Spotlight on Disability Income Insurance

Spotlight on Disability Income Insurance

The worst day in many people’s lives is the day they have a life-changing accident, or the day a doctor confirms the diagnosis of a challenging illness or disease. The emotional and day-to-day impacts can be immense, but what about the financial consequences of losing income for an extended period of time? There’s an app for that – disability income insurance.

May is Disability Insurance Awareness Month. Considering the potentially devastating impacts of lost income due to disability, let’s take the cue and improve our awareness of disability income insurance.

What is disability income insurance?
Disability income insurance replaces your income in the event you become too sick or injured to work.

The term “disability” can conjure images of a dread disease or a horrible accident – and the understandable reluctance to believe it will happen to me – but a disabling event isn’t always that dramatic, and it is more common than most people think. One injury or quiet onset of illness can prevent you from being able to work.

Disability claims are typically filed for acute or chronic illnesses or health conditions. Musculoskeletal disorders (such as arthritis, spine and joint disorders, fibromyalgia, and back pain) represent the largest percentage of disability claims, more than any other condition.1,2  Mental health problems (depression or anxiety, for example) are also a significant category of disability claims.

“In the last 20 years, deaths due to the ‘big three’ (cancer, heart attack and stroke) have gone down significantly. But disabilities due to those same three are up dramatically. Things that used to kill, now disable.”
– National Underwriter, May 2002

Why insure income?
Most people are surprised to learn that their greatest asset is not the house, not the retirement account, not even that condo in Cabo, but their income. The accompanying table shows the long-term value of your income potential. Your quality of life, your ability to send kids to college, your retirement, all depend on your ability to realize that income potential. A loss of this magnitude can be catastrophic.

Yet, few people opt for disability income coverage, even though it may be one of the most important insurance products anyone can buy. The non-profit Consumer Federation of America just polled 1,200 private-sector U.S. workers and found that 69% had no disability coverage.1

What does lost income look like?
Suppose an injury or illness prevents you from doing your job. What is your plan for dealing with the lost income?

  • How would you pay your mortgage?
  • What might happen to your credit rating after late or missed payments on your car or credit cards?
  • For how long will your savings cover your household expenses?
  • How would a disability affect your children’s prospects for higher education?
  • Could your spouse continue to work and care for you?
  • What would your lost income mean to retirement plan contributions?
  • What assets might you have to liquidate to pay expenses?
  • If you have a group plan at work, what are the benefits, and are they enough to provide income for a long enough period?

A fate worse than death?
In financial terms, some call disability as a “living death.” When you die, your income stops, but so do your expenses. If you are disabled and cannot work, your income stops … but expenses live on for you and your family. In fact, because of the cost of medical treatment, your expenses may increase. About 69% of all personal bankruptcies (and nearly 50% of foreclosures) occur as a result of medical problems.

What are the risks?
Statistically, the chances of a disabling event are higher than you might expect. According to the Council for Disability Awareness, “64% of wage earners believe they have a 2% or less chance of being disabled for 3 months or more during their working career.3 The actual odds for a worker entering the workforce today are about 25%.4” And what I find most fascinating: “Most working Americans estimate that their own chances of experiencing a long term disability are substantially lower than the average worker’s.3” 

More data from the Council for Disability Awareness:

  • Just over 1 in 4 of today's 20 year-olds will become disabled before they retire.4
  • More than 37 million Americans are classified as disabled; about 12% of the total population. More than 50% of those disabled Americans are in their working years, from 18 to 64.5

The Council gets even more specific:

  • A typical female, age 35, 5'4", 125 pounds, non-smoker, who works mostly an office job, with some outdoor physical responsibilities, and who leads a healthy lifestyle has the following risks:
    • A 24% chance of becoming disabled for 3 months or longer during her working career
    • A 38% chance that the disability would last 5 years or longer
    • The average disability for someone like her lasts 82 months
    • If this same person used tobacco and weighed 160 pounds, the risk would increase to a 41% chance of becoming disabled for 3 months or longer
  • A typical male, age 35, 5'10", 170 pounds, non-smoker, who works an office job, with some outdoor physical responsibilities, and who leads a healthy lifestyle has the following risks:
    • A 21% chance of becoming disabled for 3 months or longer during his working career;
    • A 38% chance that the disability would last 5 years or longer
    • The average disability for someone like him lasts 82 months.
    • If this same person used tobacco and weighed 210 pounds, the risk would increase to a 45% chance of becoming disabled for 3 months or longer

Why not just claim workers' comp or Social Security?
You can receive workers' compensation only if your injury or illness is job-related – but few are. The Council of Disability Awareness notes that 90% of disability claims in the United States are unrelated to workplace injury and therefore are not covered by worker’s comp insurance.

Social Security disability benefits typically provide about $1,100 per month – can your family live on that? Perhaps most problematic is that it might take a year or more for you to get your first check, if they approve your claim at all. In 2009 (in the midst of the Great Recession), the Social Security Administration denied 65% of initial SSDI claim applications.1,6,7

How much does disability insurance pay?
Insurance companies will typically cover 50-70% of your pre-disability income. An important thing to note is that you should always pay premiums with after-tax dollars; doing so makes the benefit tax-free. For many, a tax-free 65% is roughly equal to 100% of your previous after-tax take-home pay.

What does disability insurance cost?
Your policy premiums will depend on the particulars of your needs and preferences, but as a rough guideline premiums typically cost 1-3% of your gross annual income (1% is more of a bare bones plan, 3% is more of a Cadillac plan). Those premiums could purchase tax-free income replacement of 65% of your gross income, potentially to age 67.

Another way to look at the cost-benefit proposition is well illustrated in the following graphic. Which job would you choose?


How much insurance do I need?
Depending on other sources of income that may be available (a spouse’s income, passive income, investment assets, etc.), you may need to insure only a fraction of your income, or potentially none at all. Work with a professional (financial planner or trusted insurance professional) to help you calculate the right amount of coverage.

What’s right for me?
Everyone’s situation is unique, and the products and coverage options vary widely. The only way to determine the right solution for your situation is to work with a professional to analyze your needs, explore the risks, and educate you on the options.

Because income is your greatest single asset, it makes sense to take a careful look at very possible real-world scenarios where it could simply vanish. You owe it to yourself to get a professional evaluation of your risk exposures and options – especially while you are still healthy enough to qualify for coverage if you choose to pursue it.

Critical commentary
In contrast to insurance products that carry a certain amount of controversy, there is little to no rogue quality to disability income insurance. It is pretty straightforward -- the need for income is indisputable, the risks of becoming too sick or injured to work are real, and the insurance is relatively affordable. It makes sense at least to consider its place in your overall financial plan. Most planners will recommend it as part of a holistic approach to building long-term financial security.

The only caution is the same as applies to most insurance products -- the devil is in the detail. As with any type of insurance, the choices of coverage details are many and often confusing. Disability has its own particularly idiosyncratic language to describe its benefit categories, which alone can be bewildering to the uninitiate. Some of the differences in features are minor, but some are major, and the differences can be hard for the layperson to decipher. Some features -- for example, "own occupation" riders -- might be irrelevant to some people but essential to others. Again, a trusted adviser will be able to assist and advise you on choices appropriate to your situation.

Key takeaways
Disability – the inability to work due to sickness or injury – is much more prevalent than people think, and the risks of any one of us losing income to sickness or injury are much higher than we like to believe.

The financial costs of sudden and long-term loss of income can be catastrophic.

Relatively few people buy disability income insurance, perhaps because few of us believe we will become sick or injured. Or we don’t dare think about it. And few of us comprehend the varieties of “disability” that we could end up experiencing.

Disability income insurance is an efficient solution to the risk of losing income to sickness or injury (by “efficient,” I mean relatively small premiums can be leveraged into significant benefits).

The cost of disability insurance is about 1 to 3 cents on the dollar of income being protected. Benefits are tax-free and can pay you a monthly paycheck over many years, potentially from now to retirement. (Some products actually continue to make your retirement contributions for you, so you can continue to build retirement assets while on disability.)

Products and coverage options vary widely. Work with a professional to understand your risks and to help you determine an appropriate approach to insurance coverage.

Mallery Financial offers independent, objective consulting and implementation of disability income insurance under a fiduciary standard of care. For more about our unique approach to insurance services, see our insurance page. For more information, contact us.

1. [5/1/12]
2. [5/2/12]
3. Council for Disability Awareness, Disability Divide Consumer Disability Awareness Study, 2010
4. U.S. Social Security Administration, Fact Sheet February 7, 2013
5. U.S. Census Bureau, American Community Survey, 2011
6. [2/6/10]
7. [5/2/12]

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