Personal Economics 101 is not found in college catalogs, and parents untrained in personal economics are not a knowledge source for information and guidance. Thus, the highly important task of providing personal economic and financial advice is the domain of financial service professionals.
With this opportunity to provide advice comes the duty to diligently and fully provide modern and unbiased financial advice. Credentialed studies and a commitment to continuing education provide evidence that an advisor desires to be highly professional and provide competently sculpted financial plans. Changes in 21st century perceptions and functions have resulted in a class of professional generalist versus the professional specialists we knew last century. In the 20th century, financial professionals specialized in areas such as securities, life and health insurance, property and casualty insurance, real estate, accounting, law and banking. In the 21st century, financial professionals are combining their knowledge from these various venues and becoming specialists in providing expertise for overall financial planning.
In general, the change is working well except in the challenging field of disability financial planning. The industry statistics tell us that advisors are inadequately preparing consumers financially for the contingent event of becoming disabled.
Consumers face both personal and business perils as a result of disability. According to the U.S. Department of Labor, only 27 percent of income earners in the United States have disability insurance and, of that number, the majority have inadequate amounts to meet their obligations.
Dimensions of an Adequate Disability Financial Plan
Surveys by the U.S. News and World Report magazine and separately by the U.S. Department of Labor Statistics indicate that people of every income level must maintain an income cash flow level of 65 to 75 percent of normal or they will be forced to liquidate some of their accumulated assets.
Our federal and state governments have long recognized the vital necessity to have a continuing flow of income when unable to earn it and have put the following assistance programs in place:
Law Year Enacted
Workers’ Compensation 1908
Unemployment Compensation 1917
Social Security Retirement 1935
State Disability Plans (5 states) 1942
Social Security Disability 1956
Tax Advantaged Retirement Plans 1957
The need for continuing income cash flow has long been recognized by economists and scholars of finance. Life insurance, once looked upon as a burial fund, was expanded to the concept of income replacement insurance for survivors of a deceased wage earner with the 1913 book, “Life Insurance,” by Solomon S. Huebner, PhD, CLU.
Dr. Huebner expressed his belief that disability income insurance clearly belongs under the classification of life insurance because its purpose, like the basic purpose of life insurance, is to replace income when the earner is unable to. Up to that time in history, disability insurance, then known as accident and health insurance, was considered to be a casualty coverage and was offered either by casualty companies or by accident and health insurance specialty companies.
Oil and Water
Dr. Huebner is also the creator of the human life value concept. He cited the need for income replacement insurance whether the loss of income stems from “dead death or living death.”
While balancing income cash flow replacement in the case of “dead death” has been relatively easy, never in the 127-year history of disability insurance in America (with few exceptions) has an adequate amount of income replacement benefits been available from a single source. Thus, financial advisors have encountered difficulty because of the many limits imposed on underwriting disability income insurance.
Life insurance companies frequently select their leaders from other industries such as banking, accounting and finance. Thus, it is natural for them to view the companies they manage not as insurers, but simply as financial institutions. Commonly, such executives perceive disability insurance to be a disintermediation factor that works against attempts to accumulate premiums for investment purposes. Disability insurance entails a claims obligation that involves sending premium money back to policyholders during periods of disability and, in addition to the actual claims costs, substantial claims reserves must be quickly set aside.
As a result of this uneasiness about disability insurance, the number of companies underwriting disability insurance has precipitously dropped from 350 to 26 in just the past decade. However, even with the lack of competition and with only two or three reinsurers active in the disability field, the conditions for limited and controlled benefit offerings do exist.
Some financial planners have shunned disability insurance because of the lack of capacity and others because of harsh underwriting; both factors have contributed to the disappointing coverage results. Few insurance companies promote disability sales, few offer sales incentives to foster sales, and most have long ago forgone educational endeavors in this field.
To homogenize the needs of the consumer with the now available coverages, creativity is needed to forge an adequate disability plan. All sources must be considered and utilized to deliver the required amounts. Highly compensated people cannot be adequately insured with either individual disability income or group disability alone.
21st Century Disability Financial Planning
Disability insurance is not about elimination periods, benefits periods or definitions of disability—those are simply technical aspects of a given product. Disability insurance is about income and is truly a vital financial product. No longer does the 20th century approach of insuring a person with a policy that may only yield benefits sufficient for bread and water and a tent in the park suffice. In the 21st century, attitudes of underwriting and planning have begun to change.
Loss of a job is not a new century concern. In this century people will face six to eight job changes during their working careers. The measure of a career period will be replaced by a cash flow concern. The 20th century advice of “get a job with a big company, stay out of corporate politics and hang on until retirement” holds no believability.
Insurers’ issue and participation limits as well as caps are based on old century concepts. A new planning approach to measure disability income needs will overcome these limitations. The 21st century issue limits must consider the probable asset value of a person’s career earnings, not just past earnings.
Disability financial planning for the high income earner who is not yet super rich. A highly successful entertainer, athlete or professional person must set aside a portion of his earned income to create wealth, to build a passive income and a retirement income sufficient to sustain his lifestyle of choice. Financial discipline and time is required to achieve this level of independence. If earned income diminishes or ceases altogether during the wealth creation period, the plan will fail.
Bankers commonly recommend that their clients buy life insurance to cover their indebtedness to the bank. In the event of disability, earned income would cease and repayment of debts would be in doubt. Modern underwriting provides for bank loans to be insured against disability outside the insured’s personal disability financial plan. Bankers enthusiastically endorse the aspects of carrying bank loan indemnification insurance until the client is debt free.
Disability financial planning for the already rich. Let’s look at a 40-year-old CPA with inherited wealth. He earns $250,000 per year from his accounting practice. Among his inherited wealth is an apartment building, appraised at $13 million, that yields net rental income of $250,000 per year. Thus his combined earned and unearned income totals $500,000 per year.
The CPA considered not insuring the apartment building, since it cost him nothing. In the event of the building being destroyed by fire or earthquake, he still retains the land value. The loss of the building would include the value of the bricks and mortar but, more importantly, the loss of an endless income stream of $250,000 per year of passive income. Without hesitation the CPA and his financial advisor made the decision to buy insurance on the $13 million building.
Next came the question of whether the CPA should insure the $250,000 of income he earns from his practice. This income flow, when measured as an asset, achieves a comparable value of the $13 million building when the current rate of income is calculated over a period of time (to age 65) and includes a 6 percent rate of growth/inflation.
All insurance is important in protecting assets. This year the changes are:
Home 1 in 1,200 of being destroyed by fire
Auto(s) 1 in 250 of filing a claim
Death 1 in 150 of happening this year
Disability 1 in 30 of suffering a long term disability
Few people have net asset values that exceed the capitalized value of future earned income. Like the recognized hard assets owned by a person, the value of future earnings should be as insurable as buildings, autos, art, jewelry and collectibles.
If it makes sense to insure a $13 million building, it makes sense to insure the $13 million asset of future earned income.
The answer to the question “Do rich people need disability income insurance?” is, as the bankers agreed, “Yes.” The only difference between the needs of the rich and the not-so-rich is the dimensions of the coverage.
W. Harold Petersen, RHU, DFP
RHU, DFP, is founder and chairperson of Petersen International Underwriters. He is recognized as an expert in underwriting development and policy innovation for such products as high-limit disability insurance, residual disability benefits, cash-value DI, and the expanding field of disability financial planning. The life/disability industry has acknowledged his leadership as an author, educator, motivator and leader, and has bestowed upon him the Harold R. Gordon Memorial Award (NAHU), the Will G. Farrell Award (NAIFA Los Angeles), the Lifetime Achievement Award (IDIS) and the Distinguished Service Award (NAIFA CA). His extensive industry involvement includes NAIFA, LIMRA, NAHU and The American College, all on local, state and national levels as well as IDIS. Petersen can be reached at Petersen International Underwriters, 23929 Valencia Boulevard, Valencia, CA 91355. Telephone: 800-345-8816. Email: firstname.lastname@example.org.