With disability insurance, you can choose features on your policy that are kind of like upgrades on a car: you pay more than the base price to get a feature you want. With disability insurance, these features are called "riders".
The Cost of Living Adjustment ("COLA") rider on disability insurance adjusts your monthly benefit for inflation, but as with many financial matters, the devil is in the details.
COLA riders on disability policies function differently from how most people expect, including countless AboveBoard clients who had paid up for the feature on a policy bought elsewhere years ago before coming to us.
COLA is not necessarily a bad choice, but you really need to understand what you're getting by choosing to pay more for the feature.
How COLA Riders Usually Work
With most individual disability insurance policies, the adjustment does not begin until the 2nd year that you are actually on claim. That might not sound like a big deal, until you consider the fact that most people don't go on claim right after getting their policies.
Let's imagine you purchased a $10,000 / month benefit today, and received a cancer diagnosis in 10 years. Let's imagine you were unable to work for 2 years. With the vasty majority of COLA riders, you would get the the $10,000 / month for the first year, even though we're talking about 10 years from now.
If inflation had been pretty low (i.e. not eating away at your benefit too badly), 10 years from now you'd need a $12,190 / month benefit to feel like you're getting $10,000 of value today. So even though you'd bought the COLA, you'd feel like your benefit was nearly 20% short of what you'd thought you bought.
In the second year, you'd get one inflation adjustment. Most of the COLA riders follow CPI (Consumer Price Index). At 2% CPI, your benefit would be $10,200 / month in the second year.
When Would You Wish You Had COLA?
If you went on claim not too long after getting your policy and that claim was not the average claim of just under 3 years, but rather a very long-term disability claim, then you might wish you had a COLA rider. This experience is unusual, but if this is a scenario that you feel particularly concerned about or feel like you might be a bit more likely to have yourself (say you witnessed an aunt's experience and worry about facing something similar) then it may be worthwhile. But we usually find there are better strategies for managing this risk.
The Better Solution
Usually we find that the better solution is to simply buy a bit more benefit, to leave some room for inflation. This strategy is usually more cost-effective than the COLA.
We're always happy to run the analysis and let clients choose which feels like the best fit for their needs.