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Rethinking Disability Insurance

Catastrophic risk sharing

In my view, long-term disability insurance is a very valuable benefit that employers provide to their employees.  The loss of income that comes from disability can be disastrous for a worker and their dependents.  Also, LTD insurance sold on a group basis is often much less expensive than when purchased individually – and while the merits of group insurance is a discussion for another day it should be appreciated that employer sponsored LTD programs deliver great value.

A key principle of insurance is the principle of indemnity. That is, insurance is designed only to provide a benefit to an insured in an amount no greater than an actual loss. When designing LTD insurance, the insurer must consider how much of an injured or ill employee’s income needs to be replaced and for how long. Since employees would not be expected to work their entire lifetime, a cut-off date after which benefits cease to be paid must be chosen. Historically, this cut-off date for benefits has commonly been age 65.

The aging of society

It is no secret that Canada’s population is aging as it is in many developed nations globally.  Recent efforts by the government to increase immigration is at least in part an attempt to increase the number of working age people in Canada to slow the rate at which the population ages and maintain a productive workforce to support our seniors.

At the same time, the decline in popularity of defined benefit pension plans promising adequate retirement benefits and the ever-increasing cost of living, has increased the number of workers that need to work after age 65.  As a result, in recent years, some LTD insurance programs have evolved in some cases to provide an option to continue benefits for a fixed period, such as two or five years after age 65.  However, many LTD programs continue to discontinue both eligibility and the payment of benefits at age 65.

With the elimination of mandatory retirement in the 2000s, cases before courts, arbitrators and human rights tribunals have challenged the validity of ending LTD coverage at age 65.  To date, these challenges have failed because the labyrinth of charter, employment, and human rights laws in Canada carve out exemptions to allow for discrimination on the basis of age where there is ‘bona fide’ reason for doing so (bring in the actuaries).  It has been long argued that excluding workers over age 65 from group insurance plans was a necessity due to the rising costs of providing benefits to older workers.

Changing views and values

What was once seen as an unquestionable exemption to discriminate against workers past age 65, is now seen as a conditional exemption where justification must be provided.  In cases where the cost of health benefits are not materially greater after age 65 than before, precedent now suggests that excluding older workers is no longer acceptable.

In a new paper published by the Canadian Institute of Actuaries, authors Mathias Link and Joseph Nunes (yes, that’s me!) present support for continuing the current exemption that allows LTD benefits to cease at age 65.  In The Evolution of Employer Sponsored Long-Term Disability Plans the math is a little boring, but the result is that an LTD plan by design, needs an end-date for benefits tied to age.  If benefits were paid for a worker’s lifetime, then almost all workers would be over-insured, with the much higher cost of this benefit being passed along to workers one way or another.  If rather than age, a fixed period for paying benefits were used, then over or under-insurance would result depending on the age at which a worker became disabled.  These solutions to avoiding age-based discrimination are ineffective and so by necessity we return to age as the most useful metric to define insurance need.  My co-author, a lawyer, provides a roadmap for the laws and decisions on the matter which continue to support the use of age in defining benefits payable under an LTD program.

But permitting the use of age in determining when LTD benefits cease does not mean that the correct age is 65.  While most workers retire before or at age 65, there is a growing cohort of workers staying on past that age.  Therefore, there is an opportunity to revisit the cut-off age in LTD.

Correct answer

If you have read this far, you will sense that the sixty-four-thousand-dollar question is what age should replace age 65 as the cut-off age?  Unfortunately, it is not that easy.  Every workplace is different, and every group of workers have a different profile.  There is no one-size-fits-all solution and every employee group, union and non-union, will need to ‘negotiate’ the best arrangement for their circumstances.

In reaching agreement on plan design, there is also the thorny issue of how costs are shared between the employer and employees as well as among employees.  While some might wish to see LTD programs extended to age 70, no questions asked, one question that must be asked is how much extra should a 40-year-old pay for this new benefit they never had and might never need?  Some will say the 40-year-old should pay nothing – others will say ‘share the pain’ a little with everyone.  There is no right answer here – just choices and trade-offs.  Since most employers will want to transfer the risk to an insurer, it is also important that employers include their insurer in plan design discussions to ensure that any design change can be insured. 

The advice we offer in the paper, is for employers to reconsider if the current LTD plan meets the needs of the current and emerging workforce.  Change need not be feared, but it should be carefully considered.

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