Disability income insurance is a broad and complex topic. This section will introduce you to some of its basic principles. You will learn about the conditions under which a person can qualify for disability benefits, the specifics of individual and group disability underwriting, and the benefits that are available through the Social Security and Workers Compensation programs. With disability insurance, the key is to understand what injuries qualify for benefits, how much the payments will be, and how long they will last.
TERMS TO KNOW
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Benefit period — a period of time during which benefits are paid under the policy
Capital sum — a portion of the principal sum of a health insurance policy; paid for accidental dismemberment or loss of sight in one eye Earned income — salary, wages, or commissions; but not income from investments, unemployment benefits, and similar sources of income Overinsurance — insurance that exceeds in amount the actual value of the person or property insured or insurance in a greater amount than the insured can afford Principal sum — the amount of coverage paid for an accidental death under a health insurance policy Social Security Disability Insured Status — fully insured or currently insured, depending on the number of coverage credits earned Tax deductible — a qualified expense that may reduce the amount of income subject to taxation Taxable — subject to taxation Total disability — inability of the insured to perform any occupation for which he or she is reasonably suited by reason of education, training or experience Waiver — relinquishment of a right or interest | |
One major risk that individuals face in their lifetime is the possibility that they will become totally disabled and be unable to perform work duties for a period of time. Recent statistics show that there is a 30% chance of a 25-year-old being disabled for more than 90 days prior to age 65. It is far less likely that the same 25-year-old will suffer a premature death prior to age 65.
For most people who are unable to go to work, employment income would terminate after a brief period of time. Consequently, most people would be forced to turn to personal savings to pay normal living expenses such as food, rent and utilities. One should ask how long he or she could survive without any income.
Disability income insurance is designed to replace lost income in the event of this contingency, and is a vital component of a comprehensive insurance program. It may be purchased individually or through an employer on a group basis.
A. Qualifying for Disability Benefits
Disability income benefits are limited to a percentage of earned income. The insurer wants a claimant to have a financial incentive to return to work. A person becomes eligible for regular disability benefits when they meet the insurance company's definition of disability due to either a sickness or an injury. This definition of disability does vary from company to company. It is important for the applicant and the producer to be fully aware of this important benefit trigger.
1. Inability to Perform Duties
To pay benefits, a disability income policy will require for the insured to not be able to perform the duties of his or her occupation. The benefits will also depend on the definition of disability chosen for the policy.
Own Occupation
An own occupation policy will provide benefits when the insured is unable to perform any duties of his/her own occupation because of sickness or accident.
This definition is usually limited to the first 24 months after a loss. It allows insureds (claimants) to receive benefits if, because of disablement, they cannot perform the duties of their normal occupation even though they might be able to earn income from a different occupation. After 24 months, if the insured is still unable to perform the duties of his or her own occupation, the definition of disability narrows to mean the inability to perform any occupation for which the insured is reasonably suited by education, training, or experience. This is a dramatic reduction in the insurer's liability because it is very likely that claimants can find something they can do for financial gain. The “own occ” definition is generally used for highly trained, skilled occupations such as surgeons, trial attorneys, etc.
Any Occupation
A policy that has an "any occupation" provision will only provide benefits when the insured is unable to perform any of the duties of the occupation for which they are suited by reason of education, training, or experience. "Own occupation" is the more liberal definition and therefore provides a better benefit for the insured.
Although some companies still utilize the two-tier approach by combining both definitions in a single disability income policy, from an underwriting standpoint, it is much easier for an insurance company to justify the "any occupation" definition when agreeing to issue a policy.
2. Presumptive Disability
Presumptive Disability is a provision that is found in most disability income policies which specifies the conditions that will automatically qualify the insured for full disability benefits. Some disability policies provide a benefit when people simply meet certain qualifications, regardless of their ability to work. The presumptive disability benefit provides a benefit for dismemberment (the loss of use of any two limbs), total and permanent blindness, or loss of speech or hearing. Some policies require actual severance of limbs rather than loss of use.
3. Proof of Loss
All life insurance or annuity contracts that provide disability benefits, including waiver of premium, must include a proof of loss provision. Contracts must establish when and how the insured must prove the disability. They must also allow for regular examinations of the insured by the insurer.
The claim will not be invalidated or reduced if it is impossible for the insured to produce proof of disability within the time frame, provided such proof is furnished as soon as reasonably possible.
Except in the absence of legal capacity, proof of loss must be provided no later than 1 year of the time proof would otherwise be required.
B. Individual Disability Income Insurance
An individual Disability Income policy is applied for and paid for by the individual rather than through the employer as for group disability income. Individual Disability Income premiums are paid with after-tax dollars, and benefits are not income taxable.
1. Basic Total Disability Plan
A total disability plan protects the family or an individual against the economic loss that comes with the total disability of the wage earner.
Income Benefits (Monthly Indemnity)
Most often, benefits are paid monthly, but could be paid weekly in some policies. The amount of the benefit is stated in the policy and is usually limited to a percentage of one’s income at the time of application to prevent overinsurance.
Elimination and Benefit Periods
Elimination period is a waiting period that is imposed on the insured from the onset of disability until benefit payments commence. It is a deductible measured in days, instead of dollars. The purpose of the elimination period is to eliminate coverage for short-term disabilities in which the insured will be able to return to work in a relatively short period of time. The elimination periods found in most policies range from 30 days to 180 days. Just as a higher deductible amount results in lower premiums for medical expense insurance, a longer elimination period translates into a lower premium for disability income insurance. An important consideration in selecting the elimination period is that payments are made in arrears. Therefore, if the insured selects a 90-day elimination period, the insured will be eligible for benefits on the 91st day, but payments will not begin until the 121st day. The insured must determine how long he or she can go without benefit payments following disability in selecting the duration of the elimination period.
Benefit period refers to the length of time over which the monthly disability benefit payments will last for each disability after the elimination period has been satisfied. Most policies offer benefit periods of 1 year, 2 years, 5 years, and to age 65. Some plans offer lifetime benefits. The longer the benefit period, the higher the premium will be.
Injury is defined using either the accidental bodily injury definition, or the accidental means definition. Accidental bodily injury means the damage to the body is unexpected and unintended. Accidental means indicates that the cause of the accident must be unexpected and unintended. A policy that uses the accidental bodily injury definition will provide broader coverage than a policy that uses the accidental means definition.
Sickness or illness is defined as either a sickness or disease contracted after the policy has been in force at least 30 days; or a sickness or disease that first manifests itself after the policy is in force.
Often, the insurance company will allow the insured to have different benefit periods for injury and sickness. For example, the insured could apply for benefit periods of 5 years for sickness, but to age 65 for accident.
Recurrent Disability is generally expressed in a policy provision that specifies the period of time (usually within 3-6 months), during which the recurrence of an injury or illness will be considered as a continuation of a prior period of disability. The significance of this feature is that recurrence of a disabling condition will not be considered to be a new period of disability so that the insured is not subjected to another elimination period.
Waiver of Premium Feature
Waiver of premium is usually included in a basic disability income policy. This benefit allows the insured, when disabled, to forego paying the premiums once he/she qualifies for benefits. Premiums that were paid by the insured during the elimination period are usually refunded once the insured qualifies to begin receiving benefits.
2. Coordination of Benefits
The purpose of the coordination of benefits (COB) provision, found only in group health plans, is to avoid duplication of benefit payments and overinsurance when an individual is covered under multiple group health insurance plans. This provision limits the total amount of claims paid from all insurers covering the patient to no more than the total allowable medical expenses.
The COB provision establishes which plan is the primary plan, or the plan that is responsible for providing the full benefit amounts as it specifies. Once the primary plan has paid its full promised benefit, the insured submits the claim to the secondary, or excess, provider for any additional benefits payable (including deductibles and coinsurance). In no case will the total amount the insured receives exceed the costs incurred or the total maximum benefits available under all plans.
Loss - Amount covered by Primary Plan = Amount covered by Secondary Plan
If all policies have a COB provision, the order of payments is determined as follows:
- If a married couple both have group coverage in which they are each named as dependents on the other's policy, then the person’s own group coverage will be considered primary. The secondary coverage (the spouses' coverage) will pick up where the first policy left off.
- If both parents name their children as dependents under their group policies, then the order of payment will usually be determined by the birthday rule, i.e. the coverage of the parent whose birthday is earlier in the year will be considered primary. Occasionally, the gender rule may also apply, according to which the father's coverage is considered primary.
- If the parents are divorced or separated, the policy of the parent who has custody of the children will be considered primary.
3. Individual Premium Consideration and Coordination with Social Insurance
Premium payments on personally owned disability income policies are nondeductible by the individual. However, disability income benefits are received income tax free by the individual.
In order to avoid overinsurance, the insurance companies have several options to work with Social Security benefits.
Additional Monthly Benefit (AMB)
Some insurance companies offer the Additional Monthly Benefit rider in the approximate amount that Social Security would pay. The benefit only is provided for one year. It is then anticipated that Social Security benefits would commence at the end of one year.
Social Insurance Supplement (SIS)
The insurance company may offer a Social Insurance Supplement rider (note: this is a rider, and not a separate plan), which will pay a benefit in the approximate amount that Social Security would pay, but if Social Security does in fact pay, the Social Insurance Supplement benefit is reduced dollar for dollar by the Social Security benefit payment.
Social Insurance Supplement (SIS) riders are used to supplement or replace benefits that might be payable under Social Security Disability. These provide for the payment of income benefits generally in 3 different situations:
- When the insured is eligible for Social Security benefits but before the benefits begin (There is a usually a 5-month waiting period for Social Security benefits, with the payment of benefits beginning on the 6th month);
- If the insured has been denied coverage under Social Security (Roughly 75% of the people who apply for Social Security benefits are denied coverage because of their rigid definition of "total disability"); or
- When the amount payable under Social Security is less than the amount payable under the rider. (In this case, only the difference will be paid.)
These riders can also be used to replace or supplement benefits payable under other social insurance programs, such as Workers Compensation.
Occupational vs. Nonoccupational Coverage
Health insurance, including disability insurance, can be written on an occupational or a nonoccupational basis. Occupational coverage provides benefits for illness, injury or disability resulting from accidents or sicknesses that occur on or off the job. Nonoccupational coverage, on the other hand, only covers claims that result from accidents or sicknesses occurring off the job. While many individual health policies are written on an occupational or nonoccupational basis, most group plans are nonoccupational only. It is assumed that accidents or injuries occurring on the job will be covered by Workers Compensation coverage.
Cancellation and Renewability
The insurer has the right to cancel an individual accident and health policy within the first 90 daysafter its issue, as long as the insurer provides a 10-day notice to the insured. The insurer must return any unearned premium on a pro-rata basis.
Typically, disability income policies are renewableuntil the insured’s age 65. The continuation of coverage rider provides that the insured can renew the policy after age 65 as long as they are actively and gainfully working full-time.
4. Other Provisions Affecting Income Benefits
Insurance companies offer other riders, which can affect the income benefit in the disability income policy.
Cost of Living Adjustment (COLA) Rider
The purchasing power of disability benefits can be eroded by inflation. The cost of living adjustment (COLA) rider will help protect against inflation. Under this rider the insured’s monthly benefit will be increased automatically, once claim payments have begun. Generally, the first increase would be at the end of one year to be followed by annual increases for as long as the insured remains on the claim. Some of these riders provide for compound interest adjustments while others provide simple interest adjustments.
Future Increase Option (FIO) Rider
Guaranteed Insurability Rider, also referred to as the Future Increase Option, allows an insured to increase the benefit level to a specific predetermined amount at certain times or on certain occasions without proof of insurability. The times when the benefit may be increased are generally at ages 25, 28, 31, 34, 37 and 40. An increase may also be taken at one’s marriage or the birth of a child. In order to exercise this rider, the insured must qualify from an income standpoint to prevent overinsurance.
Relation of Earnings to Insurance
The danger of being over-insured is always a potential risk with health insurance coverage, but this is especially true regarding disability income. The concept of indemnity must be protected.
All disability income insurers use the Relation of Earnings to Insurance rule which allows the insurer to check the income of the insured for a specified period of time prior to the submission of an income claim. There will be a percentage cap that the insurer will enforce.
A disability income insurer does not want a situation where there is no incentive for an insured to seek rehabilitation because that insured is receiving a greater income while disabled than he/she received while working.
This is also why if an insured is covered by multiple policies, insurers are liable for only a proportionate amount of the disability benefits the insured will receive. This is figured by comparing the amount a single insurer will pay with the amount that would be paid by all insurers. However, the total monthly benefits cannot drop below the lesser of $200 or the sum of the monthly benefits specified in coverage.
5. Benefits
Accidental Death and Dismemberment
A disability policy may contain an Accidental Death and Dismemberment rider which pays for accidental losses only, and is thus considered a pure form of accident insurance. The principal sum is paid for accidental death. This amount is usually equal the amount of coverage under the insurance contract, or the face amount. In case of accidental dismemberment or loss of sight in one eye, a percentage of that principal sum will be paid by the policy, also referred to as the capital sum. The amount of the benefit will vary according to the severity of the injury.
For example, the policy will usually pay the full principal for the loss of sight in both eyes, or two or more limbs; however, it may only pay 50% for the loss of one hand or one foot. In addition, some policies will pay double or triple indemnity, meaning the policy will pay twice or three times the face amount in the event of accidental death. Most policies will pay the accidental death benefit as long as the death is caused by the accident and occurs within a specific time, such as 60-90 days.
Rehabilitation Benefit
If the insured has been totally disabled, it is possible that rehabilitation will be necessary to help get the insured back to work, either in their old occupation or in another occupation. The rehabilitation benefit will cover a portion of the cost for the insured to enroll in a formal retraining program that will help the insured to return to work. This benefit usually offers a specified sum (several times of the monthly indemnity) to cover costs not paid by other insurance.
Medical Reimbursement Benefit (Nondisabling Injury)
This benefit provides for the payment of medical expenses incurred due to an accidental bodily injury when the insured is not disabled.
Partial Disability Benefit
Partial disability is often defined as the inability to perform one or more of the regular duties of one’s own occupation or the inability to work on a full-time basis, which results in a decrease in the individual's income. The purpose of the partial disability benefit is to cover a partial loss of income when the insured is disabled to the point that he or she can still report to work, but is not able to perform all of the regular duties of the job. The partial disability benefit is typically 50% of the total disability benefit, and is limited to a certain period of time, as noted in the policy.
The benefits paid on a partial disability policy are paid in a flat amount, or a residual amount.
Residual Disability Benefit
The residual disability benefit is a coverage provided by the disability income policy. In some cases, it is an automatic coverage. In other cases, it must be added to the policy as a rider. It concerns an insured who can only come back to work on a part time basis and provides a guaranteed dollar amount. For example, Carl earns $4,000 per month. His disability income policy guarantees $3,400 per month for a covered disability. Carl recovers partially and can only work 20 days per month which forces his employer to reduce his monthly income to $2,800. Therefore, the residual disability coverage would pay Carl the difference, or $600 per month for the full benefit period.
Total Disability Benefit
In order for the insured to qualify for this benefit, he or she must meet the policy’s definition of total disability. Although this definition will differ from one policy to another, it is generally defined as the inability to engage in any work. More specifically, total disability refers to the insured's inability to perform the duties of his/her own occupation for the first 2 years; then any gainful employment for which the insured is reasonably suited by education, training and experience. No benefits are payable for partial disability.
6. 24-Hour Coverage vs. Limited or At-Work Coverage
The concept of 24-hour coverage means that an employee is provided with both a workers compensation policy and some type of medical insurance coverage such as a disability insurance policy or health care service plan for injuries or illnesses that occur outside of work. The employee is covered 24 hours a day (while at work under the Workers Compensation plan and outside of work under the medical insurance plan). This type of coverage may not be distributed using a life insurance policy.
7. Exclusions
Generally, disability income policies do not cover losses arising from war, military service, intentionally self-inflicted injuries, overseas residence, or injuries suffered while committing or attempting to commit a felony.
C. Group Disability Income Insurance
Disability income insurance is not only available in individual policies but also in group benefit packages provided by employers. Disability benefit payments that are attributed to employee contributions are not taxable, but benefits payments that are attributed to employer contributions are taxable to the employee. The premium is deductible to the employer.
1. Group vs. Individual Plans
Group plans differ from individual plans in a variety of ways. Listed below are the most common differences between group and individual disability plans:
- Group plans usually specify the benefits based on a percentage of the worker’s income, while individual policies usually specify a flat amount.
- Short-term group plans usually provide maximum benefit periods of 13 to 26 weeks, with weekly benefits of 50% to 100% of the individual’s income. Individual short-term planshave maximum benefit periods of 6 months to 2 years.
- Group long-term plans provide maximum benefit periods of more than 2 years, with monthly benefits usually limited to 60% of the individual’s income.
- Group disability plans also have minimum participation requirements. Usually, the employee must have worked for 30 to 90 days before becoming eligible for coverage.
- Group plans usually make benefits supplemental to any benefits received under workers compensation.
- Some group disability plans limit coverage to only nonoccupational disabilities.
2. Short Term Disability (STD)
It is not uncommon for an employer to provide short-term disability benefits for all of the company’s employees. The elimination period could be as short as 0 days and the benefit period not longer than 2 years, but the benefit period could be 6 months or 1 year.
3. Long Term Disability (LTD)
Group long-term disability plans are often reserved for management employees. The elimination period will usually coincide with the benefit period of the short-term disability plan. The benefit period may be to age 65. Lower-wage employees are usually limited to 66 and 2/3 % of monthly wage, while higher-wage employees are limited to 50% of monthly wage.
D. Business Disability Insurance
Just as an individual purchases disability income insurance to protect his/her ability to earn a living, a business purchases business disability insuranceon its key employees to protect it from loss when the employee becomes disabled.
1. Key Person Disability Income
Key person disability is purchased by the employer on the life of a key employee. The key person's economic value to the business is determined in terms of the potential loss of business income which could occur as well as the expense of hiring and training a replacement for the key person. The contract is owned by the business, the premium is paid by the business, and the business is the beneficiary. The person is the insured, and the business must have the key person's consent to be insured in writing.
2. Disability Buy-sell Policy
A buy-sell agreement is a legal agreement prepared by an attorney. The buy-sell agreement specifies how the business will pass between owners when one of the owners dies or becomes disabled. It is common for the business to purchase insurance to provide the cash to accomplish the buyout when the owner either dies or becomes disabled. The policies that fund buy-sell agreements generally have an extremely long elimination period, possibly one or two years. Generally, these policies funding buy-sell agreements also provide a large lump-sum benefit to buy out the business rather than monthly benefits.
3. Business Overhead Expense Policy
Business overhead expense (BOE) insurance is a unique type of policy that is sold to small business owners who must continue to meet overhead expenses such as rent, utilities, employee salaries, installment purchases, leased equipment, etc., following a disability. The business overhead expense policy reimburses the business owner for the actual overhead expenses that are incurred while the business owner is totally disabled. This policy does not reimburse the business owner for his or her salary, compensation, or other form of income that is lost as a result of disability. There is usually an elimination period of 15 to 30 days and benefit payments are usually limited to one or two years. The benefits are usually limited to covered expenses incurred or the maximum monthly benefit stated in the policy. The premiums paid for BOE insurance are tax deductible to the business as a business expense. However, the benefits received are taxable to the business as received.
E. Chapter Recap
This chapter explained the key concepts and major types of disability income insurance, including group individual, group, and business disability policies. Let's recap the key features for each category:
DISABILITY INCOME
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Disability Income Insurance
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Business Overhead Expense Policy
| Reimburses small business owners for overhead expenses incurred while the business owner is totally disabled |
Business Disability Buyout Policy
| Specifies who will purchase a business partner's interest in case of disability |
Key Person Disability
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| Group Disability |
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Chapter Complete