I don’t understand how in the below guideline answer, they just ignore parts of the human capital calculation. How are we supposed to know that you can just pick and choose from the given information?
Two persons, Debrah with a 100K salary which has high correlation with equities and 200K worth of savings. Kelly, 75K salary but very steady and secure, and 500K of savings.
Question: Provide a reason for Debrah to have:
Less life insurance: Debra has a higher correlation between wage growth and risky-asset returns because she is employed in a financial firm and part of her income is based on equity returns. Ignoring salary level differential, Debra’s higher wage growth correlation implies lower human capital as her wages are riskier and thus should be subject to a higher discount rate. Therefore, higher wage growth correlation is a factor that reduces life insurance need.
More life insurance: Ignoring wage correlation differences, Debra’s higher salary (i.e. USD 100,000 for her, compared to USD 75,000 for Kelly) implies higher human capital, thus a higher life insurance need. In addition, financial wealth can be viewed as a substitute for life insurance. Increasing financial wealth reduces the adverse financial impact of human capital loss on surviving heirs. Based on financial wealth, Debra has a higher life insurance need (she has financial wealth of USD 200,000, compared to USD 500,000 for Kelly).