Imagine yourself the captain of a transoceanic vessel.
The ocean is a big place. As a matter of fact, a mighty big place covering about 70% of the earth creating a significant challenge for oceanic transportation.
Any captain worth their salt understands that small course deviations overtime become gulf sized gaps if not corrected. So, what does this have to do with income protection? First, details matter and small differences can become gulf-sized issues over time.
"Just slap on a COLA for this guy" -- Mid-career successful financial professional
This flippant response though in good nature caused me to be curious if there was in fact a process to determine which type of Cost of Living Adjustment rider (COLA) to use. If this sounds mundane to you, you are not alone, and I too was a skeptic until I examined the numbers.
There are two general camps of COLA rider for a disability income insurance policy. First is the CPI-tied version and second the fixed rate option. Like me, you may not initially think that this is a big deal, but the difference is probably greater than you ever imagined.
In the Fig. 1 shows the monthly averaged CPI-U for 2007 through 2017.
Fig. 2 shows what you would find with a typical CPI-tied COLA option where the negative years are zeroed-out and the max annual change is capped at 3% for a policy with a first-year benefit of $10,000 per month.
Total benefit, $1,281,611
If by chance, your client had afixed 3% COLA(Fig. 3) they would have benefited by an additional $94,055 over the CPI-tied version. If you take in to account the tax-free benefit setup we see often with individually purchased disability insurance, the difference is almost like having an extra year’s worth of wages! Pretty good for a very modest premium difference.
Total benefit $1,375,666
Here’s where it gets amazing! What if by chance the CPI-U results repeated themselves for another ten years for a 20-year long term disability claim?
The difference between a CPI-tied COLA and fixed 3% COLA would be an amazing $488,876 over a twenty-year claim!
It may sound subtle, but almost a half million extra benefit may be worth a few extra dollars in premium.
Words matter. Claims matter. Details matter.