Warren Buffett said, “only when the tide goes out do you discover who’s been swimming naked”. As COVID-19 came in, the proverbial tide went out and it exposed how few of us were prepared for an unexpected loss of income. There just are not that many of us who can get by without our next paycheck, much less without a job.
When millions of people were drastically ejected from the workforce, the government stepped in with stimulus to keep people on the payroll and keep families afloat. It is a safety net that is only deployed when unemployment is so pervasive, and its impact on the economy is so detrimental. It is about protecting the whole, not any one individual.
Of course, as individuals, we always run the risk of losing our ability to earn a living, not only to downsizing or layoffs but to disability as well. In fact, disability is a far bigger risk than many of us realize. According to the CDC, one in four adults has a disability that impacts major life activities, such as a long-lasting sensory, physical, mental, or emotional condition that makes it difficult or impossible to leave the house and work. About 37% of people with a disability have jobs, as compared to 77% of people without a disability.
While there are some social safety nets in place like unemployment benefits or Social Security disability income, these programs are either short-lived or difficult to receive. Many people with disabilities find it difficult to qualify for Social Security disability income at all. That leaves it largely on us to protect ourselves from the potential loss of income resulting from a disability.
Fortunately, many employers provide long-term disability insurance to their employees, either as a company-paid benefit or as a voluntary benefit paid for by the employee. Employer, or group plans, typically cover a percentage of income, often between 50% and 70%. Someone making $100,000 a year with 50% coverage would potentially receive $50,000 a year in disability benefits. That’s right - even with group insurance, disability can mean a 50% pay cut, and that’s if there are no other limiting provisions in the plan.
Group disability insurance plans do, however, have numerous provisions that could further reduce benefits. These are a few of the most problematic provisions of group plans:
The definition of disability is too strict. The best policies define disability as being “unable to perform the activities of your own occupation”; another commonly used definition of disability is “unable to perform the activities of any job”. Imagine a surgeon who can no longer perform surgery. Under the first definition of disability, her policy would pay benefits. Under the latter definition, her policy would only pay benefits if she could no longer perform surgery and could not perform the duties required for any other gainful employment. Group plans often provide own occupation coverage for only one to three years before converting to any occupation. That means our surgeon could stop receiving benefits after the first few years if she was able to do any other job, regardless of how desirable that other job might be.
Employer plans may only cover your salary up to a certain limit. Let’s assume our surgeon makes $200,000 a year in salary and a $100,000 bonus. The group policy might cover 50% of salary up to a maximum of $12,000 per month, or $144,000 per year. If she becomes disabled, she will receive insurance benefits of $72,000 per year – 50% of the $144,000 maximum. She would receive zero benefits on her bonus income or her salary above the limit. In this scenario, even while receiving disability benefits, she would receive only 24% of her previous employment income – before taxes!
When employers pay disability insurance premiums, the benefits from the policy are taxable. If our surgeon’s income is taxed at 33%, her original $300,000 of income would have become $200,000 of take-home pay. Once disabled, her $72,000 of disability benefits would also be reduced by taxes, potentially at a lower rate, but still would leave an even bigger gap between what she earned while working and what she earns on disability. Ouch.
Group plans often limit coverage for addiction and mental illness. Employer plans will often only pay benefits for a maximum of two years for becoming disabled as a result of addiction or mental illness.
Benefits are offset by other income like Social Security disability income. Some group policies will reduce your benefits by any money you receive from Social Security or partial employment. This makes it even more difficult to get back your pre-disability earnings capacity.
Group disability insurance, even with these drawbacks, is still very valuable but given these limitations, it is not safe to assume that our employer-provided coverage is all we need. Particularly if we need to protect high incomes, bonuses, or other incentive compensation and we don’t want to be forced into an undesirable job in the event we become disabled, it is worth considering disability insurance coverage in addition to our coverage at work.
Individual disability policies can be tailored to protect income that is not covered through our work plans and it can be designed with more forgiving provisions around the definition of disability and mental health. If we pay our own premiums, any benefits we receive from the policy will be tax-free and benefits will generally not be offset by Social Security or group benefits. Additionally, and importantly, we can keep an individual disability policy even if we change jobs.
It is natural to think that disabilities only happen to other people, but if this year has taught us anything, it is that we are more vulnerable than we like to admit. Unexpected events can and do negatively impact our health and our wealth. Add disability insurance to the list with masks, gloves, and social distancing of new things we are doing to protect ourselves.
As originally published in Forbes on 6/25/2020: