Can You Have Too Much Insurance?

by Ron Haynes

Recently, Ron shared his rationale for purchasing disability insurance to protect you and your loved ones in the case of the unthinkable. This week, he’s given me the opportunity to present a different perspective.

In recent years, long-term care insurance and disability insurance have become hot topics. An unexpected disability can decimate a family’s wealth and this unpleasant possibility has led many financial advisers to encourage everyone to get insured.

Now insurance is a wonderful invention and purchasing disability insurance can be a wise decision for many people. But the decision isn’t as simple as it is often presented and many of the statistics have been designed to push people towards purchasing insurance regardless of their real needs.

Troubling statistics

Judging from the scary statistics on disability, you might be struck down at any time, unable to care for yourself. If not today, then at some point in the near future.

The growing number of reported disabilities may be the start of a troubling trend, or it might have more to do with an evolving definition.

During the past three decades, the meaning of disability has morphed into an umbrella term that includes physical handicaps as well as any ambiguous “barriers in the environment that prevent full social participation.”

Complicating matters further, there are many competing definitions and survey methods for tracking them. The U.S. Census Bureau admits that there are serious challenges to measuring disability incidence in surveys.

Not only does everyone’s definition of disability vary, but a survey is also a difficult tool to measure a now “complex, multi-dimensional concept.”

If you take the time to sort through the studies and statistics on disability, you may find some included “disabilities” that would not deter you from working outside of your home.

Additionally, many of the statistics do not clearly distinguish between the severity, term, or age at which the disability occurred. There is a large difference between a debilitating injury or condition at 20, 35, or 60.

Counting the cost

Lets assume you’d feel better purchasing a disability insurance policy.

Selecting a policy isn’t an easy process. First, you have to make sure the coverage you’re buying matches your definition of disability. It would be an expensive mistake to buy a policy that doesn’t cover the conditions you’re trying to insure against.

Assuming you can find a policy that will work, now you’re faced with a significant premium of $1-3,000 a year, possibly more. That’s money you cannot spend on something else.

Economists have a term for evaluating the next best use for your money. Your opportunity cost might mean having a smaller emergency fund, watching fewer movies, not paying your mortgage off early, or simply not being free to eat out or travel as much as you’d like.

Over the years, the policy will cost more than the sum of your premiums, whether or not you file a claim. For example, a 30 year old spending $1,000 annually is forgoing the opportunity to compound his or her money in the stock market. Over the course of twenty years, those premium payments could grow to more than $54,400 (8% return).

Is it really that simple?

Actually, no. There is more to the decision than simply estimating your risk for disability and deciding if you want to commit the money. You’ll also want to consider how reliable your policy will be and whether you might be better off self-insuring.

Will your insurer still be in business 20 years from now? Even successful businesses have been known to go bankrupt.

What will your premiums look like down the road? A non-cancelable renewable policy will guarantee your rates won’t rise, but you’ll pay a premium for it.

Some people argue that many workers will face a short-term disability, incurring medical bills when they are least able to work. Disability insurance could help you in a situation like this; but that warning sounds more like an argument for a bigger emergency fund to me.

With an emergency fund, you have more flexibility and the savings remain yours, unlike insurance premiums that only protect you while you’re making payments.

What if the unthinkable happens and you suffer a long-term debilitating disability? That is the one situation where you come out far ahead with disability insurance.

How I’m handling the possibility of disability

My wife and I have decided to draw the line at life insurance and health insurance. We can self-insure for the small bumps in the road and our life insurance and high deductible medical insurance is there for most of the bigger events.

We would rather put our money to work for us instead of acquiring disability insurance that we probably won’t need. We’re not in denial—one, or even both of us could be seriously injured.

But we’re willing to take that risk because it is relatively small risk now (we’re young) and disability payments would not significantly improve our lives. One or both of us would still be facing extra-ordinary struggles, with or without the extra check.

We’re also not worried about looking stupid if something does happen, because we’re aggressively eliminating debt from our life. We live off of one salary and either of us can earn enough to meet our living expenses.

When the day arrives where we’re finally debt free, our need for disability insurance will be further reduced.

But if the unthinkable happens, our emergency fund is there to take care of any short-term disabilities. If we face a bigger challenge, our family is ready to step in and help us transition into our new, more complicated life.

Rules of thumb, need not apply

In the end, you’ll need to weigh your risk for disability against the other ways you could use the money to improve your life.

If you’re accident-prone, not particularly healthy, or work with your hands, disability insurance might be a great idea for the short-term as you focus on building wealth. Ron’s article would be a great place to start learning more about this option.

Whatever you decide, you do need a plan for dealing with the unknown. Life is full of uncertainties—and you can be sure that the unexpected will happen.

Aaron Stroud shares reliable, easily followed steps to build wealth at On Financial Success. Subscribe to his feed to follow along or ask a question to direct the conversation.

[tags]disability, insurance, life, money, emergency, policy, risk, statistics, work[/tags]

About the author

Ron Haynes has written 1001 articles on The Wisdom Journal.


The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.


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{ 14 comments }

Baker

I hear what your saying, but what about if my employer pays some of the bill. Itns’t it a good deal then?

I’m more confused now.

Aaron Stroud

Baker, my comment below was meant as a direct reply. (I forgot Ron is running a nifty nested comments plug-in.)

Aaron Stroud

It might be, if your employer pays the majority of the cost. The key is to think about how you could best spend your money if you were not buying disability insurance.

If you’re heavily in credit card debt, paying that off first might be a better choice. If you have a large emergency fund (3-6 months worth of expenses), then you might be able to self-insure (skipping disability insurance).

If you’re still unsure, the safest route would be to get the subsidized disability insurance while you start aggressively building wealth. That will give you time to decide how insurance fits into your long range goals.

Shanti @ Antishay

You know, disability insurance is one thing I used to have that I have since stopped paying for (and being covered for). For me right now, at such a young age and able to do so many things, were I to become disabled I think I could make it through without disability insurance. I’m so young, also, that I could lean on my parents if I had to in a disability crisis situation (although I seriously hope I never go through that!).

Because I work for myself but have paid off my debts and have a strong emergency fund now (and still growing!), I have a high-deductible on my health insurance and that’s all I want. My monthly payments are relatively low and I know my emergency fund will cover whatever deductible I would have to pay for something small – or for something big that would, for the most part, be covered by insurance. I think once I’m married someday I’ll feel even more secure – knowing that there would be another income to support me during recovery and while I figure things out. But for now, I’m okay leaving the whole disability thing ambiguous.

Aaron Stroud

Great points Shanti. You’re right that many young adults are still able to lean on their parents during an extreme disability crisis situation.

In that type of situation, disability insurance would be nice of course, but it’d hardly make your problems go away. On the other hand, an extra hundred a month in your pocket has the potential to make a huge change in your life five, ten, or fifty years from now.

MoneyNing

Insurance always seemed more of a luxury to me than anything else. At this point, I’ve chosen to use the money to invest instead of buying insurance. This is almost my way of making my own life insurance.

As for health insurance, since I’m not sure whether I will retire in the US, I haven’t bought that either.

Finally, disability insurance is definitely not something I want to get because of Aaron’s points about the low risk. I have enough financial stability to take care of myself so if I ever become disabled, the last thing on my end is really about the extra money that I will get if I had insurance.

Aaron Stroud

That’s an interesting way of thinking about it. Buying insurance is a luxury. We can’t all afford to mitigate our risk of serious injury or disability and have money left over to invest.

hank

I agree with Shanti in the fact that I also am young enough now to be able to make it alright if something did happen pretty deep. My parents are by no means rich, nor is my wife, but we’d be able to make it work I think on one salary also.

I agree with your point Aaron that it WILL happen, the question is more so when for most people. I’d be interested to see the number of people that actually cash in on the disability insurance. I think that’s a “family recipe” that most insurance companies aren’t willing to share though.

Aaron Stroud

I’m sure insurers pay out plenty, otherwise they’d have enormous profits and everyone would start offering disability insurance, driving costs down.

plonkee

I have disability insurance. The risk is relatively small that I suffer a debilitating disability, but it is not zero – especially when you consider the effect that being physically unable to type would have on employment prospects.

The consequences of being unable to work would be pretty catastrophic – I am single and live on my own. I’m not in a position to be supported by anyone other than myself. I could use state benefits but they wouldn’t pay my mortgage.

Insurance is always about risk and consequences. You should be insuring for things of non-zero risk whose consequences you couldn’t financially cope with me. For me, that means that I have paid for disability insurance, but not for life insurance as no one would be financially worse off in the event of my death.

Ron

#plonkee→

But we would all be worse off without you around, plonkee!

Aaron Stroud

“I could use state benefits but they wouldn’t pay my mortgage”

plonkee, would be state benefits be sufficient to support you in a small rented apartment as you prepare to re-enter the workforce?

It sounds like you’ve chosen disability insurance to protect you from downsizing rather than protecting you from becoming destitute. Would your insurance policy disqualify you from any government disability support?

Margin

Hi, this accident happen anyone disability can occur at any time. While many people take their body and health for granted, serious accident or injury can happen to anyone.

Aaron Stroud

Great point Margin. I think when we take our health for granted, we increase the likelihood that we’ll suffer an injury. Our health certainly suffers when we don’t take care to maintain our bodies.

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