Guardian Disability Insurance Brokerage

Cost of Living Adjustment Rider - COLA
Inflation Protection For Your Disability Insurance Policy
by Anthony Delvecchio

One of the options available to you when purchasing a disability insurance policy is a cost of living adjustment rider (COLA). If you ever became totally disabled, this is an optional rider that would help to ensure that inflation did not erode the value of your monthly benefit 20 years after the start of a claim. A COLA rider will adjust your monthly benefit every year you are on claim, and for a long term disability this is vital.

The biggest misconception of the most COLA riders is that the benefit increases every year the policy is in force, and this is not the case. Most COLA riders only adjust coverage when a policy holder goes on claim, and has been on claim for one full year. It is at this point the benefit increases, typically by 3%, for each year the insured remains disabled.

Let us assume you purchase a policy at the age of 33, your monthly benefit is $5,000 and you become disabled from an illness or injury 7 years after the policy goes into force. The benefit amount is still $5,000 per month to start during that first year of your disability at age 40. Once you have been on claim for one full year, with most COLA riders the benefit would increase to $5,150 every month for the next year you are on claim because of the 3% increase.

The second major misconception I have seen about COLA riders is that all the COLA riders act the same way with every company, and this is just not true. There is the “Simple” COLA and the “Compounded” COLA.

Simple 3% COLA
Increases your original monthly benefit amount 3%.
The benefit increase stays the same throughout the disability.

An example of this would be:

Presume you have again a $5000 month benefit. You become disabled for at least a year. Your new benefit amount after year 1 is $5,150. Under a simple 3% COLA rider your monthly benefit will increase each year by $150 each month at the second year or continuous disability. The monthly benefit for your third year of continuous disability would be $5,300. At year ten, your monthly benefit would be $6,500.

With a Compounded COLA your benefit increases 3% compounding. Here is how the compounded works:

Presume you have a $5,000 month benefit and you become disabled for at least a year. Your new benefit amount after year 1 is $5,150, the same as the simple COLA. In year 2, because the rider adjusts the monthly benefit on a compounded basis, your benefit amount would be $5,304. In year 10 presuming you remained continuously disabled you monthly benefit would be $6,719. If the disability continued for 15-20 years the difference becomes dramatic.

Another misconception is that a COLA rider is always necessary. This is not always the case. When purchasing a policy your age at the time and your benefit period should dictate the importance of this rider. If you are 55 years old, does it make sense to spend hundreds of dollars more in premium for a rider that might come into play for a few years? If you have a benefit period of two, five or ten years does it make sense to have this rider? Before you make a purchase ask your agent to explain to you how this rider works.

When buying disability insurance it is very important to know what you are buying. Please ask your agent to explain the policy to you and what each rider does. This way if you ever go on claim you are aware of what your policy is going to do for you and there are no surprises and to make sure you are not paying for something that really will not impact your policy. Please be advised that depending on the COLA rider and the rate of inflation, the COLA rider may not provide complete protection against increases in the cost of living.