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Personal Finance FAQ

Why Do We Rarely Buy Disability Insurance?

Aleksandr Rou - Kashchey bessmertnyy aka Kashchei the Immortal (1944)
Not even they were immortal!

“The only thing wrong with immortality is that it tends to go on forever.”
–Herb Caen

I remember getting the call from my wife. She was back in Charlottesville spending a week at her home office while I stayed in Texas.

She’d started getting a slight tremor – a tic like she was shaking her head no – about a year before, and I hadn’t really noticed anything. Her mother and her voice teacher saw it and my wife finally asked me if I’d noticed.

Being the dutiful, observant husband, I hadn’t noticed a thing.

So, one night I watched while she read and I noticed it. All along, I’d rationalized that she was just being an active reader and never agreed with anything that she read.

She went to the doctor, who sent her to a neurologist, who sent her to get an MRI.

The MRI results came back when my wife was in Charlottesville. The neurologist saw some things with the MRI that led her to believe that my wife might have multiple sclerosis and needed to get a spinal tap to do further testing.

That’s when I got the call.

Once we got our wits about us and started to prepare in case the diagnosis confirmed that she had MS, we reviewed our financial situation, to include our insurance coverages.

Even as a planner, even though you think that you have everything tied up wire tight, you have that moment of doubt.

The OSM as I have heard it called: the oh **** moment.

Fortunately, my wife had the disability insurance coverages from her employer that she needed in case a) it was MS, and b) the MS eventually caused her to be unable to work.

So, we had the financial piece tied up and could deal with the emotional piece.

Fortunately, what the neurologist had seen on the MRI turned out not to be anything significant, and my wife received the all clear.

However, things could have turned out differently had it turned out to be MS and my wife was not covered under disability insurance.

According to the Council for Disability Awareness, an average, healthy 35 year old female has a 9.1% chance of having a 5 year or more disability that prevents her from working. An average, healthy 35 year old male has an 8.0% chance of having a 5 year or more disability that prevents him from working. See here for more details.

So, we have somewhere between an 8% and 9% chance of being out of work for 5+ years because of disability, but, according to The Hartford, only 44% of Americans carry long-term disability insurance. It doesn’t take a math major to figure out that the ones who don’t have long-term disability insurance are playing Russian Roulette with their financial health.

You have a much higher chance of filing a disability insurance claim than you do a life insurance claim (well, your beneficiaries filing it in the latter case).

But we’re awash in life insurance (relatively speaking…don’t take that to mean that we are overinsured unless you have an indexed universal life (IUL) insurance policy) compared to disability insurance.

Why Aren’t We Purchasers of Disability Insurance?

To me, there are several reasons that we do not purchase disability insurance when we should.

Our employers cover us!

In most cases, employers who provide disability insurance actually only provide short-term disability insurance. These policies will cover people anywhere from 3 months to (rarely) 2 years. The most common short-term disability insurance period I’ve seen employers providing is 6 months of short-term disability insurance.

Beyond that, you’re on your own, trooper.

Occasionally, your employer will provide long-term disability insurance. If they do, that’s great, although there are still considerations to take into account with regard to a private policy.

I’ll never get sick!

This is a case of optimism bias. As we saw in “How Optimism Bias Affects Our Future Planning,” optimism bias means that we do not contemplate a future in which things are not at least as good – if not better – than they currently are.

It’s the adult version of the kid who knows no fear. We are scared, subconsciously, to imagine a situation where we’re not hale, hearty, and raring to go and capable of working until we turn a zillion years old.

However, the reality is that time, and sometimes chance, catches up with all of us.

Social Security will take care of me!

The average Social Security disability payment as of 2019 was $1,234. If you can live off of that much income per month, then you are correct. Social Security will take care of you. For everyone else, keep reading!

That’s a lot of money for insurance!

The average disability insurance policy can cost somewhere between 1% and 3% of your annual income.

If you’re making $75,000 per year, that means that you’re paying somewhere between $62.50 and $187.50 (on average) for a disability insurance policy.

That’s a lot of simoleons!

It’s very tempting to do the math and come out with the (reasonable) conclusion that the insurance company is making a profit off of disability insurance policies.

8% chance of needing it. Payout of an average of about $262,500. Therefore, expected value is payout times probability, or about $21,000.

If you’re on the low end of the cost scale, you’d need 28 years to break even. On the high end, you’d need 84 years to break even.

However, the purpose of insurance is not to make money off of the insurance companies. If you were doing that, they’d go out of business and not be able to provide insurance to you.

Instead, the purpose of insurance is to protect you in case of a worst case outcome.

Monkey Brain stinks at calculating probabilities

As we saw in “Monkey Brain Confuses Rates and Raw Numbers,” Monkey Brain, what I call our limbic system, since it’s the part of the brain that we share with monkeys and wants fun now and doesn’t think about the future, has two mental visions of probabilities:

“NOT GONNA HAPPEN NEVER”

and

“WILL HAPPEN RIGHT NOW NO DOUBT…RUN!!!!”

So, he doesn’t deal well with numbers like 8-9% probability.

In his monkey mind, a 9% chance of something happening is exactly the same as a 0% chance of something happening (although, ironically, the moment that your plane hits turbulence, he thinks there is a 100% chance of the plane crashing).

Therefore, when you think about buying long-term disability insurance, you don’t think that there’s an almost 10% chance that you could need it for 5 or more years.

Monkey Brain convinces you that there’s a 0% chance that you’ll need it.

Why buy disability insurance?

Simply put, could you go the rest of your life with no income if you couldn’t work for the rest of your life starting tomorrow?

If you could, then you don’t need disability insurance.

If you couldn’t, then you do.

How much do you need? What type? What other factors do you need to consider?

Want to know your own personal chances of being unable to work from a disability? Go to http://www.whatsmypdq.org and take their quiz.

By

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

2 replies on “Why Do We Rarely Buy Disability Insurance?”

I bought disability in my 30s, because I’m a freelancer, so no employer benefits. (It’s very common to freelance in my industry, and even if you get a full-time job, it may not last long, agencies lay off all the time.) Since I bought it young, I pay a reasonable rate (to me) of $128 a month. Almost canceled it once when I was covered on an employer’s plan, but my agent convinced me not to. In my 40s I got breast cancer and boy, was I happy to have the disability. It paid me $3500 a month, tax-free. I was still freelancing, so if I worked and made some money during the month, I’d get a percentage of the disability. The economy was bad, and it gave me a lot of piece of mind to have that money coming in while I was undergoing treatment and work was sketchy. I did the math and I pretty much was paid back what I’d paid out in premiums. Best financial decision I ever made.

Hi Kristi–

Thanks for sharing and congratulations for being a survivor!

You’re the precise reason why people buy insurance. It’s to protect themselves from worst case scenarios that they cannot afford to otherwise financially survive. Most people won’t go through what you did and will think that insurance is not for them, but in a sense, it’s like Pascal’s riddle about the existence of God (I adapt):

  • You don’t have insurance and you don’t need it.
  • You have insurance and you don’t need it.
  • You have insurance and you need it.
  • You don’t have insurance and you need it.

Only one of those outcomes is bad (need insurance, but don’t have it), but you can only control one of the conditions (having insurance); therefore, get insurance.

Thanks again for sharing!

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