标题: human capital volitility [打印本页] 作者: ASSet_MANagemen 时间: 2011-7-13 16:08 标题: human capital volitility
The volatility of human capital and the demand for life insurance are correlated how:
positive
negative
unrelated
If vol is high, the PV of human capital is low (higher discount rate), so in my mind, the demand for life insurance would be high because you can't depend on that human capital and need life insurance to "fill the gap".
Thoughts??作者: Valores 时间: 2011-7-13 16:08
Thanks CP...
still a bit cloudy to me, but I know the explanations are correct and will just have to take it at face value. human cap vol is NEGATIVELY correlated with demand for life insurance.
I would argue that if Bob was making 250k with a 5% raise each year and very low volitility, then he has visibility to plan for retirement w/o the use of life insurance. If the portfolio takes a hit this year, its not that big a deal because he can bank on 250k coming next year.
And if Joe was making $250k average but volitility in those earnings was high, he doesn't have great visibility and would rely more heavily on life insurance. financial assets go into low risk assets because if the portfolio takes a hit, he can't rely on $250k next year. Maybe its only 100k next year...its that greater uncertainty that would make the life insurance a good idea.
I'll just remember to do the opposite of that. Right way, wrong way, CFA way.作者: thommo77 时间: 2011-7-13 16:08
"volatility" of human capital...
if human capital is more volatile I say its "less" certain. If you have uncertain capital what can you do to offset that uncertain capital? You obtain more guaranteed capital via insurance.作者: bpdulog 时间: 2011-7-13 16:08
I am not sure that the above is essentially correct = not according to CFA at least.
the earlier statement - this is how CFA wants you to think
1. human capital is more volatile, so riskier - need to have a higher discount rate.
life insurance is a substitute for hc -> so based on the higher discount rate - you would need to have lower of it.
2. your financial capital is less volatile, so need to have it invested in low volatile securities (bond).
CP作者: liangfeng 时间: 2011-7-13 16:08
Skip - I agree w/ you. You are saying volitility of human capital and insurance demand are positively correlated.
However that is wrong. human capital volitility is NEGATIVELY correlated with demand for life insurance.
My new thinking is:
1) assume everyone gets life insurance. life insurance substitutes for human capital.
2) High volitility human capital is discounted at higher rates. high rates make PV lower.
3) Low volitility human capital is discounted at lower rates. low rates make PV higher.
4) then just compare the PVs. If PV is lower, i need less of a substitute (insurance), and vice versa.
That's how they look at it to arrive at the negative correlation.
Edited 1 time(s). Last edit at Wednesday, January 12, 2011 at 05:10PM by june2009.作者: IAmNeil 时间: 2011-7-13 16:08
nice lil lesson there fellas. what has two thumbs and a better understanding of this concept now???? this guy作者: justin88 时间: 2011-7-13 16:08
That is so wrong, but CFA says:
It has negative correlation – more bond-like capital = more aggressive in financial capital = more insurance.作者: Windjam 时间: 2011-7-13 16:08
so CFA is basically saying that since the income is volatile and uncertain, it should be worth less today. volatility = a higher discount rate = less PV of human capital to protect= lower life insurance need....
sounds like a quant developed this who has never dealt with life insurance concerns of real people and families...whatever...I will hold it in until the exam and then let it out作者: bodhisattva 时间: 2011-7-13 16:08
I still dont get it bros.作者: Chuckrox 时间: 2011-7-13 16:08
Mechanics are:
human cap = PV of all your future earnings discounted back to today.
insurance is a substitute for human cap
if earnings are volitile you discount at a higher rate, making PV (human capital) lower
if the PV (human capital) is lower, one would need less of a substitute to replace it - relative to someone with a higher PV.
I hate it...but I accept it.作者: jmh530 时间: 2011-7-13 16:08
june2009 Wrote:
-------------------------------------------------------
> Mechanics are:
> human cap = PV of all your future earnings
> discounted back to today.
> insurance is a substitute for human cap
> if earnings are volitile you discount at a higher
> rate, making PV (human capital) lower
> if the PV (human capital) is lower, one would need
> less of a substitute to replace it - relative to
> someone with a higher PV.
>
> I hate it...but I accept it.
why do u hate it ....explanation makes sense to me ..................human capital = pv of future earning ============> higher vol implies greater discount rate ==============> lower present value =========> lower need for insurance to replace the possible future earnings.................also please note the premiums reduces the amount that can be invested in equities fixed and alternative investments dont forget high life insurance payouts come with higher premiums作者: mp3bu 时间: 2011-7-13 16:08
its subjective... an assumption is made that higher volatility decreases PV of future earnings. would if it is a volatile industry with an overall upward trend??? or an industry with an overall downward trend? why even consider earnings volatility in 2011?? will anyone in this economy listen to you tell them they need less insurance because they have volatile earnings? show them your little math formula and explain the discount rate to them? i scoff at this....SCOFF SCOFF....that being said... there is a negative correlation. it doesnt matter why. it just is.
Edited 1 time(s). Last edit at Thursday, January 13, 2011 at 02:23PM by SkipE99.作者: dyga 时间: 2011-7-13 16:08
insurance only pays off to surviving fam memebers as a means to replace your lost earnings stream ( it is not a lotto ticket at least it is not modeled that way which is a fair trade off since you also have to pay higher premiums which by def you cannot include in your investable portfolio leading to lost opportunity作者: bboo 时间: 2011-7-13 16:08
pimpin - the mechanics make sense. Yes.
the logic is confusing. if earnings are volitile (equity-like), uncertainty is high, hedge uncertainty with insurance guarentee, avoid high risk assets for financial capital. If earnings are steady (bond-like), uncertainty is low, less of a need for the insurance guarentee, take on higher risk assets for financial capital.作者: Valores 时间: 2011-7-13 16:08
I think what matters regarding this issue is how you interpret the "spirit" of insurance.... Insurance should definetely not regarded as a means to "get rich", it must be thought that it is there only to cover against what is at risk.
So, what is at risk?-> your smaller human capital (due to high volatility, high discount rate etc.) -> you should look for less insurance in that case. In other words, it helps you to maintain what you already had prior to the decease, not to generate a gain on it.作者: canadiananalyst 时间: 2011-7-13 16:08
revisor Wrote:
-------------------------------------------------------
> I think what matters regarding this issue is how
> you interpret the "spirit" of insurance....
> Insurance should definetely not regarded as a
> means to "get rich", it must be thought that it is
> there only to cover against what is at risk.
>
> So, what is at risk?-> your smaller human capital
> (due to high volatility, high discount rate etc.)
> -> you should look for less insurance in that
> case. In other words, it helps you to maintain
> what you already had prior to the decease, not to
> generate a gain on it.
+1 breh作者: susana 时间: 2011-7-13 16:08
The reading is basically a theoretical framework, and as such, you can take a few liberties with understanding it. Here's my take:
1. Start from a total wealth perspective. Total wealth = financial wealth + human capital (PV of future earnings)
2. Think of your career as a continuum, whereby your goal is to convert human capital (or latent earnings potential) into financial capital. Over time your total wealth picture is less dependent on human (potential capital) and more on tangible/real/financial capital.
3. Human capital, and the income derived from it functions GENERALLY like a fixed income instrument, you receive regular distributions that IN GENERAL have low volatility. Year-over-year, human capital will perhaps increase in line with inflation and maybe bumps in pay based on promotions or larger bonuses. For most people, career income is more predictable than equity market returns...it functions more like a fixed income instrument than an equity instrument.
4. Think of the discount rate that you use to derive the PV of human capital as similar to a WACC calculation. The weighted average would be based on the percentage of your total wealth derived from human capital and financial capital. For the purposes of discounting, human capital should have a smaller required return than risky capital (or equity-like) capital. Early on in your career, you probably haven't converted a lot of your latent potential into financial (riskier) capital, so your discount rate (WACC) would be dominated by the human capital impact to your total wealth. Intuitively, this makes sense - since in general human capital is less volatile, and the required rate of return is lower, your discount rate is lower. A lower discount rate generates a higher present value -- insurance is a safety-net against that PV
5. Insurance is perfectly negatively correlated with human capital. If you die, you lose 100% of your future earnings - the PV of your future earnings potential. An appropriately purchased insurance policy would yield a distribution equal to exactly the same value of the PV lost ... perfectly negatively correlated.
CONCEPTUALLY, one wrinkle has to do with the nature of your work. Perhaps you manage a hedge fund. Your income (human capital) has a distinct equity-like component to it. In this case, as you convert human capital into financial capital, you need to be mindful that you have an implicit risky asset allocation based on the nature of your work; therefore, you should try to diversify your financial asset allocation into less risky assets.
If I wanted to over think this, I could poke holes in what I've written above (i.e. the WACC argument), but directionally I think it encapsulates the intention of the reading.作者: ohai 时间: 2011-7-13 16:08
My understanding of the logic is the following:
if your income volatility is high, it limits your future spending planing, the present value of your future expenditures is lower and thus you need less insurance to cover it
when you buy an insurance you insure your life or the stream of future income per se, not its volatility... thus, the level of volatility impacts the amount to hedge
Edited 1 time(s). Last edit at Monday, January 17, 2011 at 11:09AM by diehard.作者: lcai 时间: 2011-7-13 16:08
Maybe just remove the volatility part of it for sake of understanding. Now lets consider 2 cases below:
Case 1: I earn $18,000 a year (mening PV of my Human Capital is very low). Me and my family live in dire conditions. If I die tomorrow, my family's condition will not be so much worse off as it is when I am alive today.
Case 2: I earn $500,000 a year (meaning, PV of my Human Capital is relatively very high). Me and my family is used to living a lavish life style. If I die tomorrow, the stop on $500,000 every year will make a LOT of difference in the way my family has lived so far.
So, higher the PV of human capital, higher is the need for life insurance (to substitute it). Now, PV can be high because you are actually earning high or it could be high because though you are earning relatively lower, but your earning volatility is lower.
Hope this makes sense.作者: NakedPuts2011 时间: 2011-7-13 16:09
I think of it this way:
If my human capital volatility is high (i.e - I work in a very risky environment where I could either make a lot or go home), then I'm most likely to be the guy who is risky by nature and confident that even if my career is volatile, I'll still bounce on my feet and hit it big.
Having this attitude dismisses the thought of paying for life insurance because hey, I'm the guy that's going to hit it big anyway, and the insurance money is pocket change for the lifestyle I'll be living.
Now, if I'm a professor who makes a stable salary and benefits, my human capital volatility is low, but I'm still nervous something might happen because I'm the guy that enjoys being risk-averse, so I might as well buy some life insurance should something happen.
