Disability insurance: Insuring the Money Machine
I hate columns that sound pushy or salesy. Like the Aesop fable about the wind and the sun, I genuinely believe that appealing to someone’s sense of pride will get you miles farther than shaming them into doing what you want. And yet here I go…
I’m not sure when it started, but somewhere down the line disability insurance got a bad reputation. Whether it was the fault of bad advisors and high pressure sales tactics, or unreliable payouts from bank-issued mortgage insurance, there is active resistance to what is otherwise a clear and meaningful gap in personal protection.
Do you have home insurance?
If you own a home, mortgage or not, chances are you have house insurance. Why? Because your home is an asset that you otherwise can’t afford to replace. And when a house is destroyed by fire, it’s dramatic. Families huddle together and watch as their photos, their memories, and all their worldly possessions go up in smoke. Neighbors feel for the victims, but are comforted knowing that once the fire crews leave, a restoration team will show up, and then the construction crews, then the furniture, and the homeowners. Because while house fires are tragic and scary, they are also a covered event on a home insurance policy.
Disabilities are private
Disability insurance isn’t always as dramatic, and is rarely as public. One of your colleagues stops coming to work. A replacement is hired. You don’t see their personal struggles. You don’t hear their family suffering. And you don’t notice the insurance company making monthly deposits into their bank account, coordinating them with the right doctors and specialists, and paying for their retraining so that they can eventually, get back to a normal life.
Just because it’s not as dramatic, doesn’t mean it’s not as important. You have a 1 in 1200 chance of having a house fire. Do you have a house insurance policy? You have a 1 in 3 chance of being disabled for 90 days or longer before age 65. Do you have a disability insurance policy?
Protecting your lifestyle
Disability insurance isn’t just the replacement of income – it’s the protection of your lifestyle. Have cancer but still want to renovate the kitchen? Get conked on the head but still want your kids to go to post-secondary school? Had a heart attack but still feel like you’d be useful in another industry? If you have a properly structured policy built by a licensed professional, disability insurance will replace your income. It can also provide retraining benefits. It can also increase every year, just like your wage would have. For small business owners it can also be based on loss of duties rather than loss of income (because we all know you’re still going to try to go to work). For health care professionals it can pay if you become infected with HIV (preventing you from working, even though you retain all of your physical capacity).
The Money Machine
Imagine you’ve got this machine that sits in the basement. Once a month, it makes a couple beeping noises and prints out a cheque. There’s a countdown on the case of the machine. Last month was 258. This moth is 257. Next month will be 256. It’s a countdown until the machine runs out of paper. And once it’s out of paper, no more cheques. You’re free to do what you’d like with each of the cheques you receive. You can pay down your mortgage, you can buy yourself a nice new car, and you can put some away into savings, knowing one day your machine will run out of paper.
If you had this machine in your basement, you would also spend a bit of each cheque – say, 5% for example – to insure the machine. Because money machines are sensitive and finicky. If there was a paper jam or a misfeed, it could take years to fix. If the jam was bad enough, the machine might need to be replaced altogether.
But this machine doesn’t just live in your basement. You take it with you everywhere you go. Every time you order nachos instead of salad. Every time you try to join highway 16 from the Kitscoty intersection. Every time you walk out your front door with a green tea in one hand and your cell phone in the other, trusting your feet to find the stairs.
You are that money-making machine, and you are always with you. If you can’t afford to live without the cheques you make, then you need to insure them.
Is disability insurance expensive?
So how much does one of these disability policies cost? The answer is lots. And if it’s not a lot, then it’s probably not much good.
The reason disability costs so much is not just the high rates of claim, it’s the amount that the insurance company is on the hook for.
House and land, we could probably sell our place for $300K. $310K if we’re lucky. Replacement cost on the building itself would be closer to $250K. We’ve got a wood burning fireplace and a garage, so our house insurance is going to cost a bit more than perhaps the average would, but our policy right now costs around $1,300 per year. That’s about $5.2 per thousand dollars of home value.
If you’re a 45 year old female (FYI – females cost more) with an indoor sit-down job and you earn $90,000 per year, a decent $4,500/month disability insurance policy would cost around $271 per month. At stake is 20 years of income, or approximately $1.54 million (based on 3% COLA). That’s about $2.1 per thousand dollars of income.
If you’re a 45 year old male who does light-duty oilfield work and earns $165,000 per year, a $7,000 per month decent disability insurance policy would cost around $394 per month. Twenty years of your income is worth approximately $2.4 million (based on 3% COLA), which is about $1.96 per thousand dollars of income.
So, yes, disability insurance is expensive. But only because your money machine is worth so much to you. Compared to house insurance, something you’re much less likely to claim on, disability insurance units cost less than half.
If you are actively choosing to forego disability insurance, you’re saving 5% of your income. But what you’re risking is of all of your future income for the rest of your working career. Having disability insurance doesn’t affect your chances of becoming disabled. It only affects your chances of being able to recover.