Gordon Powers

Life insurance is an excellent way of protecting your family, largely because it pays a tax-free, lump-sum amount to your beneficiaries when you die. But one of the most critical questions young families face is how much coverage they actually need.

Consider a family with two working parents in their mid-thirties, each earning $50,000, and two kids aged three and five.

Including possible coverage through group plans at work, they should have somewhere between $600,000 and $750,000, according to several online insurance calculators.

Sound like an unreasonable amount? Maybe not, particularly when you consider that this couple is probably worth a lot more than you think.

It's easy to check your bank account, review your monthly investment statement or determine the value of your house. But what many of us don't do particularly well is quantify our "human capital," says Moshe Milevsky, a finance professor at York University's Schulich School of Business and author of several books on retirement and estate planning.

In fact, particularly when you're young, the most significant portion of your net worth may not be what you can pull together in terms of stocks, bonds or real estate but the amount that you'll produce as an earning machine over the lifetime of your working life, he maintains. And this is what Milevsky means by human capital.

Most of us start out with lots of human capital and little or no money. Through education and training, we increase our earning potential, boosting the value of our human capital at the same time.

This human capital, which represents both current income and inflation protection, is an important asset that shouldn't be overlooked.

This is where life and disability insurance fits in as it protects young families who might lose a breadwinner due to an untimely death or a career-halting illness and therefore be unable to convert that human capital into financial capital.

Essentially, such coverage acts as a hedge in case things go wrong, Milvesky says.

As you move through life and have fewer earning years ahead of you, human capital eventually starts to shrink. And, in certain circumstances, this can happen quicker than you think — all of which complicates the insurance decision.

Several studies suggest that those who reach career peaks earlier tend to have shorter lives, largely due to having a Type A personality and the additional stress this can cause.

Similarly, conscientiousness has been identified in many studies as the key personality trait that's a predictor of longevity: The more conscientious an individual is, the longer he or she tends to live.

Hopefully though, your financial capital is actually increasing at an accelerating rate, as you turn earnings into assets. Upon retirement, your human capital is usually quite small, however, and is replaced by the financial capital necessary to fund your retirement.

Protecting future potential becomes less of an issue at this point, although insurance can still play an important role in preserving wealth through estate planning.

Milevsky suggests paying more attention to career paths and earning potential when evaluating your financial condition, including your need for insurance.

This human capital deserves a prominent spot on everyone's personal balance sheet, he says. And the relative stability of that human capital — whether it's more "stock-like" or "bond-like" — should influence your asset mix, the type of securities you select as you move through life, and the level of insurance coverage you put in place to secure your foundation.

For instance, if you have a job that's not particularly stable or one in which your earnings fluctuate sharply, then your human capital needs to be viewed as a stock. As a result, you should probably consider investing more of your net worth in bonds or other lower-risk investments even though the returns may be lower.

If your job is secure and your earnings steady though, then your human capital looks more like a bond and you should consider investing more in stocks to take advantage of the security you already enjoy.

The problem today is that more and more people don't have a defined-benefit pension plan, nor do they have all that much job security. Their challenge, of course, is building up enough assets soon enough while still investing most of their money in low-yielding guaranteed options.

Either way, a reasonable amount of life insurance is required to help secure your family's lifestyle — both now and in the future.