Disability Answers
If
I cannot afford to buy both life insurance and disability insurance,
which coverage should I buy?
Both life insurance and
disability insurance are important and vital to the financial security
of most individuals. In some instances, however, financial resources
are inadequate to purchase the needed amounts of both types of insurance.
Generally speaking, throughout the typical working lifetime (e.g.,
ages 20-65), the probability of an individual suffering a major
disability (e.g., a disability lasting 3 months or longer) is considerably
greater that the likelihood of dying. The probability of a young
worker suffering a major disability is as much as 6 (or more) times
the probability of dying; the multiple is still 2 or more even at
the higher working ages. These relative probabilities would suggest
that the purchase of disability income insurance is a more important
purchase than is the purchase of life insurance. Another factor
supporting this view is that, in the case of disability, total expenses
of the family unit will also be higher due to the costs of caring
for the disabled worker.
How much disability insurance should I
own?
The recommended amount
of disability income insurance generally ranges from 60-70 percent
of pretax income. The applicable percentage for higher-income persons
is usually somewhat lower than the percentage recommended for lower-income
individuals, due primarily to differences in income taxes. Amounts
considerably less than full replacement of earnings are recommended
due to a reduction in income taxes and decreases in commuting and
other work-related costs that are likely to occur in the event of
disability. On the other hand, medical, rehabilitation and certain
other expenses are often higher for disabled individuals creating
a need for larger amounts of replacement income. In determining
how much disability income insurance to buy, any benefits payable
under Workers' Compensation, Social Security, and employer-provided
disability benefits under pension or group insurance plans should
also be considered. Whether the disability benefits themselves are
subject to income taxation should also be factored into this determination.
The assistance of a professional insurance adviser normally should
be sought in making this determination.
What type of disability income insurance
is best; insurance covering short-term disabilities only or policies
that cover long-term disabilities?
Assuming that only one
of these types of disability insurance products will be purchased,
sound risk management principles would suggest the purchase of long-term
disability (LTD) insurance. LTD insurance protects the insured
against disabilities that may last many years, or even a lifetime,
and thus provides protection against large losses of potentially
catastrophic magnitude. Although long-term disabilities occur less
frequently than disabilities of a relatively short duration (e.g.,
several weeks or even a few months), the loss of income for a short
duration can be more easily absorbed by the family unit than can
an income loss that lasts for several years or longer.
What are the primary differences between
short-term disability (STD) and long-term disability (LTD) insurance
policies?
These two types of insurance
coverage differ most importantly in terms of the length of the elimination
(waiting) period, the length of the maximum benefit period, coordination
of the benefits payable under the policy with benefits payable under
social insurance programs (e.g., Social Security and Workers' Compensation),
and the "definition of disability" incorporated into the
contract language.
What is an elimination, or waiting, period
and how does its definition differ between STD and LTD insurance
policies?
The elimination, or waiting,
period in disability insurance refers to the length of time between
the onset of a qualifying disability and the point in time when
benefits under the disability insurance policy first become payable.
In STD plans, waiting periods may range from 0 days to 3, 7, 10
or 14 days, depending on the specific insurance policy and the cause
of disability. Disabilities resulting from accidents often are subject
to shorter elimination periods (e.g., 3 or 7 days) than are disabilities
caused by sickness. In LTD plans, elimination periods generally
range from 3 to 6 months, or longer, for disabilities arising from
both accidents and illnesses.
What is a maximum benefit period and how
does its definition differ between STD and LTD insurance policies?
The maximum benefit period
in disability income insurance refers to the maximum length of time
during which benefits will be payable to an insured with an ongoing,
qualifying disability. By definition, STD insurance policies are
those policies whose maximum benefit period does not exceed two
years (24 months) in length. Typically, however, STD insurance provides
coverage for benefit periods lasting a maximum of 13 or 26 weeks.
In contrast, LTD insurance policies typically provide benefits (contingent
on continued disability, of course) for as long as 5 years, to age
65 or 70, or even lifetime.
What types of "definitions of disability"
are commonly included in STD and LTD insurance policies?
Some disability income
insurance contracts provide coverage only for "total and permanent"
disabilities. Others provide coverage for "total and permanent"
disabilities, "partial disabilities," and "temporary"
disabilities. Some policies providing "partial" disability
coverage require that the "partial" disability be proceeded
by a period of "total" disability. Since these terms are
often confusing, with their definitions differing somewhat from
one policy to the next, it is recommended that insureds discuss
this issue at length with their insurance adviser.
In addition to coverage of partial or
total disabilities and temporary or permanent disabilities, what
other aspects of a "definition of disability" are important
to consider when purchasing disability income insurance?
The way in which a disability
is defined, especially as it relates to the inability of the insured
to perform a particular occupation, is exceedingly important. Several
insurers market policies that define total disability in terms of
the inability of the insured to perform the usual and customary
duties of his or her "own occupation"--the job
the insured was doing at the time of the injury or onset of sickness.
Other policies define total disability in terms of the inability
to perform the regular duties of "any occupation."
"Any occupation" is often defined as a job for which the
insured has the necessary skills and training and, possibly, at
a salary commensurate with the one in which the insured was employed
at the time of the incident. The "own occupation" definition
is more liberal to the insured and is frequently recommended over
an "any occupation" definition. Sometimes a "split
definition" is used which incorporates an "own occupation"
definition for an initial period (e.g., 2 years), followed by an
"any occupation" definition thereafter.
Are disability insurance policies available
that do not express the eligibility for disability benefits in terms
of an "occupational" definition?
Some insurers market
disability insurance policies that define disability not in terms
of a particular occupation, but rather simply in terms of the amount
of income actually lost. Under these contracts, if an insurable
event occurs such as an accident or illness, then disability benefits
are payable to the extent that the insured suffers a loss of income
that exceeds a threshold amount, e.g., a loss of 20 percent or more
of the individual's earnings prior to the happening of the insured
event. When the threshold amount is exceeded, the policy pays a
benefit that is based on the percentage of total "prior earnings"
lost due to the disability.
Do all disability insurance policies
cover losses arising from both accident and sickness?
No. Some policies cover
only disabilities arising from an accidental injury, providing no
coverage for disabilities caused by sickness. A careful reading
of the contract is recommended to determine the extent of coverage
provided under the disability insurance policy that you are considering
purchasing. Sound risk management suggests the purchase of a policy
that covers disabilities arising from either an accident or an illness.
What specific causes of disability, if
any, are generally excluded from coverage in disability insurance
contracts?
Generally, injuries that
are intentionally self-inflicted or caused by war or an act of war
are excluded. Disability policies may also include a "preexisting
conditions" exclusion whose purpose is to exclude from coverage,
during an initial period (e.g., the first one or two policy years),
a disability arising from an undisclosed health condition that was
both present within a prescribed time period prior to policy issuance
and required medical treatment or otherwise caused symptoms that
normally would require medical care. Through the "military
suspense provision," coverage under a disability insurance
policy is suspended during any period that the insured is on active
duty in the military.
The terms "noncancelable" and
"guaranteed renewable" are often used when referring to
disability income insurance policies. What do these terms imply,
and how do they differ?
"Noncancelable" policies provide insureds with the
right to renew their policies each year, typically to age 65, by
the timely payment of the required premium. A guaranteed premium
is stipulated in the contract and may not be changed by the insurer.
During the noncancelable period, the insurer is precluded from canceling
the contract or otherwise making any unilateral change in the policy
benefits. "Guaranteed renewable" contracts also
provide insureds with the right to renew their policies to age 65
(typically) through the timely payment of the premium. However,
under "guaranteed renewable" policies, the insurer retains
the right to change premiums if it does so for all insureds in the
same rating class. The insurer is not permitted to cancel the policy
or unilaterally amend the policy benefits during the period that
the policy is guaranteed renewable. Further, under both types of
contracts, the insurer is not permitted to increase the premiums,
on a selective basis, only for those insureds whose health status
has deteriorated. Because of the premium guarantee feature, "noncancelable"
policies may be somewhat more expensive than "guaranteed renewable"
policies. In general, disability policies containing a "guaranteed
renewable" or a "noncancelable" feature provide better
protection to an insured, albeit possibly at a higher cost, than
do "conditionally renewable" or other similar types of
disability insurance policies that give the insurer a right to refuse
to renew coverage for reasons stated in the policy (and typically
also give the insurer the right to increase premiums and change
benefits so long as these changes apply to all insureds in the same
class).
What factors affect the premium cost
for disability income insurance?
A number of contract
features and options affect the premium cost for disability income
insurance. Several of the more important factors are (1) the amount
of weekly or monthly benefit purchased, (2) the length of the elimination
(waiting) period, (3) the length of the maximum benefit period,
(4) whether or not the disability insurance benefits are coordinated
with social insurance benefits, (5) the occupational class of the
insured, (6) the definition of disability, and (7) whether the policy
is noncancelable or guaranteed renewable.
How do the lengths of the waiting (elimination)
period and the maximum benefit period affect the premium cost of
disability insurance?
The elimination (waiting)
period in disability income insurance serves the same purpose as
a deductible in medical expense, automobile and other types of insurance.
It eliminates initial, or "first-dollar," benefits from
coverage under the insurance policy. As such, longer waiting periods
result in lower premiums. There is a similar, but opposite, relationship
between varying maximum benefit periods and the premium cost for
disability income insurance. As the length of the maximum benefit
period increases, total premium cost also increases. When limited
dollars are available to purchase disability income insurance, it
is generally recommended that longer waiting periods be selected
so that longer maximum benefit periods can be afforded. Of course,
the amount of cash reserves available to the insured as a "safety
net" should also be factored into the determination of the
length of the waiting period that is selected.
Why is it frequently true that group
long term disability (LTD) insurance purchased at work is less expensive
than individually purchased LTD insurance?
There are a number of
reasons why group LTD may be purchased by employees at a lower premium
cost than what these same individuals can purchase on their own,
away from their place of employment. First, an employer often contributes
toward the premium cost of group LTD coverage, thereby reducing
the out-of-pocket cost to employees. Secondly, group LTD plans almost
always coordinate their benefits (i.e., plan benefits are reduced)
with any disability benefits payable under Workers' Compensation
or Social Security. In contrast, individual disability income insurance
typically pays benefits in addition to any benefits payable under
social insurance programs. Third, individual policies often contain
a longer maximum benefit period, a "noncancelable" feature,
a "cost-of-living" benefit rider, and an option to purchase
additional insurance--expensive features not always found in group
LTD policies. Fourth, marketing and sales, administrative, underwriting
and other expenses are usually lower for employer-provided group
insurance than for insurance purchased individually from an agent.
What is the federal income tax treatment
surrounding benefits received from a disability insurance policy?
The answer to this question
depends on who paid the insurance premiums. If the insured paid
the premiums with after-tax dollars, then the disability benefits
should be received income tax-free. In contrast, if an employer
paid part or all of the premiums then an equivalent portion of the
benefits are generally taxable to the insured (in this instance,
however, an income tax credit may be available to the insured).
In any event, your tax adviser should be consulted with respect
to the probable income tax treatment of any disability income coverage
that you currently have or are contemplating purchasing.
Where can more information on disability
insurance be obtained?
A free copy of the Consumer's
Guide to Disability Insurance can be obtained from the Health
Insurance Association of America, 555 13th Street N.W., Suite 600
East, Washington, D.C. 20004-1109.
These questions and answers are provided for users' general information.
Although we make every effort to insure accuracy in the information
provided, we cannot make any guarantees as to this accuracy. We
urge you to consult your lawyer, accountant or tax advisor for specific
legal or tax advice.
