Sound Bite: If you get hurt and miss work, disability insurance makes sure it doesn’t hurt to miss work.
As I was tooling around the internet this morning I came across this video. Yes, the guy looks like a dork, but it actually does a very good job talking about the basics of disability insurance.
I especially liked all the wipeouts of the guys on snowboards and skis early in the video. Sort of like America’s Funniest Home videos, Sports Bloopers addition.
Lets talk about pain. Now I’m a pretty tough guy. Might be growing up on the farm with my older cousins and brother beating on me. Might be the decades of full contact martial arts. Might just be that I’m Irish and literally have a thick skull. I can take a lot.
But there are some pains that are just too much to allow you to really function, specifically neck or back pain from disc issues.
I know a financial planner from Northwestern Mutual down in Louisiana who had a ruptured disc in his back that required surgery. He could not sleep for weeks and walked like Quasimodo. And he did not see a single client for a month because the pain was so intense that he could not focus and think clearly. As he said, he was worse than useless to his clients because he would have caused actual harm to their financial planning. The only time he wasn’t in pain until after the surgery was when he was on more drugs than the Colombian economy. Not exactly a great situation.
I had a buddy who compressed some discs in his lower back snowboarding when he hit a landing weird. This guy was a computer programmer so was seated being a code monkey for nine or ten hours a day. Until he got hurt and couldn’t sit. Now he absolutely loved what he did so he even tried lying on his stomach on his bed, keyboard in front of him to type. When he could because of the pain. Not very effective, and eventually he had surgery too.
Both of these guys were athletic and in good shape. They were professionals in their work, low risk, and did almost everything right, yet they still messed up their backs and lost significant amounts of work from it. And their injuries were relatively minor by comparison to other spine injuries.
Luckily these guys were not out long enough for a disability insurance claim to be filed. Most group coverage would not pay on these claims because both guys still could perform many of the functions of their jobs, they just couldn’t do them for the hours or at the level that they did before. But their individual disability insurance would cover them because they each had riders that covered partial disability (including a reduction in hours like they experienced).
And it is a good thing they had their disability insurance because if they tried to get some after the fact (ex post facto if you want to sound like a snobbish attorney), they would either be declined or have an exclusion for any neck, back, and spine issues because of the pre-existing condition.
So plan ahead: buy the disability insurance BEFORE you need it, before you hurt yourself doing something that you love and can never do it again.
With all due respect to the people who have suffered losses in the recent spate of storms across the South and the sort of cool Mayhem commercials on TV, people have the wrong focus.
Everyone is concerned about their house burning down, yet becoming disabled and unable to work is several times more likely from an actuarial point of view. Yet everyone with a house buys home owners insurance.
Car insurance is mandatory in many states, and people will put collision coverage on a car valued at $20k. Yet for a late 20’s individual the probability of disability is roughly the same as having an accident that totals your car, and the value of that income stream that is lost will be several times as great as the replacement cost of the vehicle.
But fires and crashes are sexy in a train wreck gotta watch the accident way. Disability isn’t. Yet Disability Insurance is the single most overlooked component in a financial plan. Think of it this way: if you get hurt or injured and have no money coming in the door, your financial plan is useless because there are no finances TO plan.
There is a major reason for young professionals to buy disability insurance that often gets over looked: portability. And given the nature of the Millennial Generation, this aspect of DI can not be stressed enough.
I saw a statistic that said that 85% of the Millennial Generation will switch jobs at least four times. This is substantial, even greater than what Gen X experienced. With this shifting in jobs and careers reaching an all time high, it is critical for a young person to do what they can to protect their insurability so that they do not become stuck in a position and unable to leave because of dependency upon the benefits.
Paralleling this is the fact that many young people start life in a technical field (such as engineering), that requires training and education, often because of being pushed by their parents. After experiencing their chosen field though they realize that they hate it, and transition out of it. Very often they found their own company (like I did), or decide (a la Monty Python) “and now, for something completely different.” Unless they have planned ahead though they can become uninsurable for a period until they have an earnings history, leaving them exposed for a period while ramping up their new venture. Thus they are most vulnerable at the worst potential time.
Furthermore, when this new business owner (or photographer, or writer in my case) can qualify for disability coverage, it is often at a lower occupational class (a measure of risk based on what you do, that reflects your premiums. Engineers and accountants are the lowest risk people on the planet. Demolitions experts not so much.). Business owners are higher risk because of the higher stress and the sales aspects that are inherent in being self employed or in a start-up. Thus, delaying the purchase of disability insurance ultimately costs the young client more, and potentially reduces the strength of their benefits substantially.
But if they purchase portable disability coverage and leave being an engineer, according to the insurance company they are still a boring engineer for risk purposes, even if they decide they want to try and become the second coming of The Macho Man Randy Savage (ooo, yeahhh!).
Many people found their own gig because they want the freedom and flexibility it can create. Purchasing portable disability insurance early in your professional career lays the groundwork for that freedom in the future. It is a very small price to pay to have more options later.
According to multiple sources (such as The Commissioners Disability Tables), the average disability that goes to a claim lasts 2.5 years. Let’s do some math on this, using my degenerate gambler’s sense of probability and expected returns.
Assume that you are a young professional making $60k per year. So this is a $5k per month gross income, which many insurance companies will insure for disability purposes at 90%, or $4,500 of after tax income. 30 months of disability is thus $135,000 (assuming no indexing for inflation). So this is the average risk for a young professional.
Assuming that there is a one in four chance of being disabled, that means the expected value is $33,750. Now let’s see the cost of getting this coverage. Checking with some of my buddies that right disability insurance, we can assume about $600 a year for this coverage. Dividing the expected value ($33.75k) by the cost ($600/year), we get 56.25, which is the number of years it would take for the cost to exceed the expected value.
Fifty six years s obviously longer than the average working career. What does this tell us?
From a mathematical perspective, buying disability insurance is a good bet.
They say a picture is worth a thousand words. But a picture is static, not dynamic like life. So a video is even better, orders of magnitude better at telling a story.
This is Bill’s story. If it were not for proper disability insurance planning, it would have a sad ending.
One of the guys that I advise on a local college campus is making a decision, a big one. He is deciding which of the two job offers he is going to take. As background he is an engineer (granted, it is RPI, whose mascot is “the Engineers”. Watch out, we’ll use our slide rules on you and dis-integrate you!), 22 years old and has a very bright future. Like many of his ilk, he is seeking stability in an organization with growth potential. Both jobs offer these things and are in the same town doing essentially the same thing, so there is no difference in cost of living or those sorts of things. So what should Fred do?
The major difference is the benefits package. The first company (let’s call it Company Meatball) is offering him $63k a year with 401k, essentially no life insurance, and no disability coverage. Company Borg has an identical 401k in terms of matching and funds, but a superior overall benefit package in that there is a pension and an excellent life insurance program that will expand with Fred’s needs over time, while simultaneously funding a savings program for the employees. The problem is that my buddy will only be paid $60k per year to start at The Borg. There is however a guarantee that if he gets hurt or sick and can’t work he will get $54k a year even if he can’t come to the office. So we crunched the numbers.
Even though the Borg is offering less in pocket compensation than the Meatball up front, it is a much better package for one huge reason: the value of that benefits package. Let’s take a look at some of the components thereof:
- Pensions have gone the way of the dinosaur. So having this guaranteed income stream later is a huge deal in that it creates stability in retirement planning (there is very long retention in each firm. Many people still spend 20+ years at each), and is a large financial asset. Even if Fred only spends 10 years with the Borg, it makes the entire compensation package better than what the Meatball is offering. This benefit is of at least six figures value to Fred, and depending upon our assumptions could be worth over a million bucks to him.
- The life insurance is not important to Fred now, but he does realize that it could be critical down the road since he actually does have a girlfriend and thinks he’ll get married and spawn some little engineers later. The fact that this part of the benefits plan means he has essentially proactively dealt with the entire issue means that he does not have to devote mental resources to the issue, something busy people like.
- The savings account is a nice little bonus for the future, but not a critical factor until 20+ years down the road. Even though Fred likes stability and guarantees (similar to other engineers of the Millennial Generation), it is not a big deal to him now. But he acknowledges that it could be very huge in 35 years if he sticks around that long, an additional five figures to the comp package at least.
- The income guarantee is a big deal and the deciding factor of the equation. As an engineer Fred knows he has about a one five chance of being unable to work for over a year due to illness or injury, so he knows that the expected value of the guaranteed income stream (again, something attractive to Millennials) is worth six figures when all the numbers are crunched. This alone eliminates the gap in value between the compensation packages from the two companies.
Now here’s the rub: The Meatball and The Borg are THE SAME COMPANY. Both of these are based on going to General Electric and their benefits package. The $3,000 annual difference in the two packages is Fred getting individual DI insurance as opposed to the optional group plan (that he opts out of in our example), participating in the contributory pension, and buying some individual life insurance. When contrasted as two separate benefit plans from different organizations it makes it pretty easy to chose what to do. Unfortunately it is rarely boiled down this simply for a new grad to make the decision as to what to do for their financial future.
Fred is just a figment of my imagination. Actually, he is an avatar of the hundreds of young clients I have worked with in the past making these sorts of financial decisions. And he chose well, taking the lower up front compensation to never have to worry about his financial future.