Can You Have Too Much Insurance?

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]

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