Tuesday, October 25, 2011

Insure Your Income, or your Assets? Disability Insurance

Is Disability Insurance a good idea?  It is staggeringly expensive as you get older.

In Stephan A. Pollan's Book Die Broke, he advises buying disability insurance.  As he is a financial adviser, I presume he sells it.

And at one time, my (former) financial adviser advised me to buy disability insurance, which he sold, and I bought it.  But I no longer have it.  Why?

Well, the answer is twofold.   First, it gets more and more expensive as you get older, and it is insurance that will likely never pay off in your lifetime.  And it is insurance you already have, to some extent.  Third, despite what the advisers say, you are not insuring your income stream, but rather your assets.  What do I mean by all of this?

Well, first of all, if you go out and buy a policy - and the "long term care" policy they also want to sell you, you may end up spending hundreds of dollars a month - thousands a year - on insurance.  At some point, this simply becomes unaffordable.  And like medical insurance, the costs ratchet up every year.  At some point, you have to take a risk and live your life, rather than buy parachutes for all sorts of long-shot propositions.

And it is a long-shot.  My insurance agent sold the policy on the line that, "Statistically speaking, you are more likely to be disabled than die."

To which I responded, "Really?  I always thought the chances of dying were pretty close to 100%!"

Of course, what he meant to say was that your chances of being disabled during your working lifetime (before retirement age) were higher than dying prematurely.

And being disabled is not a fun thing.  And if you got hit by a bus, you'd wish you had disability insurance.  However, most of us don't get hit by a bus, and wish we had all those premium payments instead.

Of course, you are covered, to some extent, by Social Security Disability.  If you are disabled, Social Security will pay you a sum (not a large amount) but something.  So it is not like you will be homeless if you become a quadriplegic.

The agents sell these policies on fear, though.  Fear that something gawdawful will happen, and there you will be, destitute and penniless.  Yes, there is a risk - always - in life that shit will happen, leaving you to live in a trailer in a run-down trailer park.  You can try avoiding that outcome and do some risk-taking, or you can try insuring against it.  Buying insurance doesn't however, reduce the risk.

And by buying insurance, what are you buying?  Are you really "insuring your income stream" or just insuring your 401(k) plan?  I think the latter.

The pitch made by my agent was, "Well, if you are hit by a bus, you'll have to tap into your savings in order to live!"  And that right there gave away the game.  What he was selling was not insurance of my income stream, but the ability to not have to tap into my savings - insuring my assets.

If, God forbid, I was hit by a bus, what would I do?  Well, likely I would collect Social Security.  That would more than pay my monthly overhead (as our home is paid for) and with my spouse's income, we could get by.  We could always sell our home and move to a smaller home and net a couple hundred grand in cash (conservatively).  And finally, we do have our savings to tap into, if we had to.  But the idea we'd starve, is, well, overstated.

Would we be able to go off on a cruise?  No.  But that's the breaks of being hit by a bus.

Of course, I am older and have some assets, so I can get by.  But for younger people, just starting out, with children, a mortgage, car payments, and the like, it might be a different scenario.  Your income stream is your major asset, and life insurance and disability insurance might be worthwhile.

And, guess what?  Both types of policies are a lot cheaper for younger people to buy, as they are far less likely to die or be disabled at that age.

But as you get older, buying disability insurance - and indeed even life insurance - becomes prohibitively expensive.  You have to figure out when it is more worthwhile to put those premium dollars into savings, rather than into insurance.

* Footnote:  One reason disability insurance is so pricey is that it is prone to fraud.  These days, people can be certified "disabled" for carpal tunnel syndrome or obesity - with the help of a friendly doctor.  The increase in premiums reflect this.