Intro to Insurance: Disability Insurance

Intro to Insurance: Disability Insurance

Disability income insurance, also called disability insurance, protects your income if you become unable to work for several months or longer due to illness or injury. The income provided by a DII policy can help you maintain your standard of living and pay your medical bills while you recover – or pay them until the policy terminates, which may be at age 65 or when you die, if you don’t recover. It can also protect anyone who has cosigned on a loan of yours but can’t really afford to make the loan payments on your behalf, such as a parent who cosigned for your private student loans, which may not offer forbearance, deferral or forgiveness if you become disabled. (See Protecting Your Income with Disability Insurance.)

Why do you need disability income insurance? Doesn’t the federal government pay benefits if you become disabled?

Yes – the Social Security Administration’s disability insurance program, also called SSDI, does pay benefits. Individuals must be eligible from their FICA payroll tax contributions, and the SSA has strict definitions of disability and low monthly benefit payments. While SSDI is certainly better than nothing, not everyone will qualify for it or be able to maintain their usual standard of living off its benefits. That's where private disability insurance is an appealing substitute or complement. (Learn more in How Is Social Security Disability Calculated?) If you collect benefits from a private disability insurance policy, you can still collect Social Security disability benefits.

Since you could become disabled at any point in your life, it’s a good idea to purchase disability income insurance as soon as you start earning substantial income from work. The policy’s benefit is based on your earnings, so getting a policy when you’re earning $500 a month working part-time during college probably isn’t worthwhile (and you might not meet the insurer’s minimum income requirements, anyway). But getting a policy when you’re earning $36,000 a year after college makes a lot of sense. The younger you are when you purchase a policy, the lower your premiums will be. You can choose to have your premiums start off low and increase over time – which makes sense for a lot of people since they expect their income to increase over time – or your premiums can be the same each year. This second choice might save money in the long run, but be difficult to afford in the policy’s early years. (For further reading, see When and How to Insure Your Income.)

Definitions of Disability

Insurers have several definitions of disability. It’s important to understand these definitions because they affect whether you’ll be able to receive benefits.

– Total disability means you cannot work at all.

– Partial disability means you cannot perform all of your job functions, but you can perform some of them.

– Permanent disability means that doctors don’t expect you to recover from your injury or illness. A permanent disability could be total or partial. If you were in a serious car accident and became paralyzed from the neck down, you would likely be considered totally and permanently disabled. If you became paralyzed from the waist down, you might be considered partially and permanently disabled. (See How to Insure Your Salary.)

– A temporary disability is one you are expected to recover substantially from. Maybe you had a serious car accident and will need multiple surgeries and months of physical therapy, but within a couple of years, doctors expect you to return to your previous level of functioning. A temporary disability could be total or partial.

– Presumptive disability means you’ve suffered from something that automatically qualifies you to receive immediate disability payments. If you’ve lost two limbs, lost a leg at the hip, become totally blind or deaf, or have suffered a spinal cord injury, to name just a few examples, your insurance company will presume you to be disabled. (For an alternative to disability insurance, see Disability Rider on Life Insurance: Should You Buy?)

Types of Disability Policies

Whether your policy will pay benefits when you become disabled depends on not just the type of disability you experience but also the type of disability coverage you have.

– An any-occupation policy only pays benefits if you are unable to work in any job whatsoever. This policy will be less expensive because it is less likely to pay benefits.

– A modified any-occupation policy pays benefits if you cannot work in a job that you are reasonably well-suited for based on your education, training or experience.

– An own-occupation policy considers you disabled and pays benefits if you can’t perform the primary duties of your own occupation. This policy will be more expensive because it is more likely to pay benefits.

– A split policy provides short-term own-occupation coverage, but long-term any occupation coverage.

(Sources: http://claritywealthadvisors.com/wp-content/uploads/2012/05/Disability-Income-Insurance.pdf and http://www.towerstrategic.com/disability-insurance/.)

(For related reading, see The Disability Insurance Policy: Now In English.)

Obtaining Coverage

Many employers offer disability insurance as a benefit; you can also purchase an individual policy on your own. While employer-provided disability insurance can be attractive because you don’t have to qualify medically and the employer pays all or part of the premiums, it may not offer as much coverage as you need and you may not be able to take your coverage with you if you are laid off or change employers. Further, if your employer pays the premiums, any disability benefits you receive will be considered taxable income, whereas if you pay the premiums, the benefits will be tax free. To learn more, read Do I have to pay taxes on disability payments? and Group and Individual Disability Insurance: What You Need to Know.)

If you qualify for an individual policy, it’s a good idea to get one since you can customize it to your needs, purchase the full amount of coverage you need and keep the policy regardless of where you work. However, some individuals may not qualify for disability insurance, depending on the insurer’s underwriting standards:

– individuals younger than 18 or older than 60

– individuals whose incomes are below $15,000 a year, or whose income is high enough that they are able to self-insure

– individuals who work in dangerous, high-risk occupations

– individuals with a history of serious mental or physical illness

– individuals with a criminal history

– individuals with risky hobbies

How Much Coverage to Buy

Buy as much disability insurance as you can afford, because an illness or injury could prevent you from qualifying later. Further, any insurance you purchase later will likely cost more due to your age and any health conditions you might experience as you get older.

The amount of disability coverage you can buy will be based on a percentage of your income. Insurers will not cover 100% of your income because doing so would tempt people to file fraudulent disability claims (yes, there are people who would give up their physical capabilities or sacrifice their health if it meant not having to work). Instead, a policy might replace 60% of your earned income. (See Is there a limit on the amount of disability insurance that I can buy?)

You may wish to look for a policy that pays residual benefits, or a portion of your total benefit, if your work hours are reduced because of a disability or illness. Sometimes this feature is included with the base policy, and other times it must be purchased as a rider.

Structuring Your Policy

Insurers offer many options for structuring your policy. It will affect how long you have to wait before receiving benefits if you become disabled, how much your benefit payments will be and how much your premiums will cost.

Your policy’s elimination period, or disability insurance waiting period, determines how long you must wait after meeting the policy’s definition of disability to start receiving benefits. It is similar to a deductible in other types of insurance in that it represents your shared responsibility for the loss before the insurance company makes its contribution. The longer your elimination period, the less your disability insurance will cost. (For more details, read What is an elimination period?)

To help prevent preexisting-condition fraud, some disability insurance policies also have a probation period of 15 to 30 days during which the policy must be in force before coverage begins. 

Riders to Your Policy

You can purchase various riders to augment a basic disability insurance policy. Here are a few of the more common ones:

– A future purchase option rider lets you increase your coverage as your income increases. You may need proof of higher income but you will not need medical underwriting. If the insurer increases your coverage, you will pay a higher premium. Without this rider, you will have to reapply for a new policy to increase your coverage and go through medical underwriting again, which might result in an even higher rate because of your age or changes in your medical history since you bought your original policy.

– An automatic increase rider gives you a higher benefit each year for the first few years of the policy without requiring medical underwriting.

– A cost-of-living adjustment (COLA) rider automatically increases your benefits to keep pace with inflation, which can be a valuable feature if you end up needing long-term benefits, though it can also increase your premiums significantly. (For related reading, see All About Inflation.)

(For further reading, see Top 6 Features of a Great Disability Policy and Choosing the Best Disability Insurance.)

In the next section, we’ll talk about a type of insurance you might want when you’re older: long-term care insurance.

Intro to Insurance: Long-Term Care Insurance