Disability is a life-long threat to your financial well-being

Posted by Rick Miller on July 23, 2013

In early May, I made a presentation to the NAPFA National Conference on the importance of disability in financial planning. I was privileged to work with the Society of Actuaries to develop the material, and Edd Bailey (Vice President and Chief Actuary, Assurant Employee Benefits) joined me in making the presentation. Edd is a Group Disability actuary – his job is to assess the likely probability and severity of disabilities that will occur among the employees of the companies who use Assurant disability insurance.

I’d like to share some of the key points of the presentation with you.

Disability is a life-long threat to your financial well-being. While there are many definitions of disability, I’ve found it helpful to think of a single dimension ranging from full capability through inability to work productively and help others to inability to care for oneself (see the diagram). This perspective conceptually links disability during working years with the need for Long Term Care later in life.

It also highlights certain disability risks as being effectively uninsurable: the risk of being unable to manage a home and care for children, and the risk of being unable to help others and enjoy activities during retirement. The difficulty in both cases is that the loss is very difficult to measure in quantitative terms.

During your working and earning years, the financial threat is two-fold. You may be unable to work and earn an income, and you may need extra (long term-like) care.

Not being able to earn is a very serious threat to your financial plan – as we often say at Sensible Financial^®, your earning power is almost certainly your largest asset. Disability insurance and life insurance play similar roles: both protect your family against the loss of your earnings.

Importantly, disability of a spouse managing your home and caring for your children can happen with similar probability as disability of an earning spouse, but no insurance is available to help protect you against this risk – such a disability would significantly damage your financial situation (to say nothing of the emotional impact). You would likely have to hire household help, and the non-disabled spouse may need to spend less time at work, implying further income reductions.

If the disability is severe enough, a disabled person may need extra care. This represents an additional financial impact – such care is likely to be costly. Fortunately, this risk is insurable – many individual disability income insurance policies offer a so-called catastrophic rider (a sort of special insurance policy attached to the basic disability income insurance), which pays a monthly benefit as long as the extra care is required, up to age 65. Another rider provides benefits in the event that a non-working spouse requires long-term like care.

Once you retire, the threat is one-dimensional. A disability which prevents you from working to earn income has no financial impact after you’ve stopped earning an income.

However, if you need help with everyday activities, you are said to need Long Term Care. Such care is expensive, and the chance that you might need it represents a significant financial risk, to you, to your spouse, and to your heirs. Long Term Care insurance can protect against this risk.

Disability income insurance is your best protection against disability. Many employers offer this coverage (long-term disability or LTD insurance). However, the extent of the coverage (percentage of income replaced) can vary from one employer to another. In addition, the conditions that must apply before you can receive benefits aren’t uniform either.

It’s a good idea to have a professional review your coverage through your employer. If the coverage is inadequate, or if you don’t have coverage, you can buy disability income insurance from a private insurer.

Disability during your working years threatens your ability to retire comfortably. If you can’t work and earn, you can’t save for retirement. Worse yet, if your disability income insurance is insufficient, you may need to draw on your savings.

In a very important way, then, carrying sufficient disability income insurance protects your ability to retire comfortably. In addition, if you have disability income insurance independent of your employer’s coverage, you may be able to purchase a rider that provides extra retirement savings if you are disabled. This extra coverage is well worth considering.

Disability is more likely than you might think. In fact, unfortunately, your risk of disability during working years is higher than your risk of dying. It may be that people don’t recognize this because they believe (inaccurately) that accidents are the major cause of disability. In fact, illness is a much more important cause of disability than accidents.

So, if you understand that you need life insurance to protect your family’s living standard, it should be clear that disability income insurance is equally essential.