The John C. Bogle Center for Financial Literacy is pleased to sponsor the 39th episode of Bogleheads Live with Broc Buckles and Dr. Rodney Mogen.
In this podcast Broc Buckles & Dr. Rodney Mogen explain how younger earners can protect their income, answering questions about disability insurance.
Broc Buckles
Dr. Rodney Mogen
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Transcript
Jon Luskin: Bogleheads® Live is our ongoing Twitter Space series where the do-it-yourself investor community asks their questions to financial experts live on Twitter. You can ask your questions by joining us with the next Twitter Space. Get the dates and times for the next Bogleheads® Live by following the John C. Bogle Center for Financial Literacy on Twitter. That's @Bogleheads®.
For those that can't make the live events, episodes are recorded and turned into a podcast. This is that podcast.
Thank you for joining us for the 39th Bogleheads® Live. Where the do-it-yourself investor community ask questions to financial experts live. My name is Jon Luskin, and I'm your host. Today's topic is disability insurance. The oh-so-important insurance coverage for those with many earning years ahead of them. For today, we have not one but two guests to help answer your questions on disability insurance, Broc Buckles and Dr. Rodney Mogen.
Let's start by talking about the Bogleheads®, a community of investors who believe in keeping it simple, following a small number of tried-and-true investing principles. This episode of Bogleheads® Live, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization dedicated to helping people make better financial decisions. Visit boglecenter.net to find valuable information and to make a tax-deductible donation.
Before we get started on today's show, some announcements for the next Bogleheads® Live. We'll be discussing how the recent tax law change -Secure Act 2.0 - impacts those targeting early retirement. Answering your questions will be Sean Mullaney, AKA “FI Tax Guy.” If you're interested in FIRE, you'll want to check that out. That'll be Thursday, March 2nd at 12:00 PM Pacific, 3:00 PM Eastern. You can see the full list of future guests at bogleheads.org/blog/bogleheads-live.
Before we get started on today's show, a disclaimer. This is for informational and entertainment purposes only. It should not be relied upon as a basis for investment, insurance, tax, or other financial planning decisions.
Thank you to everyone who submitted questions ahead of time. We had a lot of them, and probably won't have time to answer all of them.
Rodney and Broc, thank you for joining us today on Bogleheads® Live. Let's start with what is disability insurance?
Rodney Mogen: I'll start with that, Jon. With disability insurance, I like to call it income protection. It's there to protect your income or at least a portion of your income in case you are either sick or injured. And believe it or not, the injury portion of it only makes up about 15% of all claims on an annual basis. It's usually some type of sickness or mental illness that is the result of claims.
Broc Buckles: A lot of people that we talk to think it's not going to happen to me. I'm not going to be driving down the road and get hit by a bus. That's the example that we hear all the time. But I always like to make sure that people know that the vast majority are actually due to illness, not injury. So, 27.6% are musculoskeletal disorders. 15% is cancer. Mental health, 9.3%. Circulatory issues, 8.2%. Injuries only account for 12% of total long-term disability claims. So, the vast majority of time when people are actually having to file a claim, it's not because there was some sort of freak accident, it's things that are out of our control.
Jon Luskin: Absolutely. And I'd add that because it is illness-related, this can happen to anyone. So even if you have that super cushy desk job, you're not immune.
There is a couple I worked with relatively recently and the husband, he was in his mid-thirties and because of a health condition, he could not work anymore for the rest of his life. And his job was software website design at a regional bank. So, it's not as if he had some sort of position that required hard labor. Because of his disability, he wasn't working forever.
Young earners, desk jockeys, you can find yourself disabled at a very young age, and that is where this sort of insurance coverage can help manage that risk.
Let's talk about why folks should have disability insurance. ‘DEBTINATOR’ from the Bogleheads® Forums says: "I often explain that long-term disability insurance is for you and your dependents, but it doesn't always get the point across. Any tips?"
And then a related question from ‘DesertGator’ from the Bogleheads® Forums who writes: “What percent of workers are statistically likely to have an injury or illness during their approximate 40-year career that would be covered by a disability policy?”
Broc Buckles: That's a really good question. I'll take that one.
So, statistically about one in four of today's 20-year-olds will be disabled for a period of at least one year before retirement. So that's something that's really important to note because a lot of people unfortunately have this “it's not going to happen to me” attitude. I think a lot of people are very surprised to hear that it's 25%, but that's actually what it is statistically.
Another way to really think about it is this is a type of insurance that is going to take care of you if something were to happen. It helps people get through that time of disability because it's hard enough to be disabled, but it's even harder if you're having to think about the financial strain and stress that it's causing on top of the disability that you're already experiencing.
Jon Luskin: When I work with folks, I'm always talking about, at least for those younger earners, those with many earning years ahead of them, "Hey, you want to be thinking about this, you need this because your retirement plan, your financial plan rests on you generating income for 10, 20, possibly 30 years. The numbers aren't going to work unless you have that income. And in a worse case, if you get disabled, you're not going to have that."
That's why long-term disability insurance, as boring and unsexy as it is compared to some of the other topics I talk about with folks, which is going to be investing perhaps tax planning, it is very important. Folks need long-term disability insurance unless you're already sitting on millions of dollars or you're already on the cusp of retirement. Boring, but super important for those younger earners.
Let's talk about some disability insurance 101. Now, life insurance, at least term life insurance, can be pretty simple. You die, you get money. There's no fine print involved. But, with disability insurance there is a lot of fine print involved. Let's talk about some of that fine print.
That's to say, buying a long-term disability insurance policy can be complicated. You're going to have several options of what to include in your policy versus not. In this episode, we'll be breaking down what to look for in a high-quality long-term disability insurance policy.
Let's start with "own occupation." One user from the Bogleheads® Forums writes - and he's referring to own occupation in this question – “it would be helpful to hear some actual examples where having an own occupation definition made a difference.”
So perhaps one of you can answer that question and perhaps you can tell us a little bit about what own occupation is and why it's so important in a disability insurance policy.
Rodney Mogen: Jon, I think you're hitting on it really, really well. It's all about the definition. In the general sense of an own occupation, it's if you cannot do your job or your specific duties or sometimes what you are reasonably able to be trained for, but you can do something else then your disability benefit will continue to come out.
The example I generally will use is, I have a good friend that is an office manager and I got them a disability policy. They were going through some things personally. They actually had nothing to do with work, and they needed to take some time off to just get healthy again. With them, they actually had a stress claim. They could still go do things. As far as the general definition of own occupation, they did not qualify. In fact, with their group policy, their group policy at work denied their claim even though it was own occupation in there, they were able to be reasonably trained to go do something else.
The example here is the carrier that we got their individual policy was that it actually the word “specific” - their specific duties - six months prior to disability. That's a key thing right there. So, they were not able to do their specific duties, but yes, they could go do other things and that policy did pay.
So it is really about the wording, especially in disability and especially with own occupation, the word “and” or "or" is extremely important.
Jon Luskin: One thing that I see a lot in working with folks is that they're going to have an employer provided long-term disability insurance policy. Usually what I see with these policies is going to be a changing definition over time. So frequently. a workplace provided policy is going to have an own occupation definition for the first few years, and then after that it changes to an any occupation definition.
So the risk there for folks is that they get disabled, they can't do their own job and they collect benefits for a couple years. But then a couple years after that, they aren't eligible to get benefits anymore given the changing definition in that employer-provided workplace disability insurance policy.
What advice would you have for folks in that sort of circumstance? How should they be evaluating a workplace policy?
Broc Buckles: A lot of times what that definition corrects to is if you are making 20% of your pre-disability earnings, then you are no longer going to qualify for the benefit that policy is going to pay to you.
So, the way that I would combat that is by having supplemental coverage, albeit I understand that it's more expensive. But the bottom line is, the client is going to have a stronger definition and a higher likelihood that that claim is going to pay out and continue to pay out if they purchase a policy on the private market.
Rodney Mogen: A lot of times the questions we get, "what happens if I just take my group disability policy so that way I can get more coverage on the open market?"
The problem is, and this is what think a lot of people don't understand, is if you work for an employer that offers group long-term disability, whether you take it or not, when you are applying for an individual policy, we are required to actually put that in and reduce your individual benefit. If you are applying and you don't have it available at the time, not a problem.
Jon Luskin: That's going to be unfortunate for those who want high-quality coverage to protect themselves in that worst case, but aren't able to get it because of an employer plan.
So gentlemen, to protect yourself, it sounds like you've got to get a policy with an own occupation definition. That workplace policy, that can leave you open in that worst case.
When working with folks, I always like to look at the worst case. Hey, what's the worst thing that could possibly happen? Let's plan for that. And when I do that sort of approach, the answer is always, “hey, let's make sure we have a high-quality long-term disability insurance policy with an own occupation definition until age 65. Not just for two years. Something that you might find with an employer-provided policy.
Let's jump to some more disability insurance 101. Let's talk about a partial or residual provision. One user from the Bogleheads® Forums writes: “Residual is often pushed, but the case seems tenuous to me. If someone can work 60% and get by on close to that, is it really needed?”
So, gentlemen, let's see if we can answer this question, and also before we even do, let's talk about what a partial or residual disability provision means.
Rodney Mogen: Partial disability is generally something that is considered where you are still able to work, but you're not able to do all of your work. You're not able to work a full 40, 50, 60-hour work week. You're only able to maybe work 20 or 30 hours. And generally, the way the industry looks at it, a partial disability is where you are probably still going through care or treatment.
From 2021, 97.5% of all individual disability and group disability claims were considered a partial claim or residual claim. And I'll explain the difference here in a second. Which means it's a really big part of the claim.
A partial is something that's still ongoing, so you're in and out of work. Think, chemo. Think, you had an injury and you're going through physical therapy.
Residual is usually where you went on a total disability, meaning that you weren't able to work at all in your job. So hopefully you had own occupation. And then now you've gotten better, and then now you're trying to work back into going back full-time.
Let's say that you are a business owner. A bookstore or something like that. They have a lot of different things that they're doing. They get cancer. I'm just going to use this as an example. They're still running their business. They're just not there as much. For a week they're not even involved in the business. They can't think, they can't do anything. And then a week they're sort of in there. But their business is still running, so they're not really seeing a huge loss of income. Some carriers would not pay a claim there. Other carriers would pay a claim because that business owner is not actively at work the full-time. They've reduced the amount of hours because of that disability. So, they're going to actually pay the benefit for that.
If you have really adjusted your income down to 60% and you're okay with that, that is a logical argument. And I'm actually 100% partially disabled, so I guess I have a little bias to this. But when you're going through that disability and you are trying to do everything you can to feel normal, the last thing you want is a financial pressure.
Jon Luskin: That is absolutely mind blowing about that 97% of claims are residual or partial. Wow. That is huge. Which is to say, hey, if you can work a little bit, but not 100%, then you still want to be able to get some amount of benefits. So, that partial, that residual option, that rider, that's going to be critical to getting high-quality long-term disability insurance coverage to protect you in that worst case.
A rider is the technical insurance term for option. Certain options or riders, such as a partial disability rider, can be added to a long-term disability insurance policy to provide better protection.
A COLA rider or an inflation rider is another option you can add to a long-term disability insurance policy. This option increases your benefit each year you receive the benefit.
For example, consider you are age-30 and you're disabled. And you have a long-term disability insurance benefit of $5,000 per month. You receive that monthly benefit for a year. Next year, you'll receive an increase on that $5,000 per month, if you have a COLA rider.
The value of a COLA rider is at your benefit increases with inflation because $5,000 this year likely won't be worth $5,000 next year. It'll be worth less. Adding a COLA rider or an inflation provision to your long-term disability insurance policy helps protect you against the impact of inflation if you're disabled for a long time.
One user from the Bogleheads® Forums writes in about COLA, a cost-of-living adjustment - an inflation increase - and they say, “Is it a better idea for those early in their career where inflation risk is greatest to have this sort of benefit - this rider or this option - but might not necessarily be important for those later in their career. What are your thoughts?”
[Rodney Mogen: It really does depend. If you have got a client or you have an individual that really is only going to do a five-year or seven-year benefit because their financial plan really states they can cover it and they can cover their disability, let's say you're a 55-year-old and you're looking to retire at 60 or 61, and you might do a five-year benefit period to save cost, then yeah I probably would not have the COLA on there.
Definitely as a younger person, I would make sure that it is on there. If you don't really want to pay that extra cost, it's usually about 5%-6%, then you are gambling that your disability is going to be a partial disability more than likely, and it's going to fit within the average. And the average is about 2.5-3 years. And I think you can probably live on a fixed income for 2.5-3 years potentially.
But what if you are part of that 13% that the disability is permanent and doesn't go away? How is that going to affect your financial plan? Especially in today's environment where we have inflation at 6.4%. Last year was running as high as 8.5%, almost 10%. Because remember that income is not going up.
Broc Buckles: When we work with financial planners and we're trying to talk about, "okay, how do we make this policy make sense and how do we determine how long we want this benefit to last?" The last thing that we want them to do is make it a two-year benefit or a five-year benefit or a ten-year benefit, because then we're gambling with how long is the disability going to be, and the last thing that we ever want to have to do is go to somebody who's in year 9 of a disability benefit of 10 years and say, “okay, this is going to stop next year. The COLA benefit really just goes to complement that idea.
Jon Luskin: Why does it make sense for the younger earner to have that inflation, that COLA rider, that inflation protection, but not so for the older earner?
Well, that's because inflation compounds. It grows on itself. And the growth on the growth grows. So, the longer you're looking at having this policy, the longer inflation is an issue, the more important it is to manage it.
So if you have a short time period, inflation is going to have less of an impact. If you're on a longer time period, it's going to have more of an impact. So, for those younger earners, that COLA provision is going to be more important all else being equal to one with less earning years ahead of them.
Now, it does depend because certainly if you're perhaps a little bit farther from the goalpost when it comes to meeting your financial goals, how much you've saved for retirement, et cetera, then that does argue for getting a little more coverage, getting that inflation rider that's going to help give you a little bit more protection.
Rodney Mogen: Brock and I were both answering more specifically on what you were saying on the COLA rider or cost-of-living adjustment. So, I just want to make sure your listeners and everyone participating knows the difference here. A COLA rider only kicks in one year and one day after you've become disabled. So, it's only going to increase your benefit once you are disabled.
Especially for those younger earners, and I think you made a really good point that let's say you're 30 years old, you get disabled at 33, your benefit is going to pay to 65. You definitely need that COLA because inflation compounds.
But what if you are 25, 26 years old? You get that policy and you have a COLA rider, but you don't get disabled until you're 50. That can happen. You've been paying on this policy for a while. Let's say it's a $5,000 benefit when you get it when you're 26. At age 50, something happens. That $5,000 does not have the same buying power. So, one of the things that you do want to make sure especially if you're a younger income earner, is that you have some type of benefit increase or future insurability option. So as your income keeps increasing, you can keep adding to the benefit of the policy.
So I call that pre-disability inflation protection, so that way you're adding to your benefit as your income continues to increase as you continue to adjust your lifestyle.
Jon Luskin: Absolutely. Another important provision to look for when shopping for private disability insurance, that future increase option. All the more important for younger earners.
Let's do a little bit more disability insurance 101. One final provision in shopping for a high-quality private disability insurance policy that I want to talk about today is that non-cancelable, that guaranteed renewable provision. Perhaps you gentlemen can tell us about what that is and why it's important.
Broc Buckles: The non-cancelable, guaranteed renewable, has a lot to do with the ability for you to have the right for that policy to continue. You're not going to have the price change with that non-cancelable. It's guaranteed that the price is going to stay the same.
You can have a guaranteed renewable contract, but that doesn't necessarily mean pricing is going to stay the same.
Rodney Mogen: You can go a little bit cheaper with a guaranteed renewable, but there is a chance that every single year you could see a jump in rates.
Non-cancelable is really the ideal. You really want a non-cancelable, guaranteed renewable policy because the non-cancelable cancels out the guaranteed renewable and it really keeps that premium fixed.
Jon Luskin: To sum it up, when looking for a high-quality private policy, you want to look for an own occupation definition. This is going to protect you if you can't do your own job as opposed to any job. And again, that workplace policy probably only has that own occupation protection for a couple of years. That's going to leave you open to risk in that worst case.
The other thing you want to look for in that high-quality private policy that you're going to be shopping for is that partial and that residual disability provision. Since we learned that 97% of claims fall under this category, that's going to be pretty important in getting as part of your policy.
And then for inflation protection, we want a COLA, a cost-of-living adjustment on the disability insurance benefit itself, and then we want a future insurability option to increase that benefit over time. Both those provisions are especially important for younger earners. And then lastly, we want that non-cancelable, that guaranteed renewable provision. That's going to help us make sure we get to keep the policy at a similar price over time.
Let's move on to a question I got beforehand from the Bogleheads® Forums. This one is from username ‘warner25’ who writes: “Is there anything on the market these days to ensure a stay-at-home parent? My wife has been at home caring for our young children for the past two years. However, it's appeared that she's uninsurable because she doesn't get a W-2.”
Rodney Mogen: There is one carrier that will do a $2,000 a month benefit - I think it's like two- or a four-year benefit period. So may not be much, but it's something that will actually cover that stay-at-home parent as long as there's another spouse that has income and is earning an income.
Jon Luskin: I want to take this question has an opportunity to do some insurance 101. My approach to insurance is that if it's a huge financial loss, this is a loss that we just can't manage ourselves, we can't self-fund, therefore it makes sense to buy insurance.
But if we're looking at a relatively small financial loss, one that we have enough money to manage the expense on our own, then we may want to consider skipping insurance because on average, if we buy insurance, we lose. That's the way the numbers are stacked. Otherwise, the insurance company wouldn't exist.
So again, big financial loss, let's buy insurance. There's no way to manage this risk. We've got no choice. Small financial loss. Let's skip it because we're probably not going to come out ahead.
And that's why I'm a huge proponent of a high-quality, long-term disability insurance policy, especially for those young earners because for most young earners, their future income is a huge number, and they have no way of managing the risk of not getting those future earnings outside of purchasing a long-term disability insurance policy.
When I look at this question, I think about, is this a huge financial risk for this household, and not knowing enough about this household I'm not sure. But if we're talking about, hey, there is going to be some additional cost to this household if the stay-at-home parent can no longer work, is that cost - though substantial - still within their means to self-fund for? Is paying for childcare still going to be something that could come out of the salary of the working spouse?
So there is a little bit of an argument here for self-funding in this circumstance because yes, certainly paying for childcare won't be fun, but I'm not sure if it's necessarily going to ruin their household financially.
This one is from username ‘helloeveryone’ from the Bogleheads® Forums who writes, “Is there a value once you get close to financial independence, to cancel your individual disability insurance policy and simply get that workplace disability insurance policy?”
Broc Buckles: If they're in a spot to where they don't necessarily need the benefit, they've got a year or two before retirement, they've got plenty of nest egg, that's completely up to them. Are they going to take on a certain amount of risk if they do get disabled? Are they maybe going to have to go into some savings or different things like that? Sure.
It's really up to you what your goals are, what you want your life to look like in the future, and your tolerance for risk.
Jon Luskin: I think about that two-year own occupation definition as well as the other various shortcomings of workplace policies. And again, two years own occupation definition is what you see across many workplace policies. Not every policy. For example, Apple, they have a 12-month own occupation definition in their employer provided policy. So, it's not great in terms of protection.
When making the decision, “hey, I'm close to financial independence,” maybe if you're two years away, it could make sense. But again, you want to figure out just how much coverage you're going to get from that workplace policy compared to the private policy. And then consider those factors such as inflation. Perhaps check out if that workplace policy even has an inflation provision, if it has a partial residual provision as well.
This question is from username ‘Rex66’, who asks about how employers can get the most disability insurance coverage: “Every employer I've met was told that they purchased good plans even when that's not the case.”
Rodney Mogen: From an employer perspective, they're not going to get a high-quality policy because of the cost. Because it's too expensive to have. I know that sounds really bad, but really what it comes down. To really have the traditional individual benefits in there that we've been talking about today, that's what I would call a high-quality policy. For a hundred, a thousand employees, that's going to be extremely expensive. And even if they offset it with premiums coming out, people aren't going to sign up for it because they're not going to want to have $60 come out of their paycheck. So that's why employers and group carriers, they really just try to find the best type of product for the price.
Now, with that said, there is a way to do it for certain members of a company and high-income earners. You're never going to see it for all of the employees. It really is a cost thing. But what you are going to see is more for executive carve outs or carve outs for specific groups.
Jon Luskin: I've looked at a lot of workplace disability insurance contracts, and 99% of them have that own occupation for 24 months, sometimes 12 months, sometimes 30 months. But there are some rare instances where you get that own occupation to age 65.
One example recently is a partner at a law firm. So that executive level compensation package may get you a high-quality employer-provided long-term disability insurance policy.
But for the most part, you can probably expect that your workplace policy isn't any good. But then again, you can always read the contract to figure out just how long you get that own occupation definition.
Rodney Mogen: if you have a high-income earner like an executive and they do have a group policy, I really would encourage them or the financial advisor to read the group policy because a lot of times – and I think you've seen this - yeah, it might say 60%, but if you read the details it is capped at $5,000. Or if they make a lot of money off of commissions and bonuses, it's only covering their base salary. So, you really want to look at those details.
Jon Luskin: This one is from username ‘Call_Me _Op’, who writes: “What are the hoops an employee needs to jump through to receive long-term disability insurance? Does the insurance company make life difficult as long as you are receiving payments?”
Rodney Mogen: I think there's two different questions there. The first one is, what are the hoops to get it? And, that's going to depend on your disability and the definitions of that workplace disability. I have heard horror stories, I have also heard things where things went really, really smoothly. And I think Jon, it goes to your point about the own occupation definition, how they really have defined it in there.
Now as far as while you're on disability, that is something you do want to read into that contract because a lot of times a lot of those group policies, the reason why they keep the cost down is you have to go see a doctor every six months. And not your doctor. Their specific doctor. To make sure that you still qualify. There are some different things in the claim language that you may want to take a look at as well.
Jon Luskin: Broc and Rodney, any final thoughts before I let you go?
Broc Buckles: The only thing that I would say is that the policy, if you decide to get one, has the specific things that people really need.
Rodney Mogen: And the only thing I would add to that is language does matter.
[Jon Luskin: And that's going to be the contract language, that fine print. And that's why that workplace policy probably isn't going to protect you in that worst case.
That's all the time we have for today. Thank you to Rodney and Broc for joining us today. And thank you for everyone who joined us for today's Bogleheads® Live.
For the next Bogleheads® Live, we'll be discussing how the recent tax law change - Secure Act 2.0 - impacts those targeting early retirement. Answering your questions will be Sean Mullaney, AKA “FI Tax Guy.” If you're interested in FIRE, you'll want to check that out. That'll be Thursday, March 2nd at 12:00 PM Pacific, 3:00 PM Eastern.
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