When the going gets tough, the tough cut costs. Clients worried about their finances may think about dumping big expenses that may seem to be a luxury, such as disability insurance. In this case, they would likely be wrong.
"Disability insurance is essential, but it's expensive," says Howard Recht, an insurance agent in Plainview, N.Y. "People are looking at this coverage like it's a fringe benefit. They're either eliminating it or paring it down significantly to get minimal coverage."
Jim Bruyette, a managing director at Harris SBSB, a financial planning firm in McLean, Va., says disability is the "most underinsured risk" he encounters. "Forty-year-olds, for example, are much more likely to be disabled than to die early," he says. "For our client base, the main types of disabilities are conditions such as nervous disorders, heart disease and strokes."
Although most financial planning clients are not likely to be injured due to dangerous work, the threat of lost income from illness or injury shouldn't be ignored. Disability insurance can provide cash flow if clients are unable to earn income. Amid a weak economy, the challenge for planners is to help financially strapped clients rethink their coverage without abandoning it.
The economic slowdown has caused both group and individual disability coverage to slow. "In our 2011 annual benefits survey, 49% of U.S. workers had short-term disability insurance, down from 55% in last year's survey," says Laura Marzi, assistant vice president of marketing in the Hartford's group benefits division. "Similarly, 44% percent had long-term disability insurance, down from 47%."
LIMRA, an insurance marketing and research organization, also has found waning consumer enthusiasm. The number of individual disability policies sold dropped 9% in 2009 from the year before. Even after 3% increases in 2010 and the first half of 2011, sales remain below 2008 levels. In terms of premium dollars, sales fell by 9% in 2009 and another 4% in 2010, so a 6% increase in the first six months of 2011 means the numbers are still behind the 2008 rate.
AN AGE-BASED QUESTION
In some cases, dialing down disability insurance may make sense. Many clients are in their fifties and sixties, perhaps near the end of their income-earning days. Is it necessary for them to keep paying for disability coverage, which might expire at age 65?
Not always, according to Bill Baldwin, co-president of Pillar Financial Advisors in Waltham, Mass. Baldwin says he would look closely at client needs and the cost of coverage before recommending disability insurance for people in their late fifties.
"One of my clients was laid off at age 63, with no possibility of finding more work," he says. "He has multiple disability policies, and I've suggested that he stop paying the premiums. I'm even thinking of saving thousands of dollars a year by discontinuing my own disability insurance, which I've had for nearly 20 years," Baldwin, 61, adds.
Clients who are close to retirement may have enough assets to bear disability risk on their own. "We evaluate disability insurance the same way we evaluate long-term- care insurance," says Randy Thurman, co-president of Retirement Investment Advisors in Oklahoma City. "We look at clients' resources, look at the risk and see if they are self-insured. If they are - and most of my clients are - then from a financial planning point of view, they don't need disability coverage," he adds.
Thurman notes some clients may want to have coverage for peace of mind. "There is nothing wrong with that," he says, "but call it what it is - paying a premium to an insurance company to feel better."
Nevertheless, some planners are reluctant to suggest self-insurance for pre-retirees. "If you are 60 years old, planning to retire at 65, with group disability coverage that offers 60% of salary for three years, I'd still say keep your individual disability insurance," Bruyette says.
Individual coverage can supplement group disability plans by providing broader benefits and a longer payout period. Also, coverage that a client buys as an individual can be portable after a job change.
"I wouldn't advise dropping individual disability coverage unless someone is three years or less from the end of benefits," Bruyette says. "Dropping that coverage then might make sense if you have a decent group plan and sufficient net worth."
According to Grace Worley, senior financial planner at Worley Erhart-Graves Financial Advisors in Indianapolis, disability insurance can play a vital role for pre-retirees. "It remains important paycheck insurance that can be especially critical for those over 50, because such clients are more likely to develop debilitating conditions," she says.
Without disability insurance, clients who become disabled in their fifties or early sixties may not be able to build an adequate retirement fund. "They might have to draw from retirement assets too early because they have inadequate current income," Worley says.
GO WITH THE GROUP
Even the most enthusiastic supporters of disability insurance agree that coverage should be reviewed periodically and modified as a client's financial situation changes, just like every other significant expense. A good place to start is to see if clients are receiving some form of disability coverage from their employers.
"We tell our clients to explore all group options first," Bruyette says. Group coverage might provide 60% of salary - a client earning $7,000 a month, for example, could receive $4,200 a month in group disability benefits. Another idea: employer-sponsored group coverage, which might not be so expensive. Marzi estimates the typical cost at around $400 a year.
"For that, you can protect all your other investment decisions," she says. With adequate coverage, disabled workers might not have to spend down their portfolios.
In addition, if an employee pays for group disability insurance, benefits will likely be tax-free. Even if the company is paying the premiums, clients may be able to arrange for those premiums to be treated as additional taxable compensation. Paying extra income tax in this manner may turn out to be worthwhile if the client eventually receives tax-free disability insurance benefits.
Individual coverage may be a valuable supplement or standalone policy, but that protection can be pricey, costing thousands of dollars a year in premiums in some cases. "Some clients say, 'I'll stick with my group coverage and self-insure for the rest,' " Bruyette says.
Average annual premiums for individual disability policies are approximately $600 for guaranteed renewable policies and $2,000 for non-cancellable policies, according to LIMRA. Planners generally prefer policies that can't be canceled because the premiums can't be changed as long as they're paid on time. With guaranteed renewable policies, an insurer can raise premiums for an entire class of investors.
"Spending 1.5% to 2.5% of income can provide good individual coverage," says Herb Daroff, director of estate and business planning at Baystate Financial Planning in Boston. A client earning $100,000 might pay $1,500 to $2,500 a year for coverage.
OPTING OUT OF OPTIONS
For clients who wish to maintain or obtain disability coverage, Bruyette suggests that individual coverage be seen as "disaster protection." To keep costs down, he says: "They can lengthen the waiting period before benefits begin, perhaps to one year. They also may want to do without the inflation rider and do without the residual option that covers them in case of partial disability."
Another way to trim costs yet avoid sacrificing disability protection altogether is to do without so-called own occupation coverage, which will pay benefits if an insured individual can't perform the tasks of his or her specific career. A classic example is the case of a surgeon who can no longer use a scalpel, but can still earn a living teaching at a medical school.
Historically, many professionals and executives preferred own occupation disability coverage, but for some it may no longer be affordable. "Own-occ costs are brutal now," Bruyette says. "We suggest it only for people in very specialized occupations."
To lower premium costs, Worley says people could self-insure through their emergency reserves and extend the deductible period on their disability insurance. She adds that if budgets are tight, clients could reduce the benefit period to one that covers five years from one that pays to age 65, for example.
CRUNCHING THE NUMBERS
Yet another way to cut costs is to buy less coverage, of course. "Some people are buying enough just to cover essentials such as their mortgage or their rent," Recht says.
To illustrate, he relates the story of a business owner client in his early fifties. "This client really needed $5,000 a month in disability benefits, but we decided to pare that down to $3,000 a month, to cut costs." Recht offered this client an own occupation policy with just two riders: residual disability and catastrophic benefits. (The latter provides an extra payout in case of a severe disability.)
"The premium would have been around $2,600 a year," Recht says. "We wanted a COLA benefit, too, but that would have been another $350 a year, so we left it off." Deleting the residual or the catastrophic riders would have saved $400 to $450 a year.
"I thought having residual coverage was very important," says Recht, "and the client agreed. He also saw great value in the catastrophic benefit." By doing away with the own occupation coverage, the annual cost came down to $2,200.
"You might say that a $400 reduction is not that much, but we were also looking at the same disability plan for his wife, who is an equal partner in the business. She bought a similar policy. Altogether, this couple is saving about $1,000 per year in premiums," Recht says.
While some budget-conscious clients may have considered dropping coverage altogether with the intent of potentially reinstating it later, clients may be in for a unhappy surprise. "Underwriting has become stricter," Recht says. "If you drop your coverage, you may not be able to get it back."
Donald Jay Korn is a contributing writer at Financial Planning. His latest novel, In for a Pounding, is available on Kindle and Nook.