Disability insurance

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Disability insurance often called DI or disability income insurance, is a form of insurance that insures the beneficiary's earned income against the risk that disability will make working (and therefore earning) impossible.[1]

Disability definitions

Disability insurance is all about the definition of disability. Only a few people have a truly comprehensive disability policy through their employer. This is because the definition of disability for group policies usually requires that, when making a disability claim, you cannot work in your job "or any other job" (or something to that effect). As as a result, you usually must be completely and totally disabled on a permanent basis to collect long term disability from your employer.[2]

A good individual disability policy will have what's called an own-occupation definition. That definition says that if you cannot work in your job, even if you can work in another job, they will still pay 100% of the benefits.

  • True own occupation: One is disabled if they can't do their occupation.
  • Modified own occupation: The insurance company can't make one do another occupation. If he so chooses, he would no longer be totally disabled and would collect under partial disability.
  • Any occupation: You are unable to perform the material duties of any occupation for which you are trained or can be trained to perform.

Social Security definitions

The Social Security Administration provides disability benefits, but implements a very strict definition:[3]

  • No benefits are payable for partial disability or for short-term disability.

"Disability" under Social Security is based on your inability to work. You are disabled under Social Security rules if:

  • You cannot do work that you did before;
  • (Social Security Administration) decides that you cannot adjust to other work because of your medical condition(s); and
  • Your disability has lasted or is expected to last for at least one year or to result in death.

Group disability policies may integrate with Social Security disability insurance; meaning that a policy holder's benefits will be reduced by the Social Security benefit.

Well-written policy

A well-written policy should contain the following.[4] Refer to this forum thread post for further discussion regarding the differences between individual and group policies as described here.

Must have

  1. Guaranteed Renewable/Non-cancellable: You cannot be dropped, rates cannot be raised, and coverage cannot be changed.[5]
  2. Coverage for your own occupation for the entire time: This can be true own-occupation or modified own-occupation. When combined with Guaranteed Renewable/Non-cancellable this means that when a CPA quits his job to become a ditch digger, "ditch digger" is his new occupation. The insurance company must maintain the same benefit at the same price regardless that it does not insure ditch diggers and that his income is well below his former occupation.
  3. Coverage until age 65
  4. Coverage for both total and partial disability without having to be totally disabled first
  5. Cost of living adjustment (COLA): A benefit that increases with inflation (usually a flat percentage as opposed to the Consumer Price Index (CPI))
  6. Coverage past the age of 65 or money that goes into a trust for retirement
  7. A big enough benefit to allow one to maintain their standard of living that they would like if they do collect.
  8. Recovery Benefits to age 65: A must have for anyone who is self employed or will be in the future.

Nice to have

  1. True own-occupation coverage
  2. No limitations on mental/nervous disorders
  3. No integration with government programs

Group versus individual policy considerations

The policy holder should be cognizant of differences between group and individual policies. Some limitations of group policies:[6]

  1. If the policy is given to the employee without grossing up their income, the benefit is taxable.
  2. The benefit doesn't increase with inflation.
  3. The benefit is integrated with Social Security disability insurance and Workmen's Compensation.
  4. It doesn't pay for partial disability.
  5. It pays for partial disability, but one must be totally disabled first.
  6. It has an "any occupation" definition of disability or if it has an "own occupation" definition, the definition is temporary.
  7. It may offer certain "own occupation" coverage for a period of time, but after that time period, it may eliminate benefits if you can be employed in "gainful employment" in a different profession at any salary or at a percentage of your insured earnings.
  8. It isn't enough coverage.
  9. It doesn't cover retirement plan contributions.
  10. It is covered by ERISA (Employee Retirement Income Security Act). This makes it much easier to deny legitimate claims. It's not coincidental that the vast majority of claims are with group policies.
  11. The entire group can be dropped.

Another consideration is for plans that are self-insured (Company Insured) versus those where premiums are paid to an insurance company. In a Company Insured disability plan, the Company owns the policy and sets up payments with a payment agency. But if the Company goes out of business, or is acquired by another company, there is no federal regulation or requirement that the policy continue.[7]

Short-term versus long-term disability

Short-disability is intended to cover a temporary inability to work; up to 6 months of coverage may be offered. Long-term disability covers from that temporary period of time up-to and including permanent disability. The typical 6 month long-term disability waiting period reflects this intent.

Employers may offer both short-term and long-term disability insurance policies. If a short-term policy is not offered, consider costs of a private short-term disability policy versus withdrawals from an emergency fund.

State-mandated disability insurance

Five states and the Commonwealth of Puerto Rico require employers to provide Temporary Disability Insurance (TDI) programs.[8] Off-the-job injuries or illness apply here. On-the-job injuries or illness are covered by Workmen's Compensation.

States (Commonwealth) which Require Employer-Provided Disability Coverage
State Information
California Employment Development Department, Disability. There are two programs: Disability Insurance and Paid Family Leave Insurance.
Hawaii TEMPORARY DISABILITY INSURANCE (TDI). The employer's plan determines how much benefit the employee will receive each week, how long the employee will be paid and whether the employee has to serve a waiting period.
New Jersey Temporary Disability. There are 3 plans: State, Private, and Disability During Unemployment.
New York NY Workers' Compensation Board (Disability Benefits area). Introduction: What are Disability Benefits?.
Puerto Rico
(Commonwealth)
Departamento del Trabajo y Recursos Humanos (Department of Work and Human Resources)

Ley 138, Ley de Beneficios por Incapacidad Temporal - SINOT (Law 138, Benefits Law for Temporary Disability - SINOT)

Rhode Island RI Department of Labor and Training, Temporary Disability Insurance. Frequently Asked Questions.

Work-related injury (workmen's compensation)

Disability insurance benefits are generally a matter of agreement between an employer and an employee (or the employee's representative).[9] Individuals injured on the job while employed by private companies or state and local government agencies should contact their state workers' compensation board.

The Federal Employees' Compensation Act (FECA), administered by the Office of Workers' Compensation Programs (OWCP), provides compensation benefits to federal employees for temporary disability due to employment-related injury or disease.

Group disability policies may integrate with workmen's compensation; meaning that a policy holder's benefits will be reduced by the amount of compensation.

Examples

With a good contract, it is all about one's ability to do their occupation at the time of disability.[10]

Notional example 1

The following is a notional example to demonstrate the concept:

Jim is a CPA making $110,000/year. He has an individual policy with an own occupation definition of disability. His benefit is $5,000/month.
He goes to the doctor for his annual physical. The doctor informs him that he has AIDS, Cancer, hepatitis, alzheimers, parkinsons and a cold. He is not disabled because he can still do his job.
One day after work, he goes into a bar and buys a drink for the homeless man next to him. The "homeless" man turns out to be Jesus. To thank him for his kindness, Jesus cures him of all his illnesses. Jim rethinks his life and quits his job as a CPA and decides to become a grave digger for $12/hour.
In Jim's weekly basketball game, he fractures his hand and can no longer grip a shovel. He is totally disabled and instead of getting paid a taxable $12/hour, he will collect a tax free $5,000/month.

Explanation: Purchasing disability coverage is all about what one is doing when they purchase the policy. A good policy will be guaranteed renewable and non-cancellable. This means that the insurance company can't raise the rates and can't change any of the terms. Collecting on a policy is all based upon what they are doing at the time of disability.

So, although a company won't issue a policy on a $12/hr ditch digger, they are stuck insuring one when someone with prior coverage chooses to become one. Because benefits are a dollar amount and not a percentage, the insured can financially benefit from becoming disabled.

Notional example 2

A surgeon incurs permanent nerve damage in his hands. He can't perform surgery now, but can still teach at a medical school. With an own-occupation definition, he could collect the disability benefit while still earning six figures teaching at medical school on top of that.[11]

If the definition was like a group plan and said he wasn't able to work in any job, they would not pay a claim since he could still teach.

Taking that a step further, even if he couldn't teach, but could hand out stickers to shoppers at Wal-Mart, they still may not pay a claim since he can still "work" even though he'd earn $7/hour instead of $500k/year.

See also

References

  1. Disability insurance, from Wikipedia
  2. Disability Insurance -- for a "thinking" job, forum discussion, direct link to post.
  3. What We Mean By Disability, from the Social Security Administration.
  4. Disability Insurance -- for a "thinking" job, forum discussion, direct link to post.
  5. Definitions from the Insurance Information Institute, What are the types of disability insurance?:
    • Noncancellable: The policy cannot be canceled by the insurance company, except for nonpayment of premiums. This gives you the right to renew the policy every year without an increase in the premium or a reduction in benefits.
    • Guaranteed renewable gives you the right to renew the policy with the same benefits and not have the policy canceled by the company. However, your insurer has the right to increase your premiums as long as it does so for all other policyholders in the same rating class as you.
  6. Disability Insurance -- for a "thinking" job, direct link to post.
  7. Disability Insurance -- for a "thinking" job, forum discussion, direct link to post.
  8. Temporary Disability Insurance Frequently Asked Questions, from the RI Department of Labor and Training
  9. Disability Insurance, from the U.S Department of Labor
  10. Disability Insurance -- for a "thinking" job, forum discussion, direct link to post.
  11. Disability Insurance -- for a "thinking" job, forum discussion, direct link to post.

External links

Social Security Administration

Insurance Information Institute

A. M. Best