Insurance: August 2005 Archives

I have a confession to make: When I was doing financial planning, I didn't put enough emphasis on Disability Income Insurance. I was hardly alone in this; Disability Insurance is one of the two most undersold financial products there is. The other is Long Term Care Insurance, which product I at least researched properly and sold enough of (and the exact right product, also).



An article I found the other day brought Disability Insurance, or as it is technically known, Disability Income Insurance back to me. It's a good article and I really do suggest you read the whole thing, especially if you have a family or intend to. I have nothing but sympathy for the victims of this, and yet I would like to arm those reading with some information for preventing it from happening to them.



Disability Insurance isn't sexy; in fact it's damned hard to sell to the average person. Where I can sell Mutual Funds and Variable Annuities and Life Insurance all day long, it's because the basic understanding of the benefits or the needs is present in most people in society. Everybody understands that when you're making an investment, it is because you hope to Make Money. Everybody understands that Life Insurance is there for your family in case you are not. But this basic understanding is lacking for Disability Insurance. What they understand is that you Want To Sell Them An Insurance Policy. An Attacking Salesperson! Red Alert! Shields to maximum, Mr. Sulu! Fire Photon Torpedoes! Fire Phasers! Turn us around and head back to safe territory, Maximum Warp! Fire! Fire!



Disability Insurance is one of the red-headed step-children of the financial planning process. SEC and NASD guidelines don't mention it; it is only when a practitioner really digs into the nuts and bolts of financial planning that you find out how important it is. I did at least get to the point where I would discuss Disability Insurance with every one of my clients who was still working.



It's very easy to tell if you are in need of Disability Insurance. Ask yourself this question: If you couldn't work for the rest of your life, starting now, would you have enough money to live the lifestyle you want for as long as it lasts? If the answer is "Hell Yes!", you don't need it. Otherwise, you probably do.



Some basic facts about Disability Insurance: It is three times more common for a worker to go through a period of disability and need wage replacement than it is for them to die before age 65. Family finances do not tend to recover well from lack of disability insurance, whereas they do from lack of life insurance. In other words, the consequences of no Disbility Insurance on a family without it are worse and longer lived than the consequences of no Life Insurance on a family without that. Surveys of what happens to families five or ten years after the death of an uninsured breadwinner are much rosier than the equivalent ones five or ten years after the disability of an uninsured breadwinner, and the latter scenario is far more common.



The federal government does contribute something to disability insurance. But within the financial planning community, Social Security Disability is famous for three things: Denial, Difficulty, and Delay. It is far and away the most difficult Disability Income program to qualify for benefits under. A private insurer would not be permitted qualifications so strict by any state. As a percentage of from those who have some real disability, the federal government denies more claims than any private insurer. The paperwork (which I have never filled out, so I'm reporting secondhand) is supposedly awful, and it takes months for a decision, and it doesn't kick in and start paying benefits until at least five months have passed. It is my understanding that it doesn't pay back benefits if the application and approval process takes longer than five months, either.



You cannot buy, nor should you want, disability insurance which replaces your entire income. I think that there is an actual legal limit of 70% on a single policy in California. On the other hand, disability income is (typically) tax free and you're not commuting to work every day, both of which go a long way to stretch what you get. 50 to 65 percent is probably about what most folks should have.



There are two main types of disability policy: So-called "own occupation" and "any occupation," differentiated by what triggers the benefits. Both require medical certification, but the "own occupation" policy makes it easier to qualify for benefits. What you are buying here is a policy that will pay benefits when you can no longer do basically the same thing you are doing to earn your money now. It is more expensive than the "any occupation" policy, but then again, you are getting more coverage. When you get an "any occupation" policy, you will not qualify for benefits unless you are unable to perform the duties of any occupation for which you are suited by education and training. In other words, if you can still work at 7-11 or McDonalds or as a receptionist somewhere, no benefits.



Other major factors in how expensive the policy will be are: What you're doing now (an office worker gets cheaper rates than someone who works with dynamite), How much income you are looking to replace (it's less costly to replace 30% of your income than 60%), how long before benefits kick in (a policy where they kick in after one month is going to pay more benefits more often than one where they don't kick in for six months, and is therefore more expensive), and how long benefits last (a policy that pays benefits for two years is cheaper than one that pays until you're 65. Take note of this - especially if you're 63).



Disability Insurance is sold in two ways: as part of a group program, or individually. If you read the article, you may have figured out that this is a critical difference. As a general rule, Disability Insurance sold as part of a group plan through an employer is subject to ERISA, individual policies are not. This is a critical difference. If the insurance company wrongly denies your claims under a policy subject to ERISA, all you can get is the actual money you would have qualified for. No penalties, no interest, no legal fees, no court costs. I tend to look at buying insurance from a point of view of what happens if I need it. I want to make clear that most insurance companies are ethical. Nonetheless, if the most Colossal Insurance Company can lose by denying my claim is the actual money they would be on the hook for anyway, they might be going to look for any excuse to deny my claim, as they have nothing to lose and the prospective benefits to gain. If, as in most individual policies, you are the owner of a non-ERISA covered Disability Insurance policy, now there is a significant potential downside to Colossal Insurance denying your claim. If you sue and win, they're on the hook for not only the benefits they denied, but potentially also interest, penalties, and the legal costs of the fight, a much larger number of dollars. They are much more inclined to consider your claim from an unbiased viewpoint in this case.



It is to be noted that group coverage is cheaper, for precisely this reason. But why anyone would want to pay money to buy an insurance policy that's more likely to deny benefits when you need them is beyond my ability to comprehend.



Group Disability Insurance can have part of the premiums paid by an employer, group insurance can even be portable or convertible to individual policies, albeit with a higher premium. On the other hand, you can become uninsurable in the meantime, if for instance you contract any one of a number of diseases or conditions, some of which are terrible and some of which only set the stage for worse things to potentially happen. If you are uninsurable and lose you current policy through losing your employer, guess what? You literally cannot buy another policy. Individual policies offer more protection; once issued, they generally cannot be cancelled (there are exceptions!), and there are no worries with portability or conversion. If, on the other hand, you can only afford a group policy, better that than nothing. Like everything else in life, it is a set of trade-offs.



Caveat Emptor