How to Insure Your Income: Real vs. Economic Death
A long-term disability may not cause physical death -- but it very often causes economic death.
Economic death caused by a disability is far more common than a natural death during an individual's working years. This fact has real effects on just about everyone. An example: In the United States, the most common cause of mortgage foreclosures is the disability of the borrower.
It's not just ordinary people who confuse the importance of real death and economic death. Even the insurance industry does it. Insurance agents frequently sell life insurance based on the capitalized earnings during your lifetime (to age 65). So, your earning potential is discussed, analyzed and used as a selling factor for determining the amount of life insurance you should purchase.
Once the agent sells you life insurance, he or she often leaves -- without discussing the need for insurance covering the ability to earn the income upon which the life insurance amount was calculated.
When a disability occurs, life insurance isn't much help. The insurance benefits (other than usually small policy cash values) aren't available. Pension benefits usually aren't available. And even if the person can qualify for Social Security disability benefits, actual receipt of the money is at least a year away.
Of course, earned income usually ceases. But expenses -- including the added medical and related expenses caused by the disability -- continue.
Without disability income insurance, what resources are available to offset the effects of a disability?
Cash savings probably would be the first resource that you would draw upon if you were disabled. But how many people systematically save cash for dire contingencies? How many times have you intended to deposit money into a savings account and failed to do so? And even if you do systematically save, the amounts probably won't be adequate to see you through a prolonged disability.
An efficient saver may have a savings account equal to two or three months of income. If a disability lasts for a short period, the savings account can take care of the financial needs of the disabled person. However, the average disability lasts considerably longer than a month or two.
Statistically, if a 30-year-old male is disabled for at least 90 days, the average length of the disability will be 4.7 years.
The second place most people would turn for money when they are disabled is investments and other personal assets.
You might have investments, such as automobiles, real estate, cash value life insurance, stocks or bonds. Having these things can help you get through a difficult time -- but it better not take long. Converting assets into cash will provide money for only a limited period of time. And it usually drains a person or family of long-term earning power.
Another concern: How liquid are these personal assets? If you have a vintage car that you think is worth $50,000, you may not be able to find a buyer -- at least not quickly -- who will pay that amount. So, you may be reluctant to sell a prized coin collection or works of art in order to raise money.
Even if an investment is liquid, it may be volatile. You might own 1,000 shares of stock that you bought for $50 per. But if that stock's trading at $30 a share when you're disabled, if you sell, you only get $30,000.
The third place most people would look for money is any business assets they own. The problem here is that few people have these in a substantial way.
If you own a business, it may take care of your disability by generating income in your absence. Unfortunately, turning to business assets more often means selling the business or liquidating inventory or other parts of the operation. Either case usually results in a forced sale -- which may bring as little as 10 or 20 cents on the dollar.
If you're an employee, there may be some work-related benefits available from a qualified plan, a salary continuation plan, employee stock plans, workers' compensation, etc.
But group disability benefits are of short duration -- a year or less -- and cover only a percentage of lost income. And these so-called fixed and capped benefit plans tend to discriminate against higher-paid employees.
For example, a group plan might provide benefits equal to 60 percent of pay up to a maximum benefit of $2,000 per month ($24,000 annually). This may prove to be an adequate benefit for all employees who earn $40,000 or less per year.
For managers, executives or owners, the disability benefit is still limited to $24,000 per year. So, if a manager is earning $60,000 annually, her disability benefit covers only 40 percent of her ordinary pay.
Another factor related to group benefits or work-related plans is the fact that you merely "rent" this coverage. Benefits are available on the condition that you continue to be an employee. If you terminate employment, your disability benefits also are terminated. If a disability strikes between jobs, there are no work-related benefits provided.
Another potential financial resource is the federal and/or state government. Primarily, these programs consist of Social Security disability income benefits and workers' compensation.
Eligibility for disability benefits under Social Security requires that you be both fully insured and disability insured. Fully insured status means that you have paid Social Security taxes for 40 calendar quarters (10 years). Disability insured requires that you have paid Social Security taxes in at least 20 out of 40 calendar quarters (five out of 10 years) prior to filing a disability claim.
In addition, you must be under age 65, the disability must be expected to last for at least 12 months or end in death, and the disability must satisfy the definition of total disability in accordance with the Social Security law.
Basically, total disability is defined as:
the inability to engage in any substantial gainful activity by reason of a medically determined physical or mental disability relative to a person's education and prior work experience.
This means that you must be unable to perform your previous job or any other substantial work that exists in the national economy relative to your age, education and prior work experience.
In addition, there is a five-month waiting period before any benefits can be paid. In reality, due to the waiting period, plus the time it takes to process an initial claim, the first Social Security claim check is likely not to be received until about the end of the first year of disability.
(We'll look at Social Security disability benefits in much greater detail in Chapter 6.)
Workers' compensation provides another source of disability income benefits. Workers' comp offers benefits to workers who have job-related disabilities due to an accident or sickness. Workers' comp laws and the benefits provided vary somewhat from state to state.
The intent of the workers' comp system is to make the employer liable for occupational disabilities without fault having to be proved by the injured worker. Therefore, the employer may cover such claims out of company funds or elect (as almost all do) to cover this risk by means of workers' comp insurance.
The basic requirement to be eligible for these benefits is that the disability must be work-related. Falling out of bed in the morning and breaking your arm does not constitute a workers' comp claim. Slipping on a wet floor at your place of employment and breaking your arm is a workers' comp claim.
The final source of money that disabled people usually turn to is borrowing. The problem with this source: Who will lend you money if you are unable to work due to a disability? Banks and other lending institutions usually won't. Most people in need turn to friends and family. But even a relative may be reluctant to lend money under these circumstances.
And, in the end, even if you can borrow money, the amount people will lend is often not enough to see you through a lengthy period of disability.
