Disability Insurance- When Should I Stop
Once you are Financially Independent (FI), you no longer require income to pay bills. If you don’t need your income to pay bills, then you don’t need disability insurance! When should you drop disability insurance once you are financially independent?
Let’s look at the numbers! FI is about optimization. You optimize disability insurance when purchased. Let’s optimize when you should stop disability insurance as well.
Expectancy and When to Stop Disability Insurance
Expectancy is an important consideration. When do you expect that disability insurance is no longer a good deal?
Well, remember, insurance will always have a negative expectancy. After all, that’s how insurance companies make money! If consumers expected to make money off insurance, well, then we wouldn’t have insurance to cover rare, catastrophic events, would we?
What is expectancy? Expectancy is important to understand: it is the payout times the chance something will happen.
We often think probabilistically. It is more powerful, however, when you multiply probabilities times payouts to get expected future results.
Expectancy for payout of disability insurance is the probability of disability times the expected payout.
We will talk about the probability of disability in a minute, but what is the payout for disability insurance? The younger you are, the higher the expected payout for disability. This is because disability insurance generally stops paying out at 65.
Determining the probability you will be disabled is the next consideration.
Probability of Disability During your Career
There are some oft quoted statistics about disability. Look around the internet and you will see that you are seven times more likely to be disabled than to die. Ok. I also see 10-20% get disabled at some time between 25-65.
Let’s see if we can narrow that down a little more.
The SSA published probability statistics for disability if you were born in 1997. So, for a 20-year-old born in 1997, 26% of males and 24.7% of females suffer from disability before they are 65.
As an aside, it’s also interesting to note that the expected death rate is 7.4% for males and 3.7% for females. No surprise there!
Also, of note, the average disability claim lasts 2.5 years. One in eight last more than 5 years. We can use that data.
Disability Later in your Career
Let’s look at the probability of disability by age.
Above, find age-based probability of being disabled for at least 90 days before you turn 65. The data in figure 1 is from 1985 for professional and managerial occupations with office duty. Take it with a grain of salt, it is old data, but at least it is a good starting point.
Probability of Life-Long Disability
We see above that 1/8 disabilities result in long term disabilities. Can we get better number than that?
From the same data set, we can what percentage of males and females are still disabled after 2 and 5 years depending on age.
Putting figures 1 and two together, as you age, you are less likely to become disabled between now and 65, but if you are disabled, the older you are, the greater chance you will remain disabled. Intuitively this makes sense.
And now we have some numbers to work with!
Example of Expectancy
So, how long should you keep your disability insurance? Obviously since most disability insurance stops paying out at 65 and you need to be disabled for 6 months before getting paid, you should stop paying at 64.5 years of age. Likely the answer is even sooner than that, especially if you are Financially Independent and no longer “need” the insurance.
Using expectancy, can we figure out the ideal time to stop disability insurance? After all, risk management is not just about the risk something bad happens, it is also about the potential payout. You have paid for disability insurance for a long time, is disability insurance a waste of money?
What if You are Only going to Work 5 More Years?
We are running out of data here. With that in mind, I present this:
As you get closer to the age of 65, the chance that you will become disabled by 65 decreases as seen above in figure 3. This is interesting to contemplate because we know the older you get, the higher likelihood that you will become disabled. If you are disabled after 65 in this setting, it doesn’t “count” since you would receive no disability payments after 65.
The data presented in Figure 1 stopped at age 55. However, we also know at age 65, the number of people who will be disabled before 65 is zero. So, we can insert a trend line and discover 6.5% of 60 year old males become disabled and 7.8% of females become disabled before they are 65.
Summary Table: When Should I Stop Disability Insurance?
In figure 5, see the summary table. On the top, are the years left until retirement. On the left, find percent of return on investment, and percentage of short term (2-5 years) and long term (>5 years) disability.
Return on investment, in essence, means the chance that you get your money back. It is expected payout over premium payment.
Insurance is risk mitigation, or risk transfer for catastrophic problems. There is expectancy for a negative result, as obviously insurance would go out of business if they paid out more than they took in.
What makes disability insurance fascinating: the older you get, the more likely you are to become disabled but the less payout you receive.
The return on investment, then, increases until you are about 10 years out from retirement. The chance that you have a long term disability also increases as you get older, but obviously goes to 0% once you are 60.
So, when should you stop your disability insurance when you are Financially Independent? It is a personal choice, and one that can take your own health into account. If you have conditions that increase the risk for short or long term disability, it may pay to keep the insurance around. If you are healthy and financially independent, stop it 10 years before you retire.
Nevertheless, once you can self-insure for disaster, the odds are ever in favor of insurance companies.