Protecting Income – Disability Insurance

  1. Life Insurance
  2. Disability Insurance
  3. Shopping for Life & Disability Insurance
  4. Social Security Survivor & Disability Benefits
  5. Will Life insurance benefits be taxed?
  6. Emergency Fund
  7. Umbrella Insurance

Did you know you are more likely to become disabled than you are to die?  We don’t know if that is true, but you hear it a lot and there are some old statistics sited on the interwebz from agencies we have never heard of.  Not to say they are invalid, just that we can’t vouch for them.  The Social Security Administration claims you have 30% chance of becoming disabled before you reach retirement age.  Either way, you still need disability insurance.

Disability insurance is tricky.  Life insurance will seem simple after going through all this mainly because when you are dead, you are dead.

Whoo-hoo-hoo, look who knows so much. It just so happens that your friend here is only MOSTLY dead. There’s a big difference between mostly dead and all dead. Mostly dead is slightly alive. With all dead, well, with all dead there’s usually only one thing you can do.

-Miracle Max, The Princess Bride

Ok, aside from what we all learned in The Princess Bride, being dead is cut & dry.  Being disabled, now that is interesting.  It is similar to being sick, it means different things to different people.  Someone can have a headache and be sick.  Or they can have a cold.  Or pneumonia.  And being disabled, means different things to different insurance companies.

Disability Insurance differs from life insurance because you will always have at least one beneficiary, yourself.  It may make sense, even if you have no dependents, to carry disability insurance.

One common claim we hear is, “I have disability insurance through my employer.”  Great, how do they define being disabled?  And once you are disabled…

  • How much income do they cover you for?  Are there any caps?
  • What if you can do part time work, will you receive a benefit?
  • Do you have an elimination period?  How long is it?
  • Is the benefit taxable?
  • What happens if you qualify for Social Security Disability?
  • How long will your employer’s DI cover you?
  • Do you have a cost of living adjustment (COLA) on your benefit?

If you are fortunate enough to have disability coverage through your employer, the first thing to do is to get your Summary Plan Description (aka SPD, ask your HR department for it, by law they must provide this) and answer all those questions above.  Almost all people, especially “white collar” workers, will find their employer’s definition of being disabled unacceptable.  And this is the biggest hang up with employer disability insurance, along with the fact that if you leave the company for whatever reason you loose your insurance, is in the definition of being disabled.  Most policies will say that if you can do ANY job, you are not disabled.  So the surgeon who hurt her hand can no longer perform brain surgery, but flipping burgers at Micky D’s is an option where she could get a job.  Therefore, Ms. Surgeon is not disabled.

The gold standard for private disability insurance is Guardian Life.  It is a true, own occupation policy.  Meaning, Ms. Surgeon above would be considered disabled if she can’t perform brain surgery and would get a benefit even if she works Chez McDonald’s.  Let’s take a look at how Guardian defines “total disability” and “your occupation”:

Total Disability: Total disability or or totally disabled means that, solely due to injury or sickness, you are not able to perform the material and substantial duties of Your Occupation.

You will be totally disabled even if You are Gainfully Employed in another occupation so long as, solely due to Injury or Sickness, You are not able to work in Your Occupation.

Working an average of more than 40 hours in a week, in itself, is not a material and substantial duty.

Your Occupation: Your Occupation means the occupation (or occupations, if more than one) in which You are Gainfully Employed during the 12 months prior to the time you become Disabled.

Guardian also considers you to be disabled for mental and/or substance related disorders.  Many other disability coverages, including those considered to be “good” private policies, typically only allow 24 months of a disability due to mental and/or substance related reasons.  With Guardian, you’re also entitled to a partial benefit starting when you loose 15% of your income because of a disability.  If you seek an own occupation policy, Guardian definitely deserves a look.  Northwestern Mutual, Met Life, Mass Mutual are other companies often mentioned for having “good” disability policies, but not as strong as Guardian.

Once you are satisfied with a company and their definition of “disabled” and their list of disabilities, you have a whole ‘nother slew of options in front of you.  The biggest will be, how much of your income do you want to insure?  It is important to remember disability insurance is insuring the income, not the person.  The insurance company will be very interested in how much you really make, as they will not sell you a benefit greater than your current income less any other disability policies you have (your current employer’s included).  For instance, say your employer’s DI will cover 40% of income.  The maximum the insurance company will write a private policy for is 60%.  But, you will find, especially if you are looking at Guardian, that DI is expensive.  So, as always, track your expenses and know what they are.  You probably don’t need 100% income replacement because your expenses when you’re not working are less and if you pay for your private DI policy with after tax money (you don’t have an option), the benefit won’t be taxed.  This differs from an employer’s DI, as you will have to pay taxes on that benefit if you didn’t contribute after-tax dollars to the premiums.

Below is a list of considerations, in addition to what is mentioned above, for picking a suitable disability insurance contract and company:

  • Non-cancellable and Guaranteed Renewable – You want to make sure the premium will remain the same through the expiration date of the contract.  Guaranteed Renewable typically means you can always renew, but there is no promise what the premium will be.
  • Class of Risk – Your profession will be graded into certain classes of risk.  And even within each class of risk, each profession can receive a different contract.  For example, Medical Doctors will get a different contract than most other people.  Some companies may have your occupation in a different class of risk than others.
  • Presumptive Total Disability – Are there situations where the contract stipulates you will always be totally disabled?  Typically, if you loose sight in both eyes, hearing, speech and/or the loss of extremities, your elimination period will be waived and you are deemed disabled.
  • Occupational Rehabilitation – Will the insurance company help you return to work?  Guardian typically will cover the costs of approved, accredited programs under licensed practitioners in programs that help you return to work and are not covered by other insurance (e.g. workers’ comp, public programs, etc).
  • Elimination Period – This is the amount of time you have to wait to receive a benefit once you become disabled.  We keep a healthy emergency fund, so we have a long elimination period of 360 days.  Typically, they range from 30 days to 720 days.  And as you can imagine, the shorter the elimination period, the higher the premiums.  With Guardian your premiums will be waived or refunded pro-rata for premiums already paid during the elimination period.  Also, you will want to see if this is cumulative accounting of time or an elimination period per disability.  For example, say you have a policy with a 60 day elimination period and you become disabled on Jan 1, 2013.  You then recover from the disability on Feb 1, 2013.  In Sept 2013, you again find yourself disabled, is your elimination period 60 days, or 29 days (60 days less 31 days you were disabled in Jan 2013)?

Below is a list of other considerations (usually referred to as riders) which you can typically choose to have included with your policy and may or may not have a direct effect on the premium price:

  • Cost of Living Adjustment (COLA) – This is highly recommended.  When you insure a portion of your income, it will be expressed and often talked about as a percentage of your current income.  You are insuring a dollar value today, not a percentage of income.  The COLA will provide the benefit to be adjusted for inflation during payouts.
  • Residual Disability Benefit – We referred to this above, but if you loose a portion of your income due to a disability, when and how will the insurance company compensate you?  Also, is there a point when you will be deemed totally disabled (Guardian says when you loose 75% of income due to a disability, you are 100% disabled)?
  • Future Increase Option – This rider allows you to purchase of additional coverage without medical underwriting, but is subject to your income, employment etc.  In other words, you are allowed to purchase additional insurance as your income grows (or you loose benefits) without going through the medical screening and underwriting.
  • Retirement Protection Benefit Rider – This rider helps make up for contributions you and your employer make to a defined contribution (e.g. 401k, TSP) plan in the event you become disabled.
  • Catastrophic Disability – You will receive additional benefits if you become catastrophically disabled.  The additional benefit should offset such costs as home health care.  Therefore, the implication is, you have been disabled to the degree you can’t preform daily routine tasks which help to maintain your health (e.g. wiping your own butt, bathing, shaving, etc).
  • Automatic Benefit enhancement – Your benefit will be automatically increased each year and your premiums will also increase in accordance with the company’s current underwriting.  For example, our Guardian policy increases our benefit every year for the first 5 years by 4% and they will roll out what the cost is each year.  We can either reject or accept this increase.  If we reject it two years in a row, then it won’t ever happen again.
  • Unemployment Waiver of Premium – If you become unemployed, under this waiver, your premiums will be waived.  Usually up to some set period of time, e.g. up to the first 12 months you are unemployed.

As we mentioned in the life insurance article, we like to rock climb.  Because of this, we saw an increase in premiums for our life insurance.  The good news is, we didn’t see our disability insurance premiums rise.  The bad news is, it was written in our contract that if we become disabled while rock climbing, we are not covered by the policy.  This was written in as an addendum, and if we stop our rock climbing hobby, we can have the addendum removed from the contract.  Guess what we stopped doing?

These are just the major considerations when selecting a policy.  There are many more, and we are sure book volumes could be written on the various considerations.  Also, we like our Guardian policy.  But, it may not be appropriate for everyone.  We hope we laid out major considerations for selecting a (or for accepting a group) disability insurance policy.  Everyone’s considerations are different, and it is hard to prescribe a single remedy to the entire population.  We would like to also add, a policy is no good if you can’t access the benefit when you need it.  This is one area not to skimp.  Buy a policy that will protect you, not the cheapest product.

As always, we don’t receive kick backs for anything we recommend.  Due your do diligence! 


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