Disability costs: The rocky road ahead

If you ask many plan sponsors and/or group insurers, disability plan costs are increasing at concerning rates. Disability plan costs tend to be somewhat variable—always have—but are we experiencing a fundamental change in the nature of the risk? What is the road ahead for disability plan costs?

I am of the opinion that the risk profile related to disability has indeed changed—and to quote that Bachman-Turner Overdrive song, “You Ain’t Seen Nothin’ Yet.” The road ahead will be rocky and full of potholes.

First of all, let’s confirm where we are at today. Ask most benefits plan sponsors to name their biggest single benefits cost and the answer is likely to be extended health plan costs—more specifically, drugs. For many plans, this cost averages around 2% of payroll.

However, if you add up the various program costs focused on disability and absence—such as worker compensation, sick leave, salary continuance, short- and long-term disability (LTD)—these costs combined are likely to be the biggest cost item. These costs average between 2.5% and 3% of payroll. And these figures are understated as they do not factor in the cost of presenteeism, the cost of replacement workers, lost productivity, etc. So disability may already be costing more than you realize.

And the road ahead—what does that look like? The following factors have an impact on disability plan costs:

  • Demographics — Both the incidence and duration of disability increase with age and our population is aging.
  • Mental health — Claims related to mental illness are increasing significantly. Under most disability programs, mental illness is the number one cause of disability. For most insurers, mental health-related disability claims represent upwards of 30% of total claims submitted and climbing. Mental health-related claims are extremely difficult to manage, challenging the resources of plan sponsors and insurers alike.
  • Chronic disease — We are not a particularly healthy society with staggering rates of chronic illness. Drug therapy can be helpful in managing many chronic diseases for long periods of time. However, eventually some of these individuals will wind up on disability.
  • Healthcare access — In Canada, the challenges related to access to healthcare are well documented. Wait times for appropriate care—particularly in accessing specialists—are longer than most would deem acceptable. And unless governments can somehow free up additional funds to improve access to care—which seems unlikely—the situation is not likely to improve. The medical community is critical to the proactive management of disability claims. Long wait times translate into longer claims durations, which further translate into higher plan costs.
  • Low interest rates — Low interest rates are generally considered to be a good thing—just not for insured disability programs. A significant portion of the plan cost is for reserves—reserves established to fund future claim obligations. These reserves are highly interest rate sensitive; the lower the interest rate, the higher the reserve. Our relatively low rate interest environment is putting upward pressure on the cost of disability.
  • The legal environment — More and more claim adjudication decisions are being grieved or litigated; this adds costs to the overall system. Challenging disability adjudication decisions is becoming bigger business.
  • Stigma — In the past, the stigma associated with missing work due to a disability caused many people to suffer in silence. For some, the stigma still exists particularly as it relates to mental health issues however the impact feels far less significant. This is not a bad thing—no one should be placed in a position of not getting the help they need because of what others might think. However, the consequence for disability programs is that more people are claiming for disability benefits.

There seems to be little reason to expect that these factors will change in the foreseeable future. In fact, there is very little good news on the horizon. This is why I submit that the risk profile associated with disability has fundamentally changed and that we should expect that disability plan costs will continue to increase.

As a benefit plan sponsor, you have options. One option is to simply pay the related cost of disability and view it as an investment (in the health of your employees) versus a cost. I am a huge proponent of viewing benefits as an investment versus a cost so this resonates with me to a degree. I also believe a plan sponsor can and should proactively manage their disability programs—for the benefit of those on disability (recovery if possible) and to maximize their return on investment in these plans. And simply paying the higher cost of disability is obviously more problematic in situations where the benefit is fully funded by the individual.

Another option to be considered is to address the root causes of employee health—to prevent disabilities before they happen—and to proactively manage them when they do. A comprehensive organizational health strategy with programs focused on health, wellness, injury prevention and proactive disability management should arguably be the first line of defence against increasing plan costs.

Benefit plan design is another consideration in reducing future plan costs. The reality is that disability plan design has changed very little over the years other than to find ways to enhance coverage. This does not make sense (to me) within the context of a changing risk profile and higher costs. We need to challenge our thinking in this area. So to stimulate the conversation, the following are some ideas for consideration:

  • Reduction of the benefit formula—The goal should be to provide for adequate income replacement while on disability. Many disability programs provide for relatively high levels of income replacement that may in fact be a disincentive to return to work. How much is enough?
  • Change in definition of disability—It is fairly common to pay disability benefits opposite an “own occupation” definition of disability for a period of time—generally 24 months (for LTD)—after which the definition of disability switches to an “any occupation” definition of disability. Is there any magic to 24 months? Not that I am aware of, it has just evolved. Whereas it might be difficult to go against the grain, there is nothing prohibiting a plan sponsor from adopting a more restrictive definition of disability.
  • Reduction in maximum benefit period—Most LTD benefit plans pay benefits to age 65 (and in some cases to age 70). Why age 65? It corresponds to the expected working career of an individual and when these products were originally developed there was a strong probability that an individual would work their entire career with one employer. This basic premise obviously no longer exists, which begs the question: Why should an employer be expected to fund a benefit to age 65 when the individual has very little intention of spending their entire working career with that employer? From a pure risk management perspective there is a disconnect. Perhaps disability benefits should be funded by the employee (although this does not address the rising cost issue); alternatively the maximum benefit period should perhaps be realigned to reflect the practical realities of today’s workforce. I realize there is a flaw in this latter suggestion: “What happens when disability benefits run out?” Still, the question remains: Is that an employer obligation, an individual obligation or a societal obligation?

The road ahead for disability costs looks fairly stormy. Plan costs are likely to continue to increase, potentially significantly. Plan sponsors have options—pay the cost and/or proactively address the cost drivers to mitigate future cost increases. And a third option (which may be less palatable) is to look at plan design. Disability plan design has changed little over the years and if you believe that the disability risk profile has changed fundamentally—as do I—it is only practical and pragmatic to ask the question: Why is status quo appropriate?