When should I cancel my disability insurance?
In Part 1, we looked at using expectancy to calculate if disability insurance is a waste of money for someone who is financially independent and going for traditional retirement. After torturing a data set from 1985, I conclude that if you were going to work more than 10 years (but not less than 5), you were better off keeping your disability insurance.
Now, in part 2, let’s torture the data again and see when you should cancel disability insurance if you expect to retire early.
Sunk Cost Fallacy and Disability Insurance
Now might be a good time to mention the sunk cost fallacy. Like the entrepreneur, they can’t worry about past failures, just future success.
So it is true with disability insurance. You don’t look at what you have spent on insurance in the past, rather what is the expectation that it may pay out for you in the future.
If you are financially independent, you don’t need disability insurance. But using expectancy, you can determine if it a waste of money and when you can cancel disability insurance.
The past doesn’t matter as long as you learn from it and grow. Sunk costs from past insurance payments don’t matter if you have a high expectancy to benefit from it now or in the immediate future.
Review of Figure 1 and 2
Below, I will include Figure 1 and 2 from Part 1 so they are fresh in our minds.
Above, find age-based probability of disability for at least 90 days before you turn 65. Again, this data is from 1985 for professional and managerial office workers.
The difficulty in using this data for early retirement is that it assumes you will work until you are 65. So, say you are 50 and going to retire at 60. Well, there is a 15.4% chance you will be disabled if you work until 65, but what is it if you only work until 60?
Probability of Life-Long Disability
From the same data set from 1985, we can see how often someone is disabled for at least 2 or 5 years by age. This data should be useful for early retirement, as you are disabled at a specified age, I doubt plans for early retirement affect your payout. That is, if you are disabled but were planning on retiring early, would you tell the insurance company that so they stop paying you before 65?
Using Expectancy to Decide when to Cancel Disability Insurance in Early Retirement
Just to be clear, in my prior blog I assumed you were going to work until you were 65. Now, let’s see when you should cancel your disability insurance if you are quitting work early. Let’s start by you 10-year chance of disability depending on your present age.
Chance by Age You Will be Disabled if Working 10 More Years
Above, see the chance by age you will disabled if you are only going to work for 10 more years. When you are younger, you have a lower chance of disability in any 10-year period. As you age, it increases.
Note that your cumulative chance of disability would be higher when you are younger, because that includes all the periods when you are older as well. But above we are just focusing on any 10-year period. Younger people are, in general, healthier, and suffer less from disability.
Let’s look at expectancy now.
Results of Expectancy for Early Retirement
Here, find the results using expectancy.
Above, see chance of disability more than 90 days on the left. Then, of those, see the percent still disabled after 5 years and expected payout.
After that, take the chance of long-term disability and subtract out the >5 years of disability to get the chance of short-term disability. Multiple that by the 3-year payout and get expected payout.
Finally, payouts are added together and divided by costs ($60,000) and you get the return on investment. Note that return on investment increases rapidly between 40 and 45, and then goes away at 55.
Thus, as far as return on investment goes, you are best to keep your disability in your 40’s and drop it when you are 55. But remember, the above assumes you plan to quit in the next 10 years regardless of your age. So the real conclusion is: the older you are, the more likely you are going to need disability insurance. That kind of makes sense. If you can get over the sunk costs, disability insurance has a higher potential return the older you get and the longer you work.
Conclusion When should I cancel disability insurance?
In Part 1, we see that return on investment for a traditional retirement plan increases until you are about 10 years from retirement (age 55), and then rapidly falls off.
If you are considering early retirement, as seen in figure 3 above, return on investment increases until you are about 50, and then rapidly falls off. Your best chance of using disability and getting payout from it is between 40-55.
You get insurance because you hope you will never need it. If you have been paying for disability insurance for decades, however, you may want to plug in your numbers and see your expectancy. If you have low premiums and high payouts, you may not want to cancel your insurance, as you have a 70% chance of getting your money back between 50-55 years of age.
Again, you will lose money on average, otherwise the insurance company will go out of business.
With disability insurance, as you get older you are more likely to use it, but get less of a benefit as payouts stop at age 65.
Using expectancy and your own numbers, you can calculate your return on investment for the next 5-10 years and see if it is time to cancel disability insurance and self-insure.