Definitions of Disability
The most important part of any disability income insurance policy is the language used by the policy to define disability. In this blog, we explore 3 Disability Definitions with Examples.
Own Occupation (Own Occ): This is the most favorable definition of disability from the point of view of the insured. The definition states that the insured is considered totally disabled (and therefore eligible for benefits payments) if they are unable to engage in the primary duties of their own occupation.
For example, a medical surgeon would be unable to engage in their own occupation if they suffered an injury to the hands. This would be the case even if the surgeon were still able to diagnose illnesses as a general practitioner of medicine.
Modified Any Occupation (Modified Any Occ): This definition is slightly less restrictive than the Any Occupation definition but not as liberal as the Own Occ definition.
Modified Any Occ defines disability as the insured’s inability to engage in any occupation for which they are reasonably suited by education or experience and for which they could easily become qualified.
Applying this definition to the medical surgeon example, if the surgeon could become a general practitioner reasonably easily after the injury to their hands, the policy probably would not pay a benefit.
Any Occupation (Any Occ): This is the practical opposite of the Own Occ definition and requires the insured to be unable to perform the duties relating to any gainful occupation before they are considered to be totally disabled.
It is not unlike the Social Security definition of disability, except that there is no five-month waiting period and expected the length of disability.
The Any Occ definition is usually limited to blue-collar workers, although white-collar workers and professionals may also obtain a policy with this definition. The reason these individuals would want to do so is to achieve premium cost savings.
Group long-term disability policies usually use a combination of the Own Occ and Modified Any Occ definitions (called a split-definition policy). Such policies permit the insured to receive benefits for a period of months or years under the Own Occ criteria;
Then, after the insured has been retrained for another position, the policies apply the stricter Modified Any Occ definition. Why? By design, the split definition encourages the worker to return to work and remain with the company, even though it may be in a new position or occupation.
It is also possible to write an individual disability income policy with a loss-of-income definition. With this kind of policy, the type of disability is not defined; rather, if, as a result of injury or sickness, the insured suffers a loss of income, benefits based on that loss are payable regardless of whether the insured returns to work in the same or a related occupation.
Given that it does not usually provide as great a benefit, the loss-of-income policy is not as popular among professionals or other workers as the Own Occ definition.
But insurance companies like the loss-of-income standard because it establishes a simple benchmark from which to measure the number of benefits payable.
Additional Important Provisions in an Individual Disability Policy
Many of the same provisions that are included in a long-term care insurance policy are found in an individual disability income policy. For example, like long-term care policies, disability insurance includes an elimination or waiting period, a benefit period, and a benefit amount.
The elimination period in disability insurance essentially works the same way as that included in a long-term care policy. In other words, an elimination period is the period of time after the insured has met the qualifying conditions to collect under the policy but before any benefit payments are actually made.
In the case of disability insurance, an elimination period of 90 days is probably optimal when considering the trade-off between covering the required payments from personal funds for a number of days and the need for as low an insurance premium as possible.
Longer elimination periods naturally reduce policy premiums, but the longer this period, the greater the need for personal savings or other alternatives to cover the insured’s ongoing living expenses.
A somewhat novel and increasingly popular alternative that insurance agents are recommending to cover the elimination period is the separate purchase of a critical illness insurance policy.
Critical illness insurance is an insurance policy that makes a lump sum cash payment if the insured is diagnosed with one of the critical illnesses listed in the policy and survives a minimum number of days (typically 30) from the date of diagnosis.
Such a policy may be underwritten to require payment for the same illness or condition that prompts the insured to make a claim under their disability policy—and to make payment immediately rather than some 90 days later.
The maximum number of months or years that a disability income policy will pay a benefit is referred to as the benefit period. Most disability policies written today provide benefits until the insured becomes eligible for Medicare or reaches age 65. Nonetheless, some insurance companies will write a policy that ensures disability payments are made throughout the life of the insured.
The longer the benefit payment period, the higher the insurance policy premium. As such, you should think very carefully about whether this trade-off is financially worth it.
During retirement, if you are looking for a financial product to make lifetime payments, some form of annuity policy is likely a less expensive way to ensure an income stream, rather than an extremely long disability insurance benefit period.
Finally, what most people are interested in when purchasing a disability income policy is the benefit amount that is payable.
The general approach in the underwriting of all disability income policies is to pay individuals slightly less than their net after-tax income if they were able to work, thus encouraging them to return to work as soon as possible.
This typically works out to a benefit payable of somewhere between 50 and 60 percent of an employee’s previous monthly gross pay. If you are covered at work by a group long-term disability policy at the time you apply for individual coverage, the amount of new disability insurance that you can obtain will probably be limited because of underwriting restrictions.
If this is the case, ask your insurance agent if the company will sell you a rider—an addition to the insurance policy with specified benefits or conditions—that allows you to increase the benefit amount without having to undergo a qualifying medical exam.
Or, better yet, purchase and implement an individual disability policy before you participate in the group policy; then you can receive both benefits in the event that you leave the company.
You should also consider whether and how much of your disability insurance income may be taxable. In other words, how much of this income do you actually get to keep? Fortunately, unless you are self-employed, the answer is relatively simple.
If the employer pays the disability income insurance premiums on your behalf, the disability income payments are taxable. Alternatively, if you pay the disability insurance premiums yourself, the disability income payments are income-tax-free.
Therefore, when coupling a group policy with individual disability coverage, the group payments are taxable, whereas those payments made from an individual policy are not. In summary, you are now in the same position you would be in if you had been able to continue working and were receiving a steady paycheck.
Let’s now address two other questions you should be sure to ask before purchasing an individual disability insurance policy. Each of these questions has to do with continuing policy coverage in the future and the price you must pay to obtain it.
Policy Continuation Provisions
The first question you should ask with respect to policy continuation is whether the policy can ever be canceled. In contrast to group policies, individual disability income policies may be underwritten as non-cancelable.
This is a guarantee that not only can the insurance company not cancel the policy, but it also cannot increase the policy premiums unless otherwise provided for in your contract. This kind of guarantee does not come cheap, particularly in today’s inflationary society, but you want the cash-flow protection if you can get it.
The second question to ask with respect to policy continuation is whether the company can raise your premiums. Certainly, if you have been fortunate enough to secure a non-cancelable policy, the answer is no.
However, what if you cannot or do not want to incur the additional cost of a non-cancelable policy? In that case, you have another option: you can purchase a guaranteed renewable policy.
A guaranteed renewable policy allows the insurance company to increase the premiums but not to change the terms of the policy once written.
The company also guarantees that you can renew the policy at the date of expiration as long as you have paid the premiums on a timely basis. In addition, the company cannot single you out for any rate increase; it may only increase the premiums for an entire class of similarly rated insureds.
Guaranteed renewable policies generally have lower premiums than non-cancelable policies. Once issued, insurance companies are loath to increase the premiums on guaranteed renewable policies for fear of creating disgruntled policyholders.
As such, it may be possible for you to get essentially the same level of protection with a guaranteed renewable policy as with a non-cancelable policy but at a much lower cost.
[Note: You can free download the complete Office 365 and Office 2019 com setup Guide.]
Additional Policy Benefits to Consider
Many individual disability policies offer additional benefits, usually in the form of a policy rider. Here are some of the more important possible additional benefits:
Cost of living adjustment (COLA) rider: The most common form of this rider increases the disability benefit paid after you start to collect benefits, thus protecting you against inflation.
Another form increases the policy benefits by a specified percentage (usually five percent) each year before you become disabled, thus ensuring your constant purchasing power once you begin to draw benefits.
Return of premium: This benefit requires the insurance company to refund a portion of your premium if no claims are made for a specified period of time.
Waiver of premium: This benefit allows you to stop paying the premium on the policy if you are disabled for a period of time, usually 90 days.
Partial disability rider: This benefit is triggered when you are unable to perform some important duties of your own occupation but are able to perform enough other duties to allow you to return to work part-time. In this event, the policy pays a partial benefit, such as 50 percent, of the total that would otherwise be payable.
Residual disability rider: This rider provides that if you are able to return to work full-time but at lesser pay than before due to a disability, the policy will pay the difference between your former pay and the current pay for the benefit period.
Guaranteed insurability rider (also known as an increase-in-benefits rider): This rider guarantees you the opportunity to increase the benefit amount payable under the policy at specified time periods, regardless of your physical or mental health at the time.
A usual requirement to obtain this rider is that you must have initially purchased a disability policy that is at least 80 percent of the maximum benefit amount that the insurance company would approve.
Just as with other insurance contracts, it is important to know what is not covered under a disability income policy. These are known as policy exclusions and, with respect to disability income policies, refer to particular injuries or illnesses that may result in the insured not being able to work.
Those that are most frequently encountered are disabilities resulting from War or an act of war
Pregnancy or complications from childbirth
The insured committing or attempting to commit a crime
A period when the insured was incarcerated
An injury or disease that was self-inflicted, including those related to or caused by drinking alcoholic beverages or the illegal use of drugs
Remember, if your disability results from any one of these exclusions, the policy will likely not pay benefits.
Questions to Ask Before Purchasing an Individual Disability Income Policy
What is the definition of disability in my policy?
What is the amount of benefit payable from my policy?
Do I have to pay taxes on that benefit?
How long are my benefits payable?
Is my benefit adjusted for inflation (and if so, in what amount)?
Is there an elimination or waiting period before I can begin to receive my benefit (and if so, how long is it)?
Is there a way I can ensure that payments are made during this waiting period?
Can I renew my policy without undergoing a medical examination?
Can the company increase my policy premiums?
What are the policy exclusions and do they affect me?
This blog concludes our look at personal risk exposures. Now, let’s consider a risk exposure that most of us also have: the risk of loss or damage to our property, such as a home or automobile. Business insurance for self-employed individuals is also addressed in the next blog.
Ensuring Your Earning Power
Ask any financial planner or insurance agent what the most neglected or underinsured financial risk is, and they are likely to say the risk of losing your ability to earn a living. Most individuals simply do not give sufficient attention to this possibility and, if they do, believe that they are adequately covered.
In other words, they believe they will never lose their earning power. However, according to the Commissioner’s Individual Disability Table A, one in three working Americans will suffer some form of disability that lasts at least 90 days before they reach the age of 65. In addition, one in seven employees will be disabled for five or more years prior to their retirement.
You are two to three times more likely to become disabled during your working career than you are to die during this same period. These are impressive (and somewhat frightening) numbers.
Many individuals believe they are adequately insured against the loss of future earning power because they are covered by a group disability income policy at their place of employment. However, there are two major flaws in this thinking:
Most employer policies replace only 50–60 percent of your monthly income.
The replacement income provided by this benefit is likely income-taxable since the employer paid the cost of the insurance premium while you were working. In turn, this means you will receive less than the 50–60 percent of monthly income promised to you.
How can this often-forgotten risk be adequately covered? Most commonly through the purchase of an individual disability income policy.
Is the Loss of Your Earning Power Already Adequately Covered?
There are other forms of insurance that you may rely on to protect your earning power in the event that you are unable to work. Among these is supplemental income insurance, which is designed to pay your living expenses while you are disabled. The best known of these policies is issued by American Family Life Assurance Company—better known as AFLAC. Quack, quack!
In addition to supplemental policies, employee benefits from your employer are typically available, as mentioned previously. For short-term illness, your employer may provide sick leave, short-term disability income protection, or both.
Furthermore, all employers are mandated by the state to provide worker’s compensation benefits in the event of a serious injury while on the job. Keep in mind, however, that most employers only provide group long-term disability policies.
Benefits from these types of policies begin when short-term benefits if there are any, stop. Long-term benefits then generally continue until you reach age 65, until your full retirement age under Social Security, or until you return to work.
Group policies include a cap or limitation on the amount they will pay—usually no more than 60 percent of your monthly income. Plus, as with most employee benefits, once you leave your current place of employment, the disability income coverage is terminated.
Social Security income protection, on the other hand, is a disability benefit provided under the Social Security system, but qualifying for it is not easy (some would say impossible—at least for a first-time application). Specifically, to qualify for a disability benefit under Social Security, you must
Have been disabled for at least five full calendar months
Have a disability expected to last at least 12 months or end in death
Be unable to engage in any substantially gainful occupation and not just your own occupation at the time your disability begins
Like funding for possible long-term care needs, many individuals (if they have given any thought to their chances of becoming disabled) attempt to self-fund for disability through investment.
To determine what you would need to self-fund for this possibility, review the basics of what we have discussed so far—most notably, how to prepare and analyze a personal cash- flow statement—and see what your monthly expenses are.
Then multiply this amount by 12 and determine the amount of your total annual expenses. Doing so gives you some idea of the funds needed to take you through one year of disability.
Most long-term disabilities last more than a year, so you should now be able to appreciate the actual amount of savings needed to cover the risk of loss to your earning power.
Most people cannot afford to self-fund for very long, which brings us back to considering the purchase of an individual disability income insurance policy.