Income Replacement Versus Expense Approach to Insurance-Needs Analysis

Brayman, Shawn
March 2009
Journal of Financial Planning;Mar2009, Vol. 22 Issue 3, p48
Academic Journal
• Financial advisors commonly use three methodologies to determine client life insurance needs: income replacement, expense analysis, or hybrid models. Expense analysis is generally recognized as the more robust methodology, but requires greater discovery and data to perform. This paper compares these techniques to determine to what extent the simpler approaches identify greater or lesser insurance "needs" and to determine whether the differences are significant. • The study compared 2,300 actual client cases and found that the income replacement method overstated requirements 73.5 percent of the time, by an average 67.5 percent, compared with an expense analysis. • Income replacement understated needs 20.8 percent of the time. It was determined that advisors articulated 28.5 percent more goals and averaged 15.8 percent higher replacement percentages with the discovery methods of expense analysis. • Even when income replacement overstated needs, it was determined expense analysis uncovered 19.8 percent more needs and averaged a 9.4 percent increase in average replacement amounts. • Needs for younger or higher-income clients were more frequently overstated. • Client net worth was not a significant factor. • When debt repayment was added as an immediate need, overstatement of income replacement increased from 73.5 percent to 78.5 percent. • When retirement age was used to determine the income replacement period, overstatement dropped from 73.5 percent to 47.8 percent. • In short, the expense-based analysis provides a more accurate estimation of the insurance needs of the client because it reflects the specific stated needs for the survivor upon the death of their partner. • A random review of insurance needs calculators on the Web illustrated significant variation. At least half the calculators estimated an insurance need greater than full replacement of the deceased's after-tax income.


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