What is Disability Insurance?

What is Disability Insurance?

Disability insurance could be more properly termed “income insurance”. It is coverage that provides a monthly cash benefit when you can’t work because of a covered injury or illness. It should not be confused with “workers compensation” which is required insurance for those injured on the job. If you injure yourself on the job you are not usually eligible for a disability claim as the injury is already covered by workers comp.

Receiving disability insurance benefits can help safeguard your way of life in the event your regular paycheck stops because you can’t work. It helps to avoid the problems created when your mortgage payment and other bills would otherwise not be paid because you were not bringing home a paycheck. Most insurers consider older workers over age 65 to be too high a risk and do not offer coverage for that age group. The cost is lower for younger workers because they are considered less injury and illness prone.

Disability insurance policies come with a wide array of options such as the following:

Automatic Increase Option

This option increases the insured’s monthly benefit annually for a specified number of years. The premium also goes up each year because of the additional coverage. Selecting this option helps increase the insured’s benefits along with inflation without having to remember to do it every year. This option would cost the insured a higher premium expense than a plan with static coverage.

Benefit Period

This identifies the maximum number of months during which the insured is eligible to collect benefits on a disability insurance claim. The benefit period starts after the “elimination period” has been completed. The elimination period is that period after you are sick or injured until you receive payments from your disability coverage. Benefits continue until you return to your job or the benefit period has been exceeded.

A policy is generally considered short term if the benefit period is 90-180 days. Long term policies pay benefits for two years or more or even until age 65 or for life.

The average duration of a disability lasting longer than 90 days is less than 5 years across all age groups. Accordingly, a popular option is to receive benefits for 5 years. Depending on your situation, upgrading a policy from 5 years coverage to coverage until 65 or for life may not involve a significant jump in premium.

Imagining Life With No Income

Nobody likes to imagine what life would be like if they were to become disabled. For example, someone who suddenly became disabled may have to foreclose on their house or declare bankruptcy because they became unable to pay their expenses.  The loss of income can be devastating financially. That’s why it is important when meeting with your financial planner that you learn about the best policy options for you.

Mr. Smith is an excellent example of this. He is 50 years old and is responsible for a wife and 2 kids. He also has a family history of cancer and is taking a medication to treat high cholesterol. He is concerned about paying for his family’s expenses if he was unable to work, and at his current age he sees himself as a higher than normal risk of needing disability benefits either due to an accident or illness.

Mr. Smith’s financial planner pointed out that Mr. Smith’s greatest risk is becoming disabled. According to a study by American Health Insurance Plans (AHIP), 1 out of 3 people will miss 90 days of work due to a disability. The financial planner also educated Mr. Smith on the differences in having private disability insurance compared to a typical policy through the workplace, and how difficult it can be for anyone to qualify for government paid disability benefits.

At the end of the meeting Mr. Smith learned that disability policy provided by an employer may cover less than 60% of the employee’s income because employers usually take the tax deduction for providing the employee benefit. When this happens the employee’s benefit becomes taxable, and the employee’s after-tax benefit is likely lower than 60% of the employee’s annual income. He also learned that it’s extremely difficult to be approved for social security or government paid disability benefits, and for those that do qualify they often do not get enough money to pay for their expenses.  Self employed individuals are those that are most in need of disability insurance because they are exposed to a complete loss of income. They may be aware of disability insurance but often procrastinate and purchasing a disability policy is something they are always thinking about but often never purchase for themselves.

There are long term plans that will insure someone up to age 67, and there are short term plans that will insure someone for 2 years, 5 years, or 10 years.  A typical disability plan will also include accidents and sickness, or you can purchase an accident and sickness only policy.  Some plans have an optional return of premium rider, critical illness rider, or cost of living adjustment rider.

Be aware that insurance companies place disability policy owners in different occupational classes. For example, an office manager who does primarily office administration is placed in a different occupation class than someone who works as an interior painter. Insurance companies have also improved on their underwriting guidelines so it’s easier now to qualify for disability insurance than it was before.  Some companies have even developed expressed underwritten disability plans that take as little as 48 hours to be approved after the company receives the application.

There are many different policy and rider options available in order to customize a disability income plan. This also means that there is a lot of complexity in designing your optimal plan. There is plenty of information on the internet but too much information can mislead and confuse someone who isn’t an insurance professional.  So be sure to seek out a disability insurance specialist who can help make your decision manageable and easy to understand. A disability specialist can explain your options and guide you to the best company for you.