Disability Insurance & Income Protection
— Necessary but often Neglected

 PART 1:
Why is Disability Insurance important?

Your most important asset is not your home, your car, your jewelry, or other posses­sions. It’s your ability to earn a living. Think about it: All of your plans for the future — from buying a home to putting your kids through college to building a retirement nest egg — are based on the assumption that you will continue to earn a paycheck until you retire. But what would happen if those paychecks stopped? That’s where disability insurance comes in. It provides an income to you and your family if you are unable to work because of illness or injury.

Your income is typically your largest asset. Think about how much you earn in a year and what that would be over a lifetime. The financial consequences of a lengthy disability could literally cost you millions. A 25-year-old worker who makes $50,000 a year and suffers a permanent disability could lose $3.8 million in future earnings. A physician earning $200,000 per year could lose even more. You don’t hesitate to insure your home, car, and other valuable possessions, so why wouldn’t you insure something that is much more valuable than all those things?

For many, a sudden interruption of income could have serious financial consequences. Most of us have some kind of personal debt, typically a mortgage or credit card bills. Would you be able to maintain your standard of living if you were too ill or injured to work for an extended length of time? Half of all home foreclosures in the United States result from disability, as do an alarming number of personal bankruptcies.

The other thing to keep in mind is that an accident or illness that keeps you out of work for a period of time can be very costly. That’s because people who become disabled not only need to continue providing for loved ones, but for themselves as well. A disabling injury or illness could lead to medical bills, modifications to your car or home, or other unforeseen needs that can be quite expensive. For all these reasons, almost anyone who works — whether they’re single, married, with children, or without — should consider disability insurance.

 PART 2:
What does basic Disability Insurance cover?

Disability insurance replaces a portion of your income if you become disabled and are no longer able to work. A typical plan will replace up to 60-80% of your salary. (With some plans, this may be offset by any other benefits you may receive from social security or worker’s comp.) Note that no plan will cover all of your salary for fear you will have little or no incentive to get back to work. Benefits typically last for a set number of years (say five years) or until you reach retirement age. (Benefits typically stop around retirement age since once you retire, you would no longer be dependent on the income you generated by working, anyway.) If you pay the premium out-of-pocket — meaning your employer doesn’t cover the tab — benefits are tax free.

 PART 3:
Short Term vs Long Term Disability

Short-term disability insurance, also known as sick leave, kicks in as soon as you’re unable to work due to an illness, injury, or the birth of a child. Most employers provide some type of coverage, ranging from just a few days to as much as one year. In some cases, the number of weeks you’re eligible for this benefit is based upon how many years you worked at a company. The longer your service, the more paid sick leave you’ll get.

Five states require employers to provide short-term disability. Hawaii, New Jersey, New York, and Rhode Island mandate most employers provide 26 weeks of coverage. In California, employers are obligated to offer 52 weeks.

Long-term disability insurance kicks in once your short-term disability benefits run out. Unfortunately, there are no state laws that require employers to provide long-term disability, but it’s estimated that half of all midsized to large firms do provide at least some insurance.

Most people buy individual Long-term disability policies to supplement what they receive at work because group policies are usually capped at 60% of base salary. Coverage can be very low for those with significant bonuses or pay scales. Individual policies will help cover this gap. In addition, you usually lose the group disability coverage once you move to another company, and if your health has declined, it might be too late to get affordable premiums for individual coverage.

Another shortcoming: Many employer group policies limit the amount of time it will pay benefits if you can’t perform your job duties to just two years. After that, you’ll need to prove you can’t hold down a job.

But Long-term disability policies vary greatly. While some are iron-clad and pay benefits when you need them, others have more holes than a sieve. Those trying to save some money with a leaner plan may find it ultimately worthless. At the same time, you don’t want to buy extra riders and coverage to insure every remote possibility that may not occur. Disability insurance can quickly become expensive.

 PART 4:
Riders and extra costs

I happen to be a minimalist when it comes to insurance. I believe one should have enough to help in case of a rainy day, but not over-insure either. I like to insure against drastic life changes or complete income loss, but not necessarily pay for riders to cover every possi­bility. (Riders are add-ons to basic insurance policies that provide extra coverage or benefits for additional premium costs.)

Catastrophic Disability

One rider I think can be skipped — if you want to keep premiums low — is the Catastrophic Disability rider. This rider allows you to purchase an additional benefit amount that will be paid if you are catastrophically disabled. Catastrophically disabled means you have a complete and irrecoverable loss of sight in both eyes, hearing in both ears, speech; or the use of both feet, both hands, or one foot and one hand. Traditionally you will also be considered catastrophically disabled if you are totally disabled and have Alzheimer’s disease or other irrecoverable forms of dementia, senility, paraplegia, or quadriplegia. Whereas these are extremely debilitating occur­rences, they are also not so common and will have some coverage already through existing benefits in the basic plan.

Refund of Premium / Good Health Benefit

By having this rider on your policy, the insurance company will refund a percentage of the premium paid over a defined period of time that you remain healthy and not on disability claim, until age 65. (Usually 50% of premiums paid for each 5-year period you remain healthy, or 100% of premiums at age 65) This is a way of reducing the overall cost of having disability insurance, if you do not go on claim. Unfortunately, the cost of this benefit is so high (usually a 40-60% bump in your premium) that it is almost never worth it.

Residual (Partial) Disability

Adding a Residual disability rider to your policy will expand the definition of disability to include a “partial” disability. Although the specifics of this rider will differ with each insurance carrier you consider, it typically provides a partial benefit when your earnings are reduced by at least 15-25% as a result of an injury or illness. This is extremely useful to have, though it costs upto 20-25% more in premium, because it is rare for someone to be totally disabled and not working at all. The more typical scenario is that someone voluntarily returns to work because they don’t want to sit idle at home, yet they work only 25 hours per week instead of 40. This rider will kick in with a proportionate amount of coverage for the income lost.

Cost of Living Adjustment — COLA

The COLA rider is intended to protect you from the risk of inflation. Beginning after one full year of disability, your benefit will increase by 3-6%, every year that you are disabled and receiving benefits. This increase in benefit is intended to protect the purchasing power of your benefit throughout a Long-term disability. Although I almost always recommend this rider since inflation can quickly erode benefit purchasing power, one note of caution is that this rider does not increase benefits until AFTER you have a disability. So if your benefit is at $5000/month and you don’t have a claim for 10 years, the $5000 per month benefit will start seeing a 3-6% increase after the 11th year.

Future Increase Purchase Option / Automatic Increase Option

To make up for the COLA rider not kicking in until time of claim, the Future Increase rider gives you the ability to increase your monthly benefit at a later date without having to re-qualify medically. You are able to increase your level of coverage at the policy anniversary (or at certain intervals), by simply showing financial documentation (W-2, 1040) that warrants the increase in coverage. Or, if you change companies and lose your supplemental group disability benefits, you are usually allowed to increase your individual coverage soon after. Sometimes this rider is included free-of-charge, and sometimes there is a cost, but for most young people who expect to see a rise in income, especially residents, it’s a must have either way.

True Own Occupation

True Own Occupation riders seem to duplicate what’s already included for free in some policies as a “Modified” Own Occupation. With Modified Own Occupation riders, if you can’t work in your own occupation due to disability, you will not be forced to take on a minimum wage job even if you are medically able. The disability benefits will still come in.

However if you pay for an additional “True Own Occupation” rider, you can voluntarily work in another occupation, like teaching or research, earn as much as you did previously, and still get disability benefits — thus doubling your income. I find that the need for this rider depends on the situation. For those looking to lower their premium, it might make sense to forgo this because if you are earning an income in another profession, why get more disability benefits on top of it? It may not be worth paying tens of thousands in extra premiums for that benefit. You want to pay premiums to protect yourself against loss of income, not to double your income.

However, for some professions that involve physical factors such as surgeons working with their hands or radiologists working with their eyes, it might be worth to insure against the possibility that they can never return to their profession again. Often times they also have trouble getting 60% disability coverage for their salary, since they are so high, and this is one way to increase the percentage of income covered. For others, especially knowledge workers who are at their desks and not involved in a very physical or specialized profession (like an IT consultant), it might not be worth adding this rider because being able to teach or consult probably means you would be able to return to your own profession as well.

Summary of Riders

As always, my advice depends on each person or family’s situation, profession, and available coverage through work, but more often than not, I’ve usually seen myself recommending the basic Disability insurance with COLA and Residual riders, and a Future Benefit increase option if it is not included and the client expects significant income increases. For some, the True Occupation rider may also be warranted. However, as we will learn in the next section, each company varies in what they include for free or for cost, and each company differs in how they define these benefits. So shop carefully!

 part 5:
Differences between Carriers

The two most common Disability policies I see offered to white-collar professionals is Guardian or Principal. Guardian is usually the more expensive of the two, and is regarded as a good deal for many specialized physicians because of the fact that Guardian has a “True Own Occupation” benefit already included without additional cost. However, it’s overall policy is usually a lot more expensive than Principal, so the cost of that rider is there, it’s just embedded in the basic policy itself, instead of as an additional, separate rider. (Please note that carriers constantly change and update their policies, so check with your financial advisor before choosing a firm.)

Principal seems to offer a reasonable amount of coverage for a reasonable cost as compared to most other policies. MetLife’s Standard, MassMutual, Unum, and a few other policies also exist, but many of these have holes in them and will not pass the test should an actual disability claim arise.

The important point to note is that not all Disability Insurance policies are alike! There can be small, but significant differences in how they define certain terms.

FOR EXAMPLE:

RESIDUAL RIDER — Guardian will pay actual dollars lost, vs. a percentage of loss of income for the first 12 months. After that, it does percentage of income, but has a bit more leniency in that it defines partial income loss above 15% decrease in earnings, whereas the Principal Residual rider kicks in at a 20% loss.

COLA RIDER — There is no cost to keep the COLA increase in place if you go on claim and then return to work with Guardian. With Principal, you have to pay for the COLA increase in order to keep it active should you return back on claim in the future. However Principal is cheaper to begin with, so in my opinion this extra benefit isn’t worth paying for upfront.

IRREVOCABLE vs REVOCABLE DISABILITY — Guardian benefits will kick in even if certain types of disability are revocable, Principal only if it’s irrevocable. But this benefit applies only in certain cases, in most definitions of disability the two policies operate similarly.

MENTAL DISORDER — Guardian has a more liberal benefit and payment period for mental disorders.

FUTURE INCREASE OPTION — Guardian has fewer restrictions, but you have to pay for this rider whereas with Principal it’s mostly included.

SUMMARY OF GUARDIAN vs PRINCIPAL

Although I usually recommend Principal over Guardian, there are many cases — especially for Physicians — where Guardian is the better choice. So when making the very important decision of what type of Disability insurance to get, the final takeaway is that there are many variables involved in choosing the right policy. Make sure you work with a reputable, knowledgeable planner who will educate you on the right choices for your situation, and be sure you understand what you are signing on for BEFORE agreeing to thousands of dollars in premiums for the next 20-30 years. The right policy can bring peace of mind and security in time of need. The wrong policy can defeat the whole purpose of insurance and set you back financially in more ways than one.

As always, please do not hesitate to contact me if you’d like to learn more — I’m happy to help you make the right, educated decision for you and your family!