Private Disability Income Insurance

What is private disability income insurance?

Private disability income insurance is insurance purchased through an insurance company that pays you a predetermined benefit when you are too sick or too injured to work. Private disability income insurance policies come in many forms: individual policies; group insurance policies sponsored by employers, trade associations and organizations; business protection policies; and riders on life insurance policies. More and more private disability policies are being sold as people realize that coverage provided by government-sponsored social insurance programs is limited in scope and often difficult to qualify for.

Types of private disability income insurance policies

Individual policies

An individual disability policy is designed to replace income you will lose if you are too sick or too injured to work. While a group policy covers many people, an individual policy covers just one person: you. As a result, you may pay a higher price for coverage, but you often receive more for your money. You get a policy tailored to meet your needs, more liberal benefits, and guaranteed protection against disability.

Example(s): Maureen was paying $50 a month for a group policy at work that would provide disability benefits to her for two years, beginning after a 30-day waiting period. However, if she quit her job, she would no longer be insured for disability. Since she felt she needed more permanent long-term coverage, Maureen purchased a private disability policy that guaranteed to pay her benefits until age 65, after a 90-day waiting period. Although this coverage cost her twice as much as her group coverage, she felt it was worth the price.

Group disability coverage provided through an employer

Group disability insurance that you purchase through your employer is a low-cost alternative to individual coverage. Here’s how it works: Your employer buys a group disability policy and then offers coverage to you and other eligible members of the group during certain periods of the year (called open enrollment periods). If you enroll at this time, you’ll qualify for coverage even if you are older or have health problems. However, employer-sponsored group plans are not very flexible and may pay limited benefits. Many plans offer only short-term coverage and you may have to meet a stringent definition of disability to receive them.

Group disability programs sponsored by a trade association

Trade or professional associations sometimes offer disability coverage to their members. Although called group disability because it is group-sponsored, association policies are issued to individual group members who must prove insurability. However, insurability standards for association members are sometimes relaxed, and you may qualify more easily for association disability insurance than for an individual policy. If you buy an association-sponsored policy, it will initially cost less than an individual policy. However, after a certain term (5 or 10 years), your premium may rise and eventually exceed an individual policy rate. In addition, the policy will be canceled if you leave the group or if the association withdraws its endorsement, leaving you without disability protection.

Example(s): Hans bought an inexpensive group disability policy through the Michigan Tulip Growers Association. However, when he was barred from membership in the group after importing illegal bulbs from Mexico, his disability policy was canceled, leaving him without coverage.

Specialized policies

You can purchase a group policy that provides limited coverage in specific circumstances. Credit disability insurance (a policy that will make payments to a specific creditor, should you become disabled), accident-only insurance, long-term care (LTC) insurance, and limited health insurance all pay disability benefits in specialized circumstances. Some of these policies (such as credit disability insurance) are group policies issued through organizations and institutions. Others (such as LTC insurance) are individual policies purchased through an insurance company.

Example(s): When Lenny took out a car loan, the bank manager sold him a credit disability insurance policy. The cost of the policy was added into his loan and increased his car payment by $2 per month. When Lenny was disabled in a skiing accident, his insurance company made his car payment for him until he was able to return to work.

Business protection policies

If you own a business, you can purchase disability insurance that will protect your business if you or one of your employees becomes disabled. You can purchase insurance to protect your business in one or more of the following areas: long-term disability (LTD) plans, salary continuation plans, key person disability insurance, business overhead expense policies, and disability buy-out plans.

Although some of the terminology explained in this document applies to business disability policies as well as individual and group policies, business protection policies contain terms and provisions unrelated to most individual and group policies.

Disability income riders attached to life insurance policies

Some people purchase limited disability insurance by attaching a rider to their life insurance policy. This rider guarantees the insured a regular monthly benefit payment in the event he or she becomes permanently and totally disabled. The amount of benefit payment depends on the face value of the life insurance policy.

Example(s): Angie buys a life insurance policy with a face value of $50,000. She adds a disability income rider to it that guarantees that she will receive $10 per month per $1,000 in life insurance coverage. Thus, if she becomes disabled, she will receive a $500 per month disability benefit payment.

Who can purchase private disability insurance?

In general, you must be a good risk

If you are buying a group insurance policy during an open enrollment period, you won’t have to prove that you are insurable. However, if you are purchasing an individual disability policy, you will have to meet certain standards before you are issued a policy. On an application, you will answer questions regarding your age, income, occupation, health, and hobbies, and you may be turned down for coverage if you pose too great a risk to the insurance company or if you can’t meet minimum age or income requirements.

Example(s): Captain Crook applied for disability insurance. On his application, he listed the following information:

Example(s): Occupation: Pirate Income: $250,000 annually Current Health: Excellent Past Health: Arm severed 10 years ago, requiring prosthesis; had 40 stitches 3 years ago after sword fight; hospitalized six months ago after shark attack. Hobbies: Searching for buried treasure, making sailors walk the plank

Example(s): Unfortunately, although Captain Crook met his insurance company’s age and income requirements, he was denied disability coverage due to his dangerous occupation and lifestyle.

You can’t be too young or too old

Most disability policies are issued to people between the ages of 18 and 60, although coverage may continue to age 65 (and sometimes for a lifetime). In addition, age is a factor in pricing the policy; since younger people are less likely to become disabled, they pay the least expensive premiums.

You can’t be too rich or too poor

You don’t have to be rich to buy disability insurance, but most companies won’t insure individuals who make less than $12,000 (sometimes $15,000) a year. This is because individuals with low income may not be able to afford the premiums and may not have a great need for insurance. Conversely, you may also have trouble buying disability insurance if you make a lot of money or if your net worth is too high. The insurance company may decide that you don’t need disability insurance because you can afford to self-insure, or it may determine that you pose too great a risk to the company (because any benefit paid to you over a long period would cost the company a lot of money).

You can’t work in an extremely dangerous job

Statistically (and according to common sense), some jobs are more dangerous than others. For example, construction workers, firefighters, truck drivers, and mine workers are employed in dangerous occupations, whereas architects, schoolteachers, and lawyers are not. If you work in a dangerous occupation, you may be denied disability coverage outright, and if you are able to buy a disability policy, you will pay a higher premium. Unfortunately, it’s not up to you to decide whether your occupation is dangerous; the insurance company decides that for you, grouping occupations in categories based on job duties and frequency of claims experience.

Example(s): Phil and his twin brother, Bill, applied for disability insurance coverage on the same day. Phil, a chemist, had no trouble buying a policy at a reasonable price, even though he worked with dangerous chemicals every day. On the other hand, Bill, an air traffic controller, was turned down for coverage. Even though Bill had never filed a disability claim, his insurance company considered him a poor risk due to the fact that many air traffic controllers had, in the past, filed a large number of claims because of the stressful nature of their jobs.

You can’t be too sick

You won’t be disqualified from buying disability coverage if you have a cold on the day you apply for it, but if you have a heart attack in the insurance agent’s office, you might be out of luck. To get individual disability income insurance, you have to prove that you are currently healthy by disclosing any known physical or psychological problems on your insurance application and, in many cases, by taking a physical exam. In addition, your past medical history and any hereditary traits will be evaluated to determine what disability claims risk you pose to the insurance company. If you have had past medical problems, you won’t necessarily be disqualified if the condition occurred long ago and you are now completely healthy. However, that specific condition may be excluded from coverage, or you may pay a higher premium.

You must be an upstanding, careful citizen

Unfortunately, disability insurance companies have to guard against fraud. To prevent fraudulent claims, insurance companies may disqualify anyone who may have a criminal past or a history of substance abuse. In addition, the company will also try to determine your attitude toward risk. If you regularly engage in dangerous hobbies (such as cliff diving), you may pose a greater claims risk to the insurance company than someone who does not.

Key provisions of individual and group disability policies

Although there is no such thing as a standard disability policy, you are likely to see most of the following terms, conditions, and benefits included and explained in the base portions of individual disability contracts and group association contracts. Employer-provided group disability contracts also share much of the same terminology and many of the same provisions; however, they differ from individual contracts in a few ways. In addition, this list is not all-inclusive; your disability policy may include other benefits or information.

Definition of disability

If you want to make sure your disability claim will be paid when you are hurt or injured, it’s extremely important to know how your policy defines disability. No single definition of disability exists; however, all policies define disability either according to how an illness or injury affects an individual’s ability to do his or her job or any other job (total disability) or according to how an illness or injury affects an individual’s ability to earn income (residual disability). Some policies combine both definitions. One type of disability may be covered in the base contract, and the other type may be added on as an optional benefit. Many wording variations exist that take into account many different situations, but the following examples illustrate common wording found in disability insurance contracts:

  • A total disability definition that covers your ability to do your own job (own occupation coverage) might read, in part: “The inability to perform any and every duty of your own occupation”
  • A total disability definition that covers your ability to do any job (any occupation coverage) might read, in part: “The inability to perform the duties of any occupation”
  • A residual disability definition that covers a loss of earnings might read, in part: “As a result of injury or sickness, you have experienced a loss of earnings equal to at least 20 percent of your pre-disability earnings”
  • A residual disability definition that covers loss of earnings and loss of ability to work might read: “As a result of injury or sickness, you are able to perform all of the duties of your occupation but for less than full time, and you have experienced a loss of earnings equal to at least 20 percent of your pre-disability earnings”

Some disabilities (called presumptive disabilities) automatically classify you as totally disabled. These disabilities include loss of two limbs; total, permanent blindness; and loss of speech and hearing.

Benefit period

How long you receive benefits once you become disabled depends on the benefit period you choose when you purchase a disability policy. Common benefit periods are one year, two years, five years, or up to age 65. Some policies even offer lifetime benefits. Disability policies are classified as short-term or long-term, depending on the length of benefit period they offer. Short-term policies may pay benefits for as few as 13 weeks or as long as 104 weeks. Any policy that pays benefits for longer than 104 weeks (two years) is usually considered long-term. In general, the longer benefit period you choose, the higher the premium you pay.

Elimination period

When you become disabled, you have to wait a certain number of days before you begin receiving benefits from your disability policy. This waiting period (called the elimination period) ranges from 30 to 720 days. This period helps to reduce the premium you pay for disability insurance, functioning much like a deductible. The longer elimination period you choose, the lower your premium. However, most people choose the elimination period based not only on cost but also on how long they could live off their savings or other income without receiving disability benefits. The most common elimination period chosen is 90 days.

Example(s): Alice wanted to buy a disability insurance policy with the shortest elimination period she was offered, 30 days. However, after comparing the price of a policy with a 30-day elimination period with a policy with a 90-day elimination period, she decided that the policy with the longer elimination period would suit her needs and save her a lot of money in premiums. When she fell down some stairs a few weeks later, she was able to live off her investments until the 90-day waiting period was over and her disability benefits began.

Monthly benefit amount

To ensure that you have incentive to return to work after a period of disability, disability insurance pays you only a portion of your normal earnings. In general, you will receive a disability benefit equal to 50 to 70 percent of your normal earnings, subject to a monthly maximum. Your benefit will be determined when you apply for your disability policy. The insurance company will consider what disability income you will need in order to support yourself and your family, your current earned and unearned income, and other disability coverage you might have (including Social Security and other government-sponsored insurance). This will determine the maximum benefit coverage you may purchase. You can, of course, purchase less.

Example(s): Randall made $3,000 a month as a photographer. When he applied for disability insurance coverage, the insurance company calculated his maximum monthly benefit to be 60 percent of his earnings or $1,800 a month. However, to reduce his premium, Randall elected to receive a lower monthly benefit of $1,000 in the event he became disabled.

Renewability provisions

Most disability policies are classified according to their renewability provisions. The most common type of policy is the guaranteed renewable policy. According to the provisions of this policy, the insurer guarantees to renew the disability contract but does not guarantee the premium. However, the premium may be increased only on the stated anniversary date (with prior notification) and only if the premium is increased for an entire underwriting class. Another type of policy issued is the noncancelable and guaranteed renewable policy. This policy guarantees not only that the disability contract will be renewed but also that the premium won’t be increased. This provision, however, is becoming less common and is often available only to applicants at the lowest risk for disability who can afford to pay for it.

Waiver of premium

Although many policies include this in their base coverage, some offer it as an optional rider. If you become disabled, the insurance company will pay your insurance premium for you, and your policy will remain in force until your disability period ends. In addition, it may refund any premiums you paid during the elimination period.

Contestable period

If you make any false statements on your disability application, the insurance company has the right to contest or to rewrite your policy or to deny a disability claim within a certain period (usually two years) from the effective date of coverage. After that period, the company can still void the contract or deny a claim if it can prove that you gave incorrect information or if you intended to commit fraud when you made the statements. This should be stipulated in the disability insurance contract.

Exclusions and limitations

Certain causes of illness or accident may not be covered under the disability policy. Some common exclusions are injuries caused by aircraft (except to passengers on scheduled airline flights), war or acts of war, suicide attempts, and normal pregnancy. In addition, if you have a pre-existing medical condition, your disability policy may exclude that condition from coverage, either forever or for a specified period of time.

Example(s): Petra fell and hurt her back. One year later, she wanted to buy disability insurance. Her back injury had healed, but because the insurance company felt that she was likely to experience back problems in the future, they approved her application for disability insurance provided that a rider was added to her policy that excluded coverage for any disability related to back problems.

Grace period

A disability policy usually states that if you pay your premium within 31 days of your due date, your policy won’t be canceled for nonpayment.

Rehabilitation provision

Both you and the insurance company benefit if you can return to work. For this reason, most disability insurance policies cover the cost of rehabilitation in an approved program up to a certain maximum.

Optional benefits and riders

Optional benefits and riders are policy add-ons that enable you to customize an individual disability policy to fit your needs. Occasionally, some of these riders or optional benefits will be included as base coverage, but most of them often must be purchased separately and may substantially increase the cost of the policy. You may need to purchase some of the riders when you buy the policy; others may be added on to the contract after the policy is issued. The following section details some (but not all) of the optional benefits and riders that can be added on to a disability insurance policy.

Automatic benefit increase rider

This rider (sometimes offered as part of the basic policy) stipulates that the monthly policy amount will be adjusted automatically every year to account for pay raises or increased income you may receive after you’ve purchased a disability policy. The rider provides annual increases for a certain term (often five years). During this time, you won’t have to provide any proof that your income has gone up. However, upon renewal of the rider, you may have to show evidence that your income has increased; otherwise, you won’t be able to renew the rider.

Cost-of-living rider

If you are afraid that inflation will eat away at your disability benefit, you can purchase a cost-of-living adjustment rider that increases your monthly benefits if inflation rises. If inflation is low, a minimum percentage (4 or 5 percent) often applies. Although some companies cap the increase amount, others let you choose your own maximum at the time you purchase the rider. The cost-of-living rider is very expensive but may pay off on a long-term policy. If you suffer a short-term disability, however, inflation is unlikely to matter.

Future benefits increase rider

Also called an option to increase coverage or a guarantee of insurability rider, this gives you the option to buy more disability coverage if you need it later, without being turned down for medical problems. This is a useful rider if you are young and expect your income to rise significantly over the years.

Example(s): Heloise purchases a disability income insurance policy when she is 30 that includes a future benefits increase rider. At the time she buys the policy, she earns $2,000 per month, and her policy pays her a $1,200 per month benefit. By the time she is 35, however, she is earning $3,000 per month and wants to increase her benefits. She does so under the terms of her rider, which allows her to purchase an additional $400 of monthly benefits every three years.

Partial disability benefits rider

Although the terms partial disability and residual disability are sometimes used interchangeably, partial disability is actually a simpler, short-term version of residual disability. Like a residual disability policy or rider, a partial disability benefits rider will pay you benefits in the event that you can perform some but not all of the duties of your occupation full-time or part-time. Unlike a residual disability policy or rider, however, a partial benefits rider doesn’t pay benefits based on the percentage of earnings you’ve lost. Instead, it simply states that you must first be totally disabled and pays you benefits equal to 50 percent of your total monthly disability benefit once you return to work. However, the benefits will be paid only for a specified period (usually three to six months).

Return-of-premium rider

The return-of-premium rider might appeal to you if, like most people, you don’t believe that you will actually become disabled but you are buying a disability policy just in case. The return of premium rider entitles you to get back the premium money you pay in the event you don’t need to use the policy benefits. Depending on the type of rider you choose, you will either get a percentage of the money back at certain ages or after a certain number of years, or you’ll get all of your money back at age 65 when the rider expires. This rider will substantially add to the cost of your premium.

Social benefits rider

This rider provides disability benefits in addition to your base monthly benefit. This benefit amount is payable to you as long as you are not receiving (or are eligible to receive) a social benefit (e.g., Social Security disability insurance). When you receive a social benefit, your social benefits rider may be reduced by the dollar amount you are receiving. This rider typically costs less than your base benefit because it takes some of the guesswork out of underwriting and protects the insurance company against some risk.

Example(s): Hillary purchased an $800 Social Security offset rider. She applied for Social Security disability benefits and began collecting $500 a month after the five-month waiting period elapsed. When she filed a claim for disability benefits with her insurance company, she began receiving a $300 per month disability benefit from her social benefits rider in addition to her base amount benefit. This amount was equal to the difference between her rider amount and what Social Security actually paid her.

Caution: There are several versions of Social Security income riders that pay benefits in various ways. Check your policy for specific terms.

Questions & Answers

If you are already receiving disability benefits from an individual disability insurance contract you purchased, how will these benefits affect the disability payments you receive from the group disability coverage you have through your employer?

Benefits you already receive from an individual disability policy shouldn’t affect the benefits you will receive from your group policy. Ordinarily, only benefits received from social or government sources will offset private individual or group disability benefits.

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The Art and Science of Successful Planning is an independent financial services company helping individuals and businesses utilizing a variety of investment and insurance products to custom suit their needs and objectives.  Investment Advisory Services offered through The Art and Science of Successful Planning a Registered Investment Advisor registered in the state of FL. **Tyler G. Harrelson, CES, CLTC, CFS, P.A. is a licensed insurance agency doing business as the Art and Science of Successful Planning and is independent of the Registered Investment Advisory.

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