a year on themselves, expecting to work to 60, with earnings growing 6% a year and a discount rate of 8%:
After-tax income = 36,00,000 × 0.70 = ₹25,20,000
Less own consumption = ₹ 6,00,000
Annual contribution to the family = ₹19,20,000
n = 20 years, r = 8%, g = 6%
HLV = 19,20,000 × [1 − (1.06/1.08)^20] / (0.08 − 0.06)
= 19,20,000 × [1 − 0.688085] / 0.02
= ₹2,99,43,824Against an existing employer group cover of ₹50,00,000, the shortfall is ₹2,49,43,824, or roughly 2.5 crore of additional term cover. The method's virtue is that it needs only income data. Its weakness is that it answers a question about the earner rather than about the family: it makes no reference to what the survivors actually need, so it overstates the requirement for a family with few dependants and understates it for one with a large mortgage and school fees ahead.
The needs-based method builds the requirement from the survivors' side, which is why it is the one that survives a client conversation. Worked on a US client with a spouse aged 42 and two children:
Annual household spending need after the death = $95,000
Surviving spouse's own after-tax income = $48,000
Annual gap = $47,000
25 years to the spouse's own retirement, 2% real
PV of the income gap = 47,000 × 19.523456 = $ 917,602
Plus lump sums: mortgage payoff $310,000
education fund $180,000
final expenses $ 25,000 = $ 515,000
Less existing resources: financial assets $420,000
group life $250,000 = $ 670,000
Insurance need = $ 762,602The two methods will not agree, and the disagreement is the conversation. A human-life-value figure far above a needs-based one says the client earns more than the family plans to spend, so the excess cover is really a bequest decision rather than a protection decision, and it should be labelled as one in the policy statement. A needs-based figure above the human-life-value one usually means a large fixed liability, most often a mortgage, that the earnings stream alone was never going to clear.
Three practical notes. Disability cover is the more likely claim and is routinely under-bought, since the probability of a long disability during the working years exceeds the probability of death for most ages; the needs analysis is the same one with the client's own consumption still in the numbers. Term cover is the default for a pure protection need, because permanent policies bundle an investment account whose costs and returns should be evaluated against the same client's ordinary portfolio rather than accepted as part of the insurance decision. And employer group cover disappears with the employer, which makes it the wrong foundation for a plan for exactly the client whose human capital is concentrated in that employer.
The annuity taxonomy, and the argument that actually justifies one
An annuity converts a lump sum into an income stream for life, which is the only instrument that transfers longevity risk rather than merely planning around it. The product space has two independent axes.
The first axis is immediate against deferred. A single-premium immediate annuity starts paying at once and is the instrument for a client at retirement. A deferred annuity starts later, and its extreme form, a deferred income annuity bought at 65 and starting at 85, is the cheapest available insurance against the tail of the longevity distribution precisely because most buyers will not reach the start date.
The second is fixed against variable. A fixed annuity pays a stated amount and hands the investment risk to the insurer, whose credit becomes the client's dominant exposure. A variable annuity's payment moves with an investment account, so the client keeps market risk and buys only the longevity transfer, usually with a guarantee rider whose cost should be quoted as a fee rather than described as a feature.
What is the mortality credit?
The argument that makes an annuity worth its cost is the mortality credit, and it is worth computing rather than asserting. Suppose 1,000 sixty-five-year-olds each contribute $100,000 to a pool earning 4%, and 1% of them die during the year. The pool grows to $104,000,000 and is shared among 990 survivors, giving each $105,050.51. The survivor's effective return is 5.0505%, not 4%, and the difference of 1.05 percentage points is the mortality credit: the deceased members' share, redistributed to those still alive. That credit is the thing no portfolio can manufacture, and it scales steeply with age, reaching 3.22 points at a 3% mortality rate and 6.64 points at 6%.
The honest limits sit right next to it. The credit is paid out of a pool the insurer manages, so it arrives net of the insurer's expenses, profit and adverse-selection allowance, and buyers of annuities are systematically healthier than the population, which raises the price. Inflation erodes a fixed payment, so a nominal annuity purchased at 65 can lose a third of its purchasing power by 85 at 2% inflation. And the decision is largely irreversible, which is a real cost for a client whose circumstances are not yet settled.
One decision, worked across the life stage
Return to the client above at 67, now with $1,900,000 of financial capital, no human capital, essential annual spending of $54,000, and $26,000 of guaranteed income from a state pension. The floor gap is $28,000 a year, and it is the only part of the spending plan that must not fail.
At a single-premium immediate annuity payout rate of 6.2%, closing that gap costs $451,613 of premium, which is 23.8% of the book, leaving $1,448,387 invested for everything discretionary and for a bequest. Compare that with the same client at 35, whose answer to the identical set of questions was ₹0 of annuity and the maximum affordable term cover, and the life-cycle logic is complete. The instrument changes because the composition of the balance sheet changed, not because the client's preferences did.
State all of this in the policy statement rather than leaving it in a spreadsheet. The three lines that belong there are the protection need with the method used to size it, the guaranteed-income floor with the instrument that funds it, and the review trigger, since both numbers move with every change in earnings, dependants or health.