Disability Insurance: The Basics
by Richard F. O’Boyle, Jr. LUTCF, MBA
by Richard F. O’Boyle, Jr. LUTCF, MBA
Disability insurance, also called “disability income protection” or “disability income insurance,” is designed to pay you a monthly income in the event that you can’t work due to physical or mental incapacity.
Disability insurance can be one of the most difficult policies to understand, which makes it especially aggravating since most people who need it the most can be turned off by its perceived complexity. It’s advisable to thoroughly understand your disability insurance policy prior to receiving it, so that if you were to become ill or get into an accident, you will know exactly what is and is not covered. For those who find themselves overwhelmed, start by understanding just the basics. Any more intricate questions should always be discussed with a licensed insurance representative.
à If you are in New York New York
à If you are currently exploring your need for disability insurance, you are welcome to download our free Disability Insurance Worksheet to help you better assess how much coverage you might need.
Definitions of Disability
How “disability” is defined is really the crux of why this type of coverage is so valuable to individuals and their families. It is also what creates a lot of distrust on the part of individuals and insurers alike. It’s crucial to discuss the actual definition of “disability” with your advisor at the time of application and again when your policy has been approved. Don’t wait until you are sick or injured. There are three possible definitions for disability:
1. Own Occupation Definition: The priciest of the bunch, the own occupation definition is usually only held by professionals and many jobs do not qualify for such a coverage plan. What the system basically dictates is that when someone has an own occupation definition, they can still receive disability benefits even if they have found a job elsewhere. What the insurance is based upon is the inability to complete tasks at a particular job, regardless of whether you have another profession you may continue with. The own occupation standard may change if you are still disabled after two years, and you might be required to work at an occupation that provides you with a percentage of your previous income.
2. Regular Occupation Definition: With the regular occupation or “modified own occupation” definition, you can’t be coerced or pressured into finding a different field to work in. If you can’t carry out your job responsibilities for your current occupation, then you should expect to receive total disability nonetheless. This is the most popular out of the disability insurance options, and allows people who have become sick or injured to still live out their dreams rather than just grasping for a job or money for the disability insurance anywhere they can look.
3. Any Occupation Definition: Finally, the strictest of the three policies is the any occupation definition. This is a rigidly issued policy because it deals with the idea that an individual is unable to successfully work in any occupation any longer. This happens often with older people, though people of any age may qualify. Situations that may warrant an any occupation definition include a serious accident, terminal or chronic sickness or severe mental illness.
Short Term Disability Insurance
There are two different types of disability insurance – short term and long term. Just as their names suggest, short term disability coverage provides a benefit that starts soon after you get sick or hurt, but is limited in duration. A long term disability policy may only kick in if your condition is more severe, but it carries the recipient further down the road.
Short term disability is usually processed within two weeks once an injury or illness has been reported. The benefit period typically lasts between 13 and 26 weeks, while this can vary depending upon the individual plan in question. Depending upon whom you work for at the time of your need for disability insurance benefits, your employer may authorize 100% salary replacement. It completely depends on the state you live in and who you work for.
In many instances, short term disability costs are covered by the employer, and then the benefits are taxable to the employee. Short term disability is great to have if you find yourself in a sudden accident or overcoming an unexpected serious illness. Most businesses will offer short term disability as part of the job, and you may receive a packet of information on it during your first day visit to human resources. Some companies sponsor private plans such as AFLAC through the jobsite which allow the employee to pay for the coverage themselves.
Long Term Disability Insurance
Since disability in the long term sense is more complex and open to risks like fraud, the process is lengthier. It usually takes between 60 and 180 days before you can receive a payment, with the most common time frame being around 90 days. Your employer may pay your premium of up to 70% of your pre-tax income, but some premiums must be paid by the employee. Most long-term disability insurance plans are privately paid for.
Group Disability Insurance
Group plans are cheaper for everyone involved, and usually do not require a medical exam. The company is always the policy owner in the instance of a group plan, and the individual may lose the policy if they lose their job. With an individual plan, there is more flexibility since you are the owner of the policy. Many companies offer some form of short term and long term disability insurance. It is sometimes the most cost effective way to ensure you will have appropriate financial support in the event of accident or illness. Keep in mind that if the employer is paying your insurance premiums, the benefit paid to you will probably be taxable as income, reducing its value.
How to Choose an Individual Disability Insurance Policy
Buying private disability insurance generally will give you more freedom to customize the plans features and enhance the income payment amount. Begin by selecting an insurance agent who has experience with disability insurance. The agent can help you “run the numbers” to see how much coverage is appropriate and which companies offer the most competitive plans. Keep in mind that when selecting a company, the lowest monthly premium is only part of the choice: find a company with a solid financial background and claims paying history. Always look for a policy that is guaranteed renewable and non-cancelable.
Choose a Monthly Benefit Amount: Use the Disability Income Insurance Worksheet to find an approximate range of monthly benefit that you should insure yourself for. Generally, an insurance company will allow a maximum amount of coverage of up to 60% of your recent earned income. Earned income for most professionals is income reported on your tax return from W-2 or 1099 sources.
Choose an Elimination or Waiting Period: Your monthly benefit payment usually does not kick in right away. Assess your “rainy day” savings to see how long you can cover your own expenses before you need the insurance company to start paying you. The longer the waiting period, the lower the monthly premium payment. Typical waiting periods are 60, 90, 180 and 360 days.
Choose the Benefit Period: The benefit period is the duration that the insurance company will pay you. You may select a period of 2, 3, 4 or 5 years; or else a benefit period up to age 65 or 67. The longer the benefit period, the higher the monthly premium payment. Some clients tie their benefit period to an expectation that they will qualify for federal Social Security Disability Income payments after two years. Lengthier benefit periods cover catastrophic conditions.
Choose Optional Riders and Supplemental Benefits: Private disability insurance allows you to enhance your policy with additional benefits. Most companies offer each of these riders in some form. Specifics will vary greatly from company to company.
- Waiver of Premium Rider: While you are on claim, you will not have to pay the monthly premium
- Cost of Living Adjustment Rider: Each year that you are on claim, the monthly benefit amount will increase
- Catastrophic Disability Rider: Your monthly benefit is increased dramatically if you become permanently and profoundly disabled.
- Future Increase Rider: Each year you can increase your monthly benefit amount (with a corresponding increase in the monthly premium) without a medical exam.
- Residual Disability Rider: If you are able to return to work following a disability claim, but are not functioning at 100% of your capacity, you will continue to receive a portion of your benefit payment.
- Retirement Income Protection Rider: A trust is established and the insurance company funds it with cash to serve as a supplemental retirement account, assuming that you had an active retirement plan at the time the policy is approved.
- Long-Term Care Insurance Conversion: When you reach age 65 or 67 you can convert your disability insurance plan (which would normally expire) into a Long-Term Care Insurance plan without a medical exam.
- Waiver of Premium Rider: While you are on claim, you will not have to pay the monthly premium
- Cost of Living Adjustment Rider: Each year that you are on claim, the monthly benefit amount will increase
- Catastrophic Disability Rider: Your monthly benefit is increased dramatically if you become permanently and profoundly disabled.
- Future Increase Rider: Each year you can increase your monthly benefit amount (with a corresponding increase in the monthly premium) without a medical exam.
- Residual Disability Rider: If you are able to return to work following a disability claim, but are not functioning at 100% of your capacity, you will continue to receive a portion of your benefit payment.
- Retirement Income Protection Rider: A trust is established and the insurance company funds it with cash to serve as a supplemental retirement account, assuming that you had an active retirement plan at the time the policy is approved.
- Long-Term Care Insurance Conversion: When you reach age 65 or 67 you can convert your disability insurance plan (which would normally expire) into a Long-Term Care Insurance plan without a medical exam.
Underwriting Guidelines for Disability Insurance
Qualifying for a disability insurance policy requires a somewhat different application process compared to life insurance or long-term care insurance. In addition to standard medical underwriting, underwriters will ask questions about your occupation and financial history. Not all riders are available to all applicants.
Medical Underwriting: Disability insurance providers are looking for the likelihood not that you will die (mortality), so much as the likelihood that you will become incapacitated (morbidity). While a condition like arthritis might not impact your life insurance application, it would likely impact your chances of getting a cost-effective disability plan. Medical underwriting includes asking detailed medical questions, collecting copies of doctor records and running new blood. After analyzing your medical state, the insurer may offer you a policy, but exclude coverage for certain preexisting medical conditions, tag on an extra premium for a period of time or limit the inclusion of certain riders.
Financial Underwriting: Your “insurable income” may not be what you consider to be your actual income since the insurance company focuses on what you are actually “earning” in a given year. “Earned income” is your compensation. “Unearned income” is generally cash flow that would continue whether or not you were working, such as rental income, royalties, pensions, dividends and alimony. You will be required to submit your most recent tax filings as part of the overall application to justify the maximum benefit amount.
Occupational Underwriting: Jobs are ranked and rated according to how hazardous they are. The occupational rating also includes the actual duties performed in the job, size of the organization, level of education, moral hazard, time spent traveling, and other factors. For most policies, a minimum of 30 hours per week are required to be considered full-time. Home-based businesses generally are also acceptable occupational classes.
Making a Claim to Receive Disability Insurance Payments
Ultimately receiving disability insurance benefit payments from the insurance company hinges on which definition of disability is specified in your policy. This is where most people get turned off by insurance companies, in my opinion and experience. It is absolutely crucial to have a frank discussion with your agent at the time you are applying for the policy so that you understand what “disability” actually means. If you do meet the criteria and are working with a reputable company, the payments can mean the difference between financial stability and ruin for you and your family.
Remember that some disability payments to you may be taxable, depending on who paid the premiums: if your employer paid for part of your group coverage, then that portion will be considered taxable income. If you paid for the premiums out of your own pocket, then you can expect the benefit payments will not be taxable. This is a tricky area and often misunderstood, so please consult your advisor.
If your disability is not presumed to be permanent, the insurance company will expect you to have regular check-ups with an approved doctor, and perhaps even receive specific treatments or surgery to improve your condition. The company may also give you financial incentives to ease back to work part-time. In the event that you are seriously disabled and qualify for federal Social Security Disability Income payments, the insurer may reduce their payment to you according to the terms of your policy.
à If you are in New York New York
à If you are currently exploring your need for disability insurance, you are welcome to download our free disability insurance worksheet to help you better assess how much coverage you might need.
