The Demand for Disability Insurance

By Scott, Janine K.; Finke, Michael S. | Financial Services Review, Spring 2013 | Go to article overview

The Demand for Disability Insurance


Scott, Janine K., Finke, Michael S., Financial Services Review


Abstract

Disability insurance is a vital hedge against an unexpected loss in human capital, yet less than half of U.S. households own this type of insurance. This article explores factors that affect demand for disability insurance and investigates the impact of financial sophistication and professional financial advice on insurance ownership. Prior research shows that low financial knowledge, behavioral biases, and other barriers to purchase are related to low demand among households. Using the 2007 Survey of Consumer Finances, we find that demand for disability insurance increases with financial sophistication, the use of a financial advisor, and proxies for group insurance availability. Results indicate that low demand for disability insurance can be attributed to both demand and supply factors. © 2013 Academy of Financial Services. All rights reserved.

JEL classification: G22

Keywords: Disability insurance; Household finance; Financial advisor; Human capital

1. Introduction

Human capital, or the present value of expected future earnings, represents a significant proportion of a working household's portfolio. The impact of a stochastic health shock on earning ability can be mitigated by ownership of disability insurance, which provides a buffer against the loss of permanent or transitory income (Angerer and Lam, 2006; Bodie, Merton, and Samuelson, 1992). Because human capital is often the largest asset in the household portfolio (Ibbotson, Milevsky, Chen, and Zhu, 2007; Campbell, 2006; Washer and Nippani, 2004; Lee and Hanna, 1995; Becker, 1985), a sharp, unexpected decline in its value can have a large impact on household welfare. Other potential effects of a disability include medical expenses, loss of employee benefits, loss of retirement saving ability, the need for additional child care, and possible nursing home care (Cox, 1991).

The Consumer Disability Awareness (CDA) survey (2010) estimates that three out of 10 American workers entering the market will become disabled before retirement. Given the catastrophic nature of the loss, the nondiversifiable nature of the risk, and the existence of insurance products that protect against a loss from disability, many households should demand disability insurance products. However, like long-term care insurance (Brown and Finkelstein, 2004), disability insurance is less popular than many other property and casualty consumer insurance products (Mooney, 1999). If disability arises and protection is inadequate, many households may be forced to draw on assets or rely on government aid which may not sufficiently meet needs.

Consumers may not realize the importance of disability insurance, which may explain the small percentage of the population who purchase it (Ibbotson et al., 2007). Many advisors and personal finance textbooks primarily focus on financial assets rather than on human capital protection (Washer and Nippani, 2004). In addition, other products such as life insurance may appear more important to many consumers who may be less aware of the likelihood or severity of potential loss from disability versus the risk of premature death (Cox, Gustavson, and Stam, 1991).

The supply side of the insurance market also has an impact on disability insurance ownership rates. Access to inexpensive disability insurance may be dependent on availability through one's employer and these policies typically cover only 60% of earnings (Opiela, 2004). However, insurance companies are adopting a narrower definition of disability and this presents a challenge to consumers by making it more difficult to qualify for benefits (Opiela, 2004). The existence of public insurance and reliance on family members may also constrain demand for private insurance by creating a perception that losses from disability will be less severe (Brown and Finkelstein, 2009). However, the process to obtain social security disability income (SSDI) can be lengthy and overwhelming, with strict qualification criteria (Brown and Finkelstein, 2004a). …

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