Frequently Asked Questions - Disability Insurance

Disability insurance is an income protection policy that pays a monthly benefit to the policy owner in the event of an accident or sickness to help replace lost earnings. There are two main types of coverage: short term disability (STD) coverage, often provided as part of an employee benefits package to provide for the early part of a disability; and long term disability (LTD) coverage, which may be part of an employee benefits package or purchased individually, and which helps to replace income for an extended period of time.

This will vary from policy to policy. Some policies contracts provide coverage only for “total and permanent” disabilities; others, for “partial;” and yet others, for “temporary” disabilities.

This definition will vary from policy to policy as well. A policy may cover the inability to perform the usual and customary duties of the insured’s “own occupation,” or what the insured was doing at the time of the disability. Others will define total disability as the inability to perform the duties of any occupation; and yet others may define the disability in terms of the lost income.

Some policies cover only accidental injury, and do not cover illness. Others protect loss of income due to injury or sickness, and may provide benefits for disabilities due to complications of pregnancy or childbirth. In some circumstances, a person may be presumed to be totally disabled whether or not he or she is able to work or whether he or she is under a physician’s care, as when a person has lost the use of his or her sight or hearing, or the use of both hands, for example, and in other circumstances as specified in the policy.

Generally, pre-existing conditions will be excluded, as well as disabilities caused by any act or accident of war, or disabilities during periods of time during which the insured is incarcerated. Policies vary as well, excluding self-inflicted injuries and some injuries caused by substance abuse. Disability as part of normal pregnancy and childbirth is generally excluded, although complications arising from pregnancy and childbirth may be covered. It is important to check individual policy provisions. Some policies are guaranteed standard issue, which means the insurance carrier will provide coverage regardless of any pre-existing medical condition.

Employer programs will of course vary by employer; one should check with one’s employee benefits handbook for detailed coverage information. Employers pay for worker’s compensation coverage for their employees for work-related injuries, and these benefits are determined as a percentage of the employee’s wages. Such policies do not cover injuries or sicknesses occurring outside the workplace. More than half of the 19 million annual accidents occur off the job.1 Social security benefits are paid to “totally and permanently disabled” employees, based on a series of variables.  The disability must be anticipated to last for 12 months or to result in death.2 The benefits, if and when approved, will replace only a small portion of income: the average monthly total family benefit for a family of four where the spouse is under 65 is $1256;3 the average disabled worker benefit in April 2000 was a princely $755.4 There is a five-month waiting period, and benefits are reduced by worker’s compensation and other government benefits if available. Only five states (California, Hawaii, New Jersey, New York, and Rhode Island) and the Commonwealth of Puerto Rico have state disability programs, and even these provide only minimal benefits short term benefits: for a maximum of 26 weeks in Hawaii, New Jersey, New York, and Puerto Rico; 30 weeks in Rhode Island; and 52 weeks in California. Most people’s savings will not cover six months of usual expenses, so that a family’s entire savings could be depleted before Social Security Disability Insurance begins to pay.5

1 National Safety Council, Accident Facts Edition 1998
2 Social Security Administration publication: U.S. Government brochure “Social Security. Disability Benefits” 9/99. Internet. June 26, 2000. Available: http://www.ssa.gov/top10.html
3 Fact Sheet on the Old-Age, Survivors, and Disability Insurance Program, December 31, 1999; Social Security Administration. Internet. June 26, 2000. Available: http://www.ssa.gov/OACT/FACTS/fs1999_12.html. See also Office of Policy Publications, Social Security Administration, “Annual Statistical Supplement, 2000; Table 5.H3. Internet. June 26, 2000. Available: http://www.ssa.gov/statistics/Supplement/2000/pdf/index.html
4 The Office of Policy; Social Security Administration. Internet. June 28, 2000. Available: http://www.ssa.gov/policy/programs/ssd.html.
5 Business Almanac

 

It is important to remember that most group employer plans will not provide benefits for 100% of the employee’s earnings, and these plans generally protect salary only, excluding incentive earnings and bonuses in determining employee income. The benefits received will also be coordinated with benefits from other sources such as government programs, so that the insured receives no more than some percentage of his or her usual income up to a stated ceiling, and generally for a limited period of time.  Such plans are likely to leave vastly underinsured the high income earner and those who earn a substantial amount of their annual income through performance or other incentives. Individual disability insurance is designed to supplement or “wrap around” such programs, to increase the benefits received to approximate more closely the usual net income of the insured person. Individual disability policies will also include incentive and total income from the employer, rather than only salary, in computing benefit levels and amounts, and are not offset by disability income from other sources.

It becomes even more essential to preserve income in the event of a disability.  The disabled person is likely to have an interruption and reduction in income at the same time that he or she must cover uninsured or underinsured medical and/or hospital costs, while attempting to maintain the family’s lifestyle. The nature of the disability may require additional but uninsured care needs or rehabilitation expenses not anticipated within the person’s usual budget.

It is also important to recall that your individual disability policy is your policy, and coverage remains independent of your employer. It is fully portable, covering you in all circumstances, whether you choose to leave your current employer; and disability coverage remains independent of corporate reorganizations, merger, acquisitions, or other involuntary events. Once the policy is purchased, benefits may not be reduced by the insurance carrier.

The waiting, or elimination, periods before one may receive benefits are different for short term vs. long term disability policies, and will differ from policy to policy. In short term plans, the waiting periods may range between 0 to 14 days, depending upon the cause of disability. In long term plans, the waiting or elimination periods are longer, ranging from three to six months or longer, for disabilities arising from both sickness and accidents.

By definition, a short term disability policy will extend benefits for a maximum benefit period of no longer than two years. Typically however, these policies generally cover benefit maximum benefit periods of 26 weeks. Long term disability policies provide benefits for the stated policy period: for five years, to age 65 or 70, or even lifetime, depending on the policy and contingent on continuing disability.

Most Americans have a greater chance of becoming disabled before retirement than of dying. Nearly 15% of the population aged 22-44 is disabled, and of those severely disabled, 54.2% are between the ages of 22-64.1 The employment rates and earning power are reduced substantially among these groups. Advances in modern medicine have resulted in declines in death rates, while chronic long term disability increased over the same period. * 48% of all home foreclosures are the result of disability, while only 3% of all foreclosures are related to deaths.2 The reason most people purchase life insurance is to provide a replacement for the income stream of the insured. Disability insurance is designed to provide the same protection, under circumstances less drastic and more likely to occur than death.

1 McNeil, J. M. “Americans with Disabilities: 1994-95.” U.S. Department of Commerce Economics and Statistics Administration. P70-61 (August 1997): 2, 3. figure 2. Internet. June 13, 2000. Available: http://www.sipp.census.gov/sipp/pubsmain.htm
2 Housing and Home Finance Agency, U.S. Government

Disability insurance is protection against lost earnings as a result of accident or illness; while health insurance covers direct medical and hospital costs, disability insurance covers the need to protect income to maintain one’s family during the period of recuperation and to sustain additional expenses. If a disability last longer than 90 days, the average length of the disability is over two years. Few people have savings sufficient to protect their homes and families’ needs over that period of time in the pre-disability standard of living.

Average Length of Disability if Disability Lasts Over 90 Days1
Age 25 2.1 years
Age 35 2.8 years
Age 45 3.2 years
Age 55 2.6 years


1 UNUM

You should plan on replacing at least 60-70% of your after-tax income, and more if you can afford the additional coverage.  Although work-related expenses and income taxes may be decreased as a result of the disability, unreimbursed or uninsured medical and rehabilitative expenses can be anticipated to increase.

Small business owners have special concerns, and should consider as well overhead expense coverage, recovery benefits, and if applicable, key-person or buy-out insurance coverage.

The total amount of the benefits you receive cannot exceed approximately 80% of your usual net income, so that you are not encouraged to remain disabled rather than returning to work.

If you elect a non-cancelable policy, the insurance company may not increase your premiums nor change the benefits, provided that you have made all the premium payments.

If the policy is guaranteed renewable, you may automatically renew your policy, but the insurance company may increase the premiums if it does so for an entire class of policyholders.

An optional renewable or conditionally renewable policy may be extended at its anniversary date if the insurance company decides to do so.

Frequently, insurers offer as optional coverage cost-of-living allowance (COLA) coverage, inflation increase benefit coverage, or an additional purchase benefit permitting the purchase of additional insurance, subject to financial insurability. Others insurers provide automatic increase benefits, which provide for increases in benefits annually increasing a policy owner’s monthly benefit without evidence of either medical or financial insurability. Check out the various kinds of policies.

If your policy lapses because of unpaid premiums, it will be reinstated if premium is received within the grace period. If the premium is received our Home Office within 57 days of the premium due date, the policy will be reinstated without requiring proof of insurability. After that, a reinstatement application will be required, and if approved, the policy will be reinstated.

After you have been totally disabled for 90 days, we will waive any premiums that have become due during the 90 days, and premiums that become due during the time you are totally disabled.

Built into some policies, available as an option with others, this benefit is called a residual disability benefit, which pays the insured a portion of the total disability benefit after a return to work based on the level of disability, or in some policies, based on the percentage of income lost due to the disability. For example, if after rehabilitation and therapy, you were able to perform some 70% of your job duties, you would be eligible for 30% of your disability benefit.

These are to be distinguished from recovery benefits, which provide for partial payment of benefits after a person has returned to work after a long term disability, until his or her earnings have been restored to pre-disability levels, even though he or she is fully recovered and no longer disabled in any way.

Recovery benefits, featured in some policies, provide for partial payment of benefits after a person has returned to work after a long term disability, until his or her earnings have been restored to pre-disability levels while the insured is re-establishing a client or customer base. This feature is particularly valuable to those engaged in professional practices and to those whose compensation is heavily incentive based.

Suppose I have a disability that prevents me returning to my former occupation. Must I return to any occupation? Are expenses for rehabilitation covered?

Individual policies and coverage can vary. Some insurers will permit the insured to choose whether to return to work if he or she cannot return to the former occupation. Additionally, some insurance policies will provide for rehabilitation or retraining expense coverage in addition to the regular benefits, under certain terms and conditions.

Own occupation” refers to the occupation in which you worked at the time of the disability; this term should always be distinguished from “regular occupation,” which is interpreted to mean the occupation you had at the time of the disabling event until you have received 24 months of benefits due to the same disability—after those 24 months, “regular occupation” means any gainful occupation for which you are reasonably fitted by training, education or experience, whether or not that gainful occupation yields earnings commensurate with pre-disability levels. If you are not employed at the beginning of a disability, regular occupation means any gainful occupation for which you are reasonably fitted by training, education or experience.

If you become disabled during the period of time for which you purchased benefits, you will be covered for the income protection level you elected at the time of the policy purchase. Calculations for residual benefits will be based on your ability to perform those activities that you had been able to do prior to the disabling event.

The answer depends on the source and nature of the funds used to pay the insurance premiums. If you paid for the premiums with after-tax dollars, then you should receive the disability benefits tax-free. If you paid for the premiums with pre-tax dollars, then the benefits are generally taxable to you, as are benefits paid for by your employer. You should consult with your tax advisor about tax treatment of any disability insurance that you have and/or are considering purchasing.