The last two years have seen inflation climb to levels not seen this century. The Consumer Price Index (CPI) was 8.6 in 2022, more than four times the average, and the CPI was 4.7 for 2021, more than twice the average. Now is the time to thoroughly examine the merits of the Cost-of-Living Adjustment Rider (COLA) available on individual disability insurance policies.
To review, the COLA rider is an optional rider that increases the base monthly benefit of a disability insurance policy. So far, so good, but let’s look deeper. This rider only becomes active once you have filed a claim and have been receiving benefits for 12 months. Each company is different in how much extra benefit they provide and the rules for how they calculate it, and an extra premium is charged to add the rider.
Should a COLA rider be added to your future or current disability insurance policy? If the insurance companies included this rider for no extra premium, the decision would be easy. Why would you not want your monthly benefit to keep pace with inflation? Unfortunately for the consumer, insurance companies are experts at assessing risk and levying the premium required to insure that risk. COLA is no different. In this guest post, we will study the costs of a COLA rider and the benefits, and we will provide the data for you to make an informed decision on whether that rider is worth it.
Comparing the COLA Rider from the Big 5 Disability Insurance Companies
For this study, we obtained illustrations from Ameritas, Guardian, MassMutual, Principal, and Standard for male and female rates at ages 30, 35, and 40 for various states. We used various medical specialties and occupational classes and illustrated a $5,000 per month benefit with a benefit period of age 67 and a 90-day elimination period. To make this as accurate as possible, we wanted to simulate the real-life everyday policies that physicians are requesting and obtaining, so we added enhanced residual/partial benefits. We also included a benefit increase rider or future insurability/increase option (FIO).
We ran these both with and without COLA to gauge the premium differences. We ran all illustrations with California rates and policy provisions and compared them against New York and Texas rates to make sure the cost differential was the same with all carriers, which we found to be true. We then reduced the monthly benefit for the policy with COLA to equal the premium of the $5,000 monthly benefit without COLA. Since each company has a different way to calculate how they pay the COLA increase, we used the following rider from each company for our study:
- Ameritas: 3% simple annually, regardless of CPI
- Guardian: 3% compounded annually, regardless of CPI
- MassMutual: 3% compounded annually, regardless of CPI
- Principal: Up to 3% compounded annually, depending on the performance of CPI. Negative or flat CPI will result in a 0% change, and anything above 3% will be capped at 3%.
- Standard: Up to 3% compounded annually, depending on the performance of CPI. Negative or flat CPI will result in a 0% change, and anything above 3% will be capped at 3%.
Since each age, gender, and specialty produced virtually the same percentage premium differential between premiums with and without COLA, we used a 35-year-old male invasive physician as our case study subject with California rates and level premiums. We then reduced the monthly benefit for the policy with COLA to equal the premium of the $5,000 monthly benefit without COLA, which resulted in the following:
** Based on equal premiums paid with and without COLA for each company; however, we did not adjust for the premium differences between companies.
The chart above illustrates the amount of monthly benefit received based on equal premiums paid for policies with and without the COLA rider. As you can see, one can start with a higher monthly benefit for the cost of adding a COLA rider.
We then used the following CPI-U chart, taken from the Federal Reserve Bank of Minneapolis.
From this chart, we took data from the last 23 years—which we felt would be the most pertinent—and averaged it out to 1.925%. With all carriers, the cap increase is 3% (some carriers offer a higher cap percentage, but for the purposes of our study, we only used the 3% cap premium), so for the six years that the CPI exceeded 3%, we only used 3% for the average calculation. As noted above, some carriers guarantee 3% while others follow the CPI, since that was the most a carrier would pay each year.
Our final calculation determines the number of years an insured will have to be on claim to receive equal total payments to someone without COLA who is also on claim. We assumed with each policy that benefits would be paid and ignored any differences in any other contractual provisions. We also did not take into consideration the time value of money that would make receiving the extra funds sooner much more valuable.
The chart above indicates the number of years a policyholder must be on claim for the total benefit received from the COLA policy to equal the total benefit received from the $5,000 per month policy without COLA, based on the average CPI of this century. Take note that if the average CPI is lower than 1.925%, equalization would take more time, and if the CPI average was higher, it would take less time.
The chart above illustrates how many years a policyholder would have to be disabled before a lower monthly benefit policy with COLA would equal a higher monthly benefit policy without COLA.
Since the premium expenditure is equal, each physician should determine if they want the additional benefits immediately upon claim or deferred in the future. Our claims experience points to higher benefits sooner when the shock of lower income is greater than later when an individual has had time to plan and adjust for lower income.
More information here:
Is a COLA Rider Worth the Cost?
Based on our research above, it is preferable to increase the monthly benefit in lieu of adding a COLA rider. This is especially true in times of higher inflation because the majority of companies cap COLA benefit increases at 3%. A higher monthly cap is available with some companies; however, this would increase the disparity between the COLA and non-COLA monthly benefit.
A superior allocation of premium in most circumstances is to obtain a higher monthly benefit and pay the same premium as a policy with a lower monthly benefit and COLA. There are some instances when it may be advisable to obtain the maximum monthly benefit available and add the COLA rider, such as when a physician is in the military and has limited monthly benefits in relation to income.
A physician can always remove the COLA rider in the future and increase the monthly benefit at that time.
Do you have a COLA rider on your disability insurance policy? Have you had to use it before? What was the experience like? Do you think the COLA rider was worth it? Comment below!
[Editor's Note: Andy Borgia is the co-founder of DI4MDS with over 40 years of experience specializing in life and disability coverage for physicians. As a Chartered Life Underwriter, he has advised countless residents, fellows, and medical professionals nationwide. Being independent from insurance companies allows Andy to prioritize his clients' interests. He enjoys family time and studying disability insurance, and he is an active triathlete, cyclist, and traveler. Andy is a member of the National Association of Insurance and Financial Advisors and the Society of Financial Service Professionals.
D.K. Unger is a highly experienced disability insurance specialist, possessing 10 years of expertise in analyzing disability insurance policies. Operating independently, he strives to identify optimal plans that strike a balance between affordability and comprehensiveness. His staunch advocacy helps ensure favorable underwriting decisions. Central to his business philosophy is the unwavering commitment to prioritize each client's needs.