What to Look for in a Disability Policy, Part II

In a previous post, we explained why it is important to examine a long-term disability (LTD) policy for:

• • An own occupation definition
  • The cost-of-living-adjustment
  • A partial disability provision
  • The elimination period

For this week’s post, we’ll examine additional important factors in selecting a long-term disability policy.

Is Your Insurance Company Going to Stick Around?

Nancy McCready, CFP® of the Certified Financial Planner Board of Standards, Inc. (CFP Board) notes that:

It is . . . very important to assess the financial soundness of the potential insurer – you want to be confident that they will still be in business when and if you need to file a claim.

Rating agencies, such as A.M. Best, dole out grades to insurance companies. The grades measure a company’s ability to pay an insurance claim. A high grade, such as an “A,” means that – in A.M. Best’s opinion – the insurance company will be able to make good on its promise to pay. A lower letter grade – i.e. “F” – means that A.M Best thinks just the opposite: the insurance company is short on money. If issued a poor grade, the insurer may not have enough cash to pay for policy holder’s claims.

To keep you up at night, consider that even once highly-rated companies have gone bankrupt. (The vast majority of insurers are highly highly-rated.) Despite the failure of rating agencies to do their job, it is still more prudent to purchase your insurance policy from a highly-rated insurer than from a poorly-rated one. Any company with a grade of “B” or lower should be avoided.

To help you sleep at night, consider that your state’s insurance guarantee association can step in if your particular insurance company goes belly up. However, there are limits on what the guarantee associations will cover. So, if your particular insurance policy insures a relatively smaller income stream, you may be okay. However, you can face a significant haircut if your policy benefits are sizeable. The maximum amount covered is roughly $485,000 for 2013.

Will your Disability Outlast your Benefits?

A long-term disability policy will provide benefits for a certain period of time. How long an individual can collect benefits is called the benefit period. The length of the benefit period varies by the particular LTD policy. Common benefit periods include:

• • Five years
  • 10 years
  • Until age 65
  • Until age 67

The greater the benefit period, the more expensive the insurance premium. While you can save money by choosing a shorter benefit period, you run the risk that your disability will outlast your benefits.

Using myself as an example (male, office job, etc.), the average length of a long-term disability is 78 months, or six and half years. Given those odds, I should at least pick a policy with a 10 year benefit period. For greater piece of mind (and a higher premium), I can purchase a policy with an even longer benefit period. Wealth Analytics recommends a minimum benefit period extending to age 65.

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The entirety of an individual’s needs should be evaluated when constructing a financial plan; a long-term disability policy is just one tool for managing risk.

If you’re unsure of how to decipher your existing employer-provided LTD policy – or are in the market for a LTD policy – work with a fee-only financial planner to help you navigate the important variables that affect how you will receive benefits in the event of disability. Without the conflict of interest stemming from the desire to sell an insurance product, a fee-only planner can work with you to determine the best solution for your insurance needs.

References

A.M. Best. (2014). A.M. Best’s Consumer Insurance Information Center. Retrieved from A.M. Best Company: http://consumers.ambest.com

California Life and Health Insurance Guarantee Association Act. (2010). CALIFORNIA CODES INSURANCE CODE SECTION 1067-1067.19. Retrieved from https://leginfo.legislature.ca.gov/faces/codes_displayText.xhtml?lawCode=INS&division=1.&title=&part=2.&chapter=1.&article=14.7.

Council for Disability Awareness. (2012). Personal Disability Quotient; Calculate Your Risk – DisabilityCanHappen.org. Retrieved from Council for Disability Awareness: Prevention, Financial Planning, Resources and Information: http://www.disabilitycanhappen.org/chances_disability/pdq.asp

STATE OF CALIFORNIA DEPARTMENT OF INSURANCE. (2011, AUGUST 11). BULLETIN NO. 2011-3. Retrieved from

https://wealthanalytics.com/wp-content/uploads/2020/12/Bulletin-2011-3.pdf

https://community.pepperdine.edu/hr/content/benefits/fulltime/lifecertspd.pdf