Academic journal article Journal of Risk and Insurance

Disability and Life Insurance in the Individual Insurance Portfolio

Academic journal article Journal of Risk and Insurance

Disability and Life Insurance in the Individual Insurance Portfolio

Article excerpt

Disability and Life Insurance in the Individual Insurance Portfolio

The "conventional wisdom" regarding the relative importance of disability income

insurance compared to life insurance in the individual insurance portfolio is

investigated. An expected value model is applied to actuarial data for insured lives to

provide a direct comparison with respect to individual objectives. The results provide

preliminary support for the dominance of disability over mortality objectives and raise

questions about the financial planning techniques currently in use.

In the literature pertaining to personal financial planning, personal insurance, and employee benefits, "conventional wisdom" strongly suggests disability income insurance should take priority over life insurance when forming an insurance portfolio (Amling and Droms, 1986, p. 311; Beam and McFadden, 1985, p. 113; Rejda, 1986, pp. 430-31). The basic tenets of the conventional wisdom are: (1) the probability of an earner suffering a long-term disability (LTD) is greater than the probability of death at every age during the working lifetime, and (2) given that a loss occurs, the severity of an LTD loss exceeds the severity of a mortality loss because the family continues to incur personal care and other expenses related to the disabled earner. Statements of the conventional wisdom imply that income and other losses attributable to long-term disability are both more probable and more severe than losses caused by an earner's death.

Consumer behavior does not reflect the conventional wisdom. The 1986 Life Insurance Fact Book indicates that 81 percent of U.S. households owned life insurance in 1984, with a mean coverage amount of $64,200. For the same year, the U.S. Department of Health and Human Services shows that only 21.9 percent of the working population carried LTD insurance.(1) Because consumer behavior has not responded to the conventional wisdom, an investigation of the relative value of LTD and life insurance to the individual is appropriate.(2)

The primary purpose of this study is to provide preliminary evidence on the basic issue of holding disability income insurance versus life insurance in the individual insurance portfolio. In the next section, a brief review of relevant research is provided.

Prior Research

The literature pertaining to LTD insurance is largely restricted to descriptive studies of products (Miller, 1978; Morris, 1986; Soule, 1984) and macroeconomic studies of demand or claims (Doudna, 1977; Rea, 1981). Researchers generally have not investigated rational purchasing behavior by individuals with respect to LTD insurance.

In contrast, programming models for determining family life insurance requirements have been developed by Belth (1964), Gustavson (1982), and Rose and Mehr (1980). Expected value models, impounding both income replacement and other anticipated needs conditional upon death of the earner on a certain date, are proposed in these studies(3). The earner is assumed to make decisions in isolation, i.e. without consideration of liquidity constraints or needs for other types of insurance. Jenkins (1988) demonstrates that such models ignore bequest motives, but alternatives are not provided.

Statements of the conventional wisdom often are based upon loss data for insured lives generated by The Committee to Recommend New Disability Tables for Valuation (Disability Committee) (1985) and The Special Committee to Recommend New Mortality Tables for Valuation (Mortality Committee) (1981). These data were approved for ratemaking purposes by the National Association of Insurance Commissioners.

Table 1 contains disability and mortality incidence rates derived from data generated by the two committees. The data show that males and females in white-collar occupations are much more likely to become disabled than to die at every age during the working lifetime. …

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