Private Client Services by Mercer
Income Replacement is a concept which introduces a way for the policy holder’s beneficiaries to receive income through an alternate source, should an untimely death occur to the insured.
It is the essence of life insurance - should one no longer be around to provide financially for one’s loved ones and for them to have sufficient financial security to live comfortably, the insurance pay-out can fill that void. Though some in the industry may feel that a HNWI does not necessarily need to replace his or her income in the event of death, the potential loss of financial security for loved ones is a significant risk to the value of his/her estate.
One of the basic tenets of insurance, the principle of indemnity states that the insured or his/her beneficiaries should not profit from a loss or damage, but should be returned to similar financial position that existed before the occurrence of the loss or damage. In other words, the insured party is paid proportionately to the loss and there is no profit or damage upon receiving the insurance pay-out.
Although a life insurance policy is not a contract of indemnity, the insurance company is guided by the principle of indemnity when determining the appropriate amount of protection to write in a policy, as a check on the moral hazard.
Insurance companies are required to determine the capacity for each individual they insure in the high net worth space. Not everyone can just go and get $50 million worth of Life Insurance. The insurable need has to be determined to avoid individuals being “worth more dead than alive”. A main form of supporting this need/ capacity is through Income Replacement - the primary and secondary income the individual would expect to gain, should he or she live to old age. Generally, the industry has adopted the following method of determining the Income Replacement capacity:
Income Replacement is the main form of determining capacity, however other forms may further increase the capacity on an ad hoc basis (e.g. cover for future inheritance tax obligation).
Age: 50 year old Male
Family: Wife and two sons
Occupation: Business Partner
Net worth: $50M categorised as follows:
Yearly Business Income: $1M
Capacity for this Profile:
Total Income Replacement Capacity = $38.5 Million
Without Income Replacement Insurance:
An untimely event occurs at 60 years of age and the Client had no life insurance.
With Income Replacement Insurance: