Debunking the myths of adequate income-protection
by Dick Weber, MBA, CLU, AEP (Distinguished)Mr. Weber is a past-president of the Society of Financial Service Professionals and is a fee-only Insurance Fiduciary consulting with clients and financial institutions. For the past decade, Dick has provided his consulting services to many carriers, including The Guardian Life Insurance Company of America. He makes recommendations based upon his relationships with the companies and the integrity of the products and people that back them. He can be reached
After a 50-year career in the life, disability, long term care and annuity business, I thought I’d heard all the excuses. My favorite objection for buying disability coverage was, “It won’t happen to me.” I can deal with that.
Most consumers assume their chances of becoming disabled are 10 to 20 percent of what’s real—and the numbers are a lot higher than they think:
- The Council for Disability Awareness (CDA) indicates more than 20 percent of workers under age of 40 believe they are more likely to win a Mega Millions jackpot than become unable to work due to illness or injury. The real odds: one in 259 million for the jackpot versus one in four for an income-interrupting disability.
- 25 percent of individuals will miss work for 90 days or more and there’s a 40 percent chance that such a disability will last five years. CDA statistics indicate fewer than five percent of disabling accidents and illnesses are work-related. The other 95 percent are not, meaning Workers’ Compensation doesn’t cover them
But, the excuse I recently heard from a high-earning executive quickly created a sense of déjà vu and rose to the top of my hit parade. He said, “That’s okay, I’ve got group disability insurance.” While I was happy that individual had some coverage, I knew he wouldn’t be happy when we got into the details. Still, I encouraged the executive to get a more complete description of his benefits from his HR Department. Once he had the description of his benefits in hand, he confirmed my expectation when he expressed his shock at seeing how limited those benefits really were.
It turned out his group plan covered only 60 percent of his salary once a disability was determined to qualify under the terms of the contract, but since the employer-paid benefit is taxable, net benefits available to cover his expenses would be more like 40 percent of his monthly salary. Also, his group coverage didn’t provide any benefit for his bonus income that typically represented one-third of his total compensation.
To make matters worse, since he was a high earner in his company, the monthly benefit cap reduced his income replacement substantially below his monthly income. This concept is often referred to as reverse discrimination. The bottom line: his total coverage amounted to just 22 percent of his monthly earnings in the event of a qualifying disability.
The good news is that this client had some coverage, and I was able to activate him to know more about the details of his coverage. A 32-year-old making $100,000 a year today would earn about $6.9 million over his/her working career (assuming an average of three percent annual increases).
As financial professionals, we can all agree none of our clients would be able to live on only 22 percent of their income. Such an amount might cover the mortgage and perhaps the property taxes but not much else. Also consider how long we could afford to live on a partial income before having to tap into savings or retirement, or be forced to live off credit cards. This could result in missing student or car loan payments and retirement contributions, setting an individual even further back financially. I’ll address this more completely, but this is an excellent example of where an individually owned disability policy can supplement an employer’s group coverage and make up for these shortfalls.
Premium & Benefit: A Delicate Balance
Group LTD is a desirable – sometimes even necessary – foundation for many, but shortfalls such as those just described can disrupt the delicate act of balancing premium expense to likely benefits received. It’s important to engage clients as an active participant in the inquiry of what to look for in a group disability plan and what it may translate into net dollars before just assuming it provides what they need.
Some of the shortfalls of group disability include:
- Premiums can change and coverage can be canceled. Premiums are evaluated annually and subject to change for group and association coverage. For larger groups and associations, this is not as much a concern as the age-banded escalation of rates charged as we get older. By contrast with individually underwritten disability income insurance coverage, premiums and benefit definitions are determined at the outset and guaranteed not to change for the duration of the policy. Unlike group and association plans, this is because individual policies are “non-cancellable and guaranteed renewable.” As long as the policy owner pays her premiums on time, the coverage rates are fixed and the insurance company cannot cancel their coverage.
- You cannot take the policy with you – you don’t own it. While health benefits are typically covered by “COBRA” and portable for at least a short period of time, group plans aren’t portable. For individual disability policies, on the other hand, portability is inherent. Portability means the policy owner can take it with them from employer to employer – or even career to career. Again, because employers are not required to (even temporarily) continue providing group disability coverage after an employee leaves the company, portability becomes an important inherent feature for individual coverage, especially amongst younger clients who tend to change jobs more frequently. As with other forms of self-owned insurance, the policy owner naturally takes the coverage with them when changing jobs, locations or even careers, ensuring they are not at risk for a gap in disability coverage.
- Taxation on employer-paid coverage. When the individual pays the premium or the premium is paid by the employer but included in W2 income, individual disability benefits will be completely income tax-free. Benefit payments from an employer-paid group plan, on the other hand, are considered fully taxable to the recipient. Depending on total tax bracket, that can make a 30 to 45 percent difference in the value of the benefit, year-in and year-out. Could there be a push-back on paying income tax on the $3,500 annual premium for individual coverage the employer pays on an employee’s behalf? Or the after-tax equivalent of paying the premium with income that has already been taxed? Sure, but bring to the client’s attention the difference between the premium’s $1,000 tax cost compared to the $20,000 tax on a $60,000 benefit saved because the tax isn’t due for as long as a long-term disability may persist.
- Can’t customize the coverage to your needs. Group coverage will have limited options depending on what types of packages an employer makes available to employees. The smaller the group, the fewer the options. An individual policy allows the policy owner to customize options to their specific needs. There are even options to replace retirement plan contributions or repay student, car loans or the mortgage during the disability period.
Most of us don’t think twice about getting periodic health check-ups, especially when there’s a symptom to get our attention. Financial check-ups aren’t quite so motivating, and often the “symptom” that would indicate the start of a problem doesn’t make itself known until it become a substantially bigger problem.
A differentiating characteristic amongst financial professionals is to provide annual or bi-annual reviews to our clients. The stock market’s progress is obvious, but how about a review of the client’s liability coverage? Or employee benefits with a special focus on customizing an allocation of group and individual DI? There are likely deficiencies in a group/association-only strategy for disability coverage, but the client probably won’t realize it until it’s too late. Individually-owned disability insurance isn’t as expensive as people think, and when combined with group or association coverage, can provide meaningful total coverage and financial security at a reasonable cost
There’s an online calculator that’s helpful for figuring out just how much an individual disability policy would cost. Click here to access it. ◊
1 Gen Re, U.S. Individual DI Risk Management Survey 2011, based on claims closed in 2010.