DISABILITY INSURANCE
 
 

Contemplating the prospect of a serious physical or mental disability is about as pleasant as standing on a precipice and looking into the depths of an abyss. The idea that either our bodies or our minds might someday be so damaged as to render us unable to work productively — let alone lead a meaningful life — is not especially cheering. Yet disability could someday rob you of the wherewithal to earn a living. In fact, most people don’t realize how common disability is. You are seven times more likely to become disabled before you retire than you are to die. In fact, one out of four people suffers a disability of six months or longer at some point before they retire.

You may think that Social Security and worker’s compensation alone will provide you with an adequate safety net. Neither of these sources of protection, however, is likely to provide you with anywhere near the financial cushion you’ll need should you become disabled. Indeed, the Social Security administration denies disability benefits to over half the individuals who apply. And worker’s compensation pays only for job-related disabilities. Most accidents and illnesses are not job-related. While you may blanch at the idea of having to buy yet another insurance policy, you may find that the coverage you have is inadequate and that you need to buy additional disability insurance (insurance against loss of income due to partial or total disability) to protect yourself against a financially catastrophic event. In the following section, you’ll find out whether you’ll need additional coverage, and if you do, you’ll learn some cost-saving ways to purchase it. Protecting Your Earning Potential

Lack of adequate disability insurance is one of the most common gaps people have in their insurance. Yet you could wipe out years of hard-earned savings if you suffer a disability that is under- or uninsured. And remember, the young and healthy need as much, if not more, disability insurance protection than do the middle-aged. That’s because younger people usually have limited investments, and they have to rely almost entirely on their many productive money-making years to achieve financial security. If younger persons’ earning power is compromised by a long-term disability, their potential to achieve financial security may be seriously impaired if they do not have disability insurance coverage.

Therefore, it’s important to assure that you — and any other working family member — have the right kind and amount of disability insurance protection.

Determining How Much Disability Coverage You Need

Ideally, all of your disability coverage taken together should provide you with benefits equal to 60 to 70 percent of your current gross salary. If your disability benefits are received tax-free (more on that in a moment) and your benefits fall around the 60 to 70 percent mark, your disability income will compare favorably with your current after-tax work income. Your policy or policies should guarantee benefits until you either recover or reach age 65 — when you will be eligible for Social Security retirement benefits.

Sources of Disability Insurance Coverage

You can obtain disability insurance from a variety of sources.This bears repeating: While Social Security and worker’s compensation are automatically provided to disabled workers, they come nowhere near to providing adequate protection against disability. There are three common sources of disability insurance.

1.  Company-Provided Insurance

Your employer may — or may not — already provide you with some disability coverage (in addition to worker’s compensation).  Take a careful look at your company’s policy. Make sure you know:

v  How much does it pay?

v  How long do you have to be disabled before benefits begin?

v  What other policy provisions determine how, where, and when you receive disability payments?
 

The reason you need to review your policy is that company-provided insurance may have low monthly benefits and a short benefit period. By itself, it may not offer adequate protection against disability. Note also that disability insurance may be included in your company health insurance plan or life insurance plan.

A Word to the Taxwise

You may be fortunate enough to have your employer pay for your disability insurance coverage. Even so, you may want to reimburse your employer for it. “Why in the world,” you might ask, “should I pay for something my employer provides me at no cost?” The reason is that paying the premiums yourself could result in big savings if you become disabled. By paying your own disability insurance premiums, any disability benefits you receive will not be subject to federal income tax. On the other hand, if your company pays the premiums, you will have to pay income taxes on those benefits. A little extra expense now may result in big savings later, should you become disabled.

If, after you have reviewed your company insurance, you find that you really need additional disability coverage in order to be adequately protected, you have a couple of ways to acquire the coverage.

2. Group Insurance

You may be able to get the advantages of group disability coverage similar to what employers provide by acquiring insurance through a professional group or fraternal organization. For example, self-employed people may be able to obtain disability coverage for themselves through the local Chamber of Commerce, small business organizations, or trade associations. Even if you are not self-employed, it may be worth your time investigating group disability coverage offered by various organizations that you may already belong to or may be able to join.

3. Individual Insurance

You may find that you will need to purchase a disability policy on an individual rather than group basis. Individual disability policies are expensive. But the good news is that you can obtain much more comprehensive coverage — coverage that meets your exact needs — than you can with a group policy. Make sure any individually purchased disability insurance is coordinated with any company-sponsored insurance that you may have so that you don’t risk paying for more coverage than you need.
 
 

THE MECHANICS OF DISABILITY INSURANCE

Somewhere along the line, you’ve no doubt at least once or twice encountered an insurance salesperson who tried to sell you more homeowner’s or life insurance coverage than you could ever possibly need. You don’t have to worry about such a salesperson ever doing the same with a disability policy. Insurance companies will sell only limited amounts of coverage because they don’t want to encourage goldbrickers who might, if too well insured, have little incentive to go back to work after an injury.

How much coverage can and should you obtain? Insurance companies typically limit the total amount of disability insurance coverage to 60 percent to 70 percent of your job income. To a disability insurance underwriter, the best customer is someone who will scramble to get back in the workforce quickly should he or she suffer a disability.

The Basic Structure

As with any insurance you (or your employer) pay a periodic premium for disability coverage. The two main types of insurance are any occupation coverage and own occupation coverage. Any occupation coverage will take effect only if your disability prevents you from working at even the simplest, most menial, or low-paying job. Own occupation coverage takes effect if your disability prevents you from working at your own occupation. For obvious reasons, you should be sure that your disability insurance provides own occupation coverage. Some insurance policies define disability as any condition leading to a loss of income. These policies are the most comprehensive, but they are also the most expensive.

Once you’re insured, if you do have the misfortune to become disabled, your policy won’t take effect until the elimination period has expired. The elimination period is the time that elapses between the onset of disability and the beginning of the benefit period. During the elimination period, which is analogous to health and automobile insurance deductibles, you must fend for yourself.

As with health insurance deductibles, the more substantial the elimination period, the lower your premium will be. Most carriers give you the option of taking an elimination period ranging from 30 days to one year. Taking a long elimination period will only work, of course, if you have enough savings in reserve to replace your salary. If you can salt away the equivalent of one year’s after-tax salary, there is no reason not to opt for a 365-day elimination period. The premium savings can be substantial if you can afford to support yourself in the intervening time. Your employer may provide short-term disability insurance, which may also allow you to opt for a relatively long elimination period.

Choosing Riders Intelligently

Like most insurance products, disability insurance can be “souped up” by purchasing riders that broaden your coverage. While riders are not cheap and some certainly will take you for a “ride,” others are well worth considering. First things first, however. Be sure that any policy you purchase is guaranteed renewable. With these policies, the insurer must renew the policy at your request (as long as you continue to pay your premiums). No questions are asked, and no physical examinations are required.

The COLA (cost-of-living adjustment) rider is — at least on the face of it — a worthwhile adjustment. If you are saddled with a long-term disability, you would ordinarily be forced to watch the buying power of your fixed monthly benefit slowly erode. The COLA rider is designed to index your benefit to inflation, so that your benefit will stay constant in real dollars. Unfortunately, some insurers use simple, rather than compound, interest in calculating the COLA. This means that your benefit still won’t keep pace with inflation, despite the sales pitch. Other COLAs have a cap that limits how much your benefit can grow. Despite these duds, a COLA that truly fulfills its promise is an investment worth considering — particularly if you’re young and could really be hurt by inflation if you suffered a permanent disability.

Another rider designed to ameliorate the effects of inflation is the automatic benefit increase rider, which increases your benefit each year while you are healthy. If you buy a policy today and become disabled ten years from now, inflation will have significantly diminished the value of that benefit. It will cover much less of your salary loss, assuming your salary has kept pace with inflation. Once the insurance takes effect, however, the benefit is fixed at the level it reached at the time of your disability. Ideally, should the cost be acceptable, you ought to combine this rider with a COLA rider. You would then be sure that, no matter how many years have elapsed since you bought your policy, inflation won’t have wiped out the value of the disability benefit. You would also know that your benefit would continue to grow once disability had set in.

Even with these two riders in place, you should also consider purchasing a guarantee of physical insurability rider. Why? Your salary may rise so much in your peak earning years that an old disability policy may have become inadequate. But if your health has deteriorated over these intervening years, you may be unable to renegotiate your policy. With the guarantee of physical insurability rider, the carrier will have to sell you a new policy, regardless of the condition of your health.

Riders That Won’t Take You For a Ride

Two riders you should definitely avoid are the cash value and return-of-premium riders, both of which allow you to bet on staying healthy. In theory, the idea behind these riders seems sensible. The insurance company has made a great deal of money on your policy because you haven’t drawn on any of its benefits — so why not try to get some of your money back? The problem is that these riders are much too expensive to be worth the limited savings that purchasing them will achieve.

Limitations That Render Policies Worthless

Some disability insurance policies cover only disability that results from rather specific causes, such as accidental injury. These policies are just as useless as dread disease health insurance, so avoid them. Make sure that you purchase a multiperil policy that will protect you from disabilities resulting from any cause.
 
 

For Further Information

Reminder:

v   Obtain and maintain sufficient disability insurance coverage to replace 60 to 70 percent of your work income.

v   Make sure you understand your disability insurance policy’s features and limits, particularly your company disability policy.

v   If you need to purchase disability insurance on your own, first check to see if you can obtain a group policy.

v   If you need to purchase a disability policy individually, compare several policies and evaluate carefully the various features they offer.