Everyday investors tend to speculate on stocks based on the often ill-conceived notion that they have unique information or better information than the rest of the investment world. This perception of ‘asymmetric information’ is often the polar opposite of reality. In fact, institutional investors have an enormous information advantage over retail investors – one that it too great for retail investors to comprehend. The misguided perception makes it very profitable for institutional investors to trade against retail investors and, in turn, quite costly for retail investors to buy and sell stocks. Yet, individual investors continue to lose billions of dollars each year in a speculative game where the deck is stacked against them.
The opposite tends to be true in the insurance industry. While insurance companies seek to gather useful information about consumers and businesses in order to price risk appropriately, there can often be asymmetric information that favors the retail consumer.
Picture the individual who is careless with his cellphone – frequently dropping or losing it. His careless propensity provides asymmetric information – the knowledge that he’s more likely to benefit from cell phone warranty plans than the general public. Insurance companies price risk based on the expectation that people like this careless cell phone user are more likely to purchase insurance than those who take care of their cell phones. Yet there is still the occasional opportunity for consumers to use information asymmetry to their advantage when considering insurance.
Pregnancy and Voluntary Short-Term Disability (VTSD) Insurance
We almost always advise that voluntary short-term disability insurance (VTSD) is an unnecessary and wasteful form of insurance – similar to other wasteful insurance types like accidental death and dismemberment or rental car insurance. The reason, as we explain here, is that insurance should be used to protect against financial catastrophe and nothing more. For families that have set aside an emergency reserve and planned well, losing pay for a few weeks because of a short-term disability is not a financial catastrophe.
However, women planning to conceive a child in the near future can use information asymmetry to their advantage by considering the purchase of an employer-provided VTSD policy. This is true because nearly all voluntary short-term disability policies purchased through an employer include maternity leave following “normal” childbirth. These plans generally cover between 50-100% of salary for 6-8 weeks of maternity leave. (Alternatively, VTSD purchased directly from an insurance company (not employer-provided) do not treat normal child birth as a triggering event for paid benefits – only pregnancy complications that occur prior to delivery and never maternity leave.)
When Can Voluntary Short-Term Disability Insurance be a Useful Purchase?
Women who meet the following conditions tend to be good candidates for voluntary short-term disability insurance:
- Working before planned pregnancy and intends to return to work following postpartum absence;
- Employer is among the 84% of US employers that does not provide paid maternity leave and the family does not reside in one of the few states like New Jersey or California that mandates paid maternity leave (full list of states here); and
- Employer offers the ability to purchase VTSD.
The reason for the second bullet point is that women who already get paid maternity leave coverage from their employer do not get any maternity leave benefit from VTSD insurance. It is also important to note that individuals should not wait until right before or immediately after conception to buy the insurance as policies will not cover pre-existing conditions (such as pregnancy) and most will exclude benefits for normal childbirth if delivery occurs within 9-10 months after the start of coverage.
What is the Financial Benefit of Voluntary Short-Term Disability Insurance?
If these conditions are met, the decision to purchase or not purchase VTSD becomes one of economics and probabilities. Consider the calculation from a recent client experience:
- The individual could purchase a VTSD insurance policy through her employer with a monthly disability benefit of $5,000.
- There was a bi-weekly cost of $24.50 (via payroll deduction) which translates to an annual cost of $637 ($24.50 x 26).
- The individual effectively has to purchase VTSD for two consecutive calendar years to have coverage in place before conception and following delivery (although it is obviously possible that conception and maternity leave could fall in the same calendar year which would improve the economics below). The total cost for two years is $1,274.
- The maternity leave benefit for a normal delivery pays for 2 months following 20 day waiting period. This translates to a total pre-tax benefit of $10,000.
- If we assume this individual pays a marginal tax rate of 30%, she would receive an after-tax benefit of $7,000 compared to a total insurance cost of $1,274.
- This all means that if there is >18.2% chance (1,274 / 7,000) that the woman becomes pregnant and delivers a child during this two-year period, purchasing the VTSD insurance would be a financially beneficial decision (this ignores some nuances like the possibility that the individual loses her job before the pregnancy).
We find that most people are not aware that voluntary short-term disability insurance covers normal child birth and can pay benefits that turn what would otherwise be unpaid maternity leave into paid leave. As a result, individuals often fail to sign up for this coverage during the open enrollment period.
In our experience, women who are considering pregnancy and meet the short list of conditions above will significantly benefit from purchasing voluntary short-term disability insurance. Our math demonstrates the benefit of a specific scenario but it almost always works out to be similarly advantageous.
This is a unique situation where individuals are not necessarily buying insurance because they need it to protect from financial catastrophe but, alternatively, because the insurance provides an attractive opportunity to take advantage of favorable asymmetric information.