January 22, 2004   Copyright © 2003, Greenwich Financial Management Inc., a registered investment advisor.  Securities offered exclusively through Purshe Kaplan Sterling Investments of Albany, NY, a NASD member firm.

Demystifying Insurance, Part 7:

Disability Insurance for Individuals

            Disability insurance protects you against the risk that you will be unable to work for an income. 

You need coverage if disability would be a financial catastrophe for you.  Here is a test.  First, determine what amount of income you would need to preserve an adequate lifestyle in the event of disability.  It's prudent to include some saving each year, as a hedge.   Against this needed income, subtract your expected income.  The first component is any disability insurance income you can already count on.  The second is other reliable income, including that of a spouse, rent, interest, alimony, dividends, etc.  Do not include retirement income, such as regular social security payments or pension, unless you are close to retirement age or would qualify upon disability.  On investments, use a conservative multiplier, such as 5% annual return on your investments.  The difference between needed income and expected income is your disability insurance requirement.  If you leave a large gap unaddressed, you face the risk of serious hardship if disabled.  This situation particularly faces many self-employed people without any group disability benefits (to be discussed in the next article).  On the other hand, some individuals and families have enough wealth to self-insure against disability risk.

            Insurance is founded on the principle of indemnity, which provides that you are secured against loss-but not more than your loss.  The principle of indemnity helps protect insurers against "moral hazard"-the risk that an insured person might cheat to get a windfall.  A digression: some life insurance contracts provide for a doubling of the death benefit in the event of accidental death-think of the great Billy Wilder movie "Double Indemnity."  Although it is difficult to monetize the value of a human life, insurance companies do put a cap on the insurable value of a policy, based on income and wealth.  In the same way, insurance companies cap the amount of disability income an individual may carry, and any other disability policies in force must be declared when applying for new disability insurance; you cannot normally obtain disability insurance for more than about 80% of your recent annual income. 

            Social Security Disability Insurance may pay benefits to you and certain members of your family if you have worked long enough and contributed to the Social Security system.  Supplement Security Income pays federal benefits based on need.  See http://www.ssa.gov/disability/.    Social Security pays benefits only for total disability, not partial.  It does not cover short-term disability.  Their definition of disability is strict.  It is very difficult to obtain the federal benefit, especially if you have a college education and the disability does not affect your mind; the government apparently figures that you can do something with it to make a living.  In the best case, if qualified, total benefits for a family may amount to several thousand dollars a month.

            Leading providers of disability insurance with strong credit ratings [strengths shown in parentheses] include Berkshire (white collar, high income), Principal Financial Group, Met Life, Assurety (substandard risk and blue collar), Mass Mutual, Fidelity Security (substandard risk), and Lloyd's of London (surplus coverage).   Avoid poorer and unknown credits.  It is good to have your agent shop around for quotes; don't just sign up with the guy who knocks on the door. 

            Make sure your disability contract covers the risk that you cannot continue your current occupation.  Otherwise, you might be denied benefits if you can still do menial work.  Keep in mind the value of a cost of living rider, with compounding, despite its higher cost; inflation is almost a certainty.       

            Disability is a major risk, and therefore it is not cheap to insure against.  You can secure a lower annual rate if you start a policy while young.  You can save money by expanding the elimination period before you can collect disability and by not over-insuring.   Keep in mind the principle of covering catastrophe, not inconvenience. 

Andy Szabo, CFA, is Managing Director of Greenwich Financial Management Inc., a Registered Investment Advisor, which advises individuals and companies on investments, insurance and employee benefits.  Questions or comments welcome by phone (203-531-2877) or e-mail: Szabo@GreenwichFinancial.com.