Mortality Risk and Bequest Motives

A human capital is inherently linked to their mortality risk, which is the potential loss of all future income and wages in the event of premature death.⁶⁰ Life insurance mitigates this risk by providing a financial safety net for dependents. When assessing human capital, it’s essential to consider the adequacy of life insurance coverage to protect against the financial consequences of an unexpected loss of income. Furthermore, bequest preferences, or the desire to leave an inheritance, can also influence asset allocation decisions in the context of human capital.⁶⁰ Individuals with strong bequest motives might adopt a more conservative investment approach to ensure they can pass on assets to their heirs. While bequest preferences and subjective survival probabilities significantly affect insurance demands, they have minimal impact on optimal asset allocation.

The volatility of human capital is inversely correlated with the demand for life insurance. In the event of death, one loses all future earnings, equating to the total PV of future earnings potential. An appropriately tailored insurance policy compensates for this loss by providing a payout equal to the PV of the lost future earnings. This relationship can be understood through the following steps:

1.

Life insurance acts as a substitute for human capital.

2.

High volatility in human capital leads to it being discounted at higher rates, resulting in a lower present value (PV).

3.

Low volatility in human capital is discounted at lower rates, yielding a higher PV.

4.

Comparing these PVs, a lower PV implies a reduced need for substitution via insurance, and vice versa, establishing the negative correlation.