Saturday, October 21st, 2017

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Do You Need Disability Insurance?

The average 30 year old has a 1 in 3 chance of becoming disabled for more than 90 days before retirement.  That statistic means that between you, your spouse and your siblings, the odds are overwhelming that at least one of you will face long-term disability before you retire.  Being disabled means sacrifice, doctor bills, and having to make difficult personal decisions such as:

  • Would you want to continue living in your present house?
  • Could you afford to pay the mortgage?
  • Would you be willing to change your lifestyle?
  • Would your spouse take a second job to make up for your lost income?

These are hard questions, but having disability insurance can make your answers a lot more bearable.  Disability insurance is meant to provide you with income each year you’re disabled so that you and your family can begin living again.  Unfortunately there’s no such thing as a “standard” disability policy, and as you shop for coverage you’ll find each policy has its own unique provisions.  Two of the provisions you should pay close attention to are the definition of disability and the benefit period.  Before you sign on the dotted line and purchase a policy, make sure you fully understand what these provisions mean.

The Definition of Disability
Each policy has its own definition of disability, and that definition is critical for separating the good policies from the bad ones.  There are three main definitions of disability you should be aware of:
1) Any occupation
2) Own occupation
3) Split definition

Definition 1: Any Occupation
The first definition of disability is known as “any occupation”, and it’s the least favorable definition for you and the best one for the insurance company.  “Any occupation” means that if you become disabled your policy will only pay you benefits if you’re unable to perform the duties of any occupation.  In other words, your skills and training will mean nothing if you become disabled with this kind of policy.  For an extreme example, consider a surgeon who makes $1 million per year but gets in a car accident that leaves him with severe brain damage.  He is now only capable of mopping the floors in the hospital where he used to operate.  Because the surgeon can perform the duties of any occupation (being a janitor) he will not receive disability benefits.  You should try to avoid policies that contain the any occupation definition of disability.

Definition 2: Own Occupation
The “own occupation” definition of disability is much better for you than the more liberal “any occupation” definition.   “Own occupation” means that you will receive disability benefits if you’re unable to perform the duties of your own occupation for which you were trained and educated.  In the example above, the surgeon would receive up to 60% of his pre-disability income (subject to certain high income limits) and would not be required to take a lower paying job if he were disabled.  For the safety of you and your family, you should only consider policies that use the own occupation definition of disability.

Definition 3: Split Definition
The third definition of disability is known as the “split definition”, and it’s the most common definition for employer provided disability policies.  A policy with a split definition of disability will pay you benefits if you become disabled and you’re unable to perform the duties of your own occupation for a certain period of time (usually two years) and then it will pay you benefits only if you’re unable to perform the duties of any occupation afterwards.

The Benefit Period
Even if you have a policy with the best definition of disability (own occupation) you may still not have adequate coverage unless you check the benefit period.  Some disability policies will pay benefits for a maximum of five years, while others pay benefits from the time of disability until age 65.  There are even some policies that pay a lifetime benefit, but these are becoming less common and more expensive.  In general, five years of benefits will not be sufficient unless you’re expecting a new source of income afterwards, and you should consider policies with a benefit period to age 65 instead. 

You should also pay close attention to your policy’s elimination period.  This is the length of time you’ll have to wait after you become disabled until you start to receive benefits.  Elimination periods can range from 7 days to 1 year.  A 30 day elimination period is most common but you should review your specific needs with your agent.  Be careful that you don’t purchase an inexpensive policy only to find out you have to wait 1 year before you receive a benefit.

How Much Disability Insurance Do You Need?
There are limits as to how much disability insurance a company will sell you.  The maximum benefit is capped at about 60% to 66% of your pre-disability annual income.  This limit may be further reduced if you’re a high-income earner, have a dangerous job, or are in poor health.  This makes it simple to determine how much disability insurance you need; the maximum you can afford.

Employer Provided Disability Insurance
Employer disability policies are either contributory or non-contributory.  A contributory policy means that you, the employee, must pay for at least part of the cost of coverage.  Unless the definition of disability is “own occupation” and the benefit period is to age 65, you may want to think twice before taking part in a contributory policy.

A non-contributory policy means you do not have to contribute any money towards the cost of the policy, making it free coverage.  Although any future disability benefits you receive will be taxable under a non-contributory policy, it doesn’t cost you any money to own, so it’s usually a good idea to take this coverage.  But keep in mind that employer provided disability insurance by itself may not be enough to protect you if it has a poor definition of disability or a short benefit period.  You may still need to purchase additional disability coverage through a private insurer.

How to Purchase Disability Insurance
If you need to purchase disability insurance through a private insurer you should make sure the following questions have been sufficiently answered before you buy coverage:

  • What is the company’s quality of service?
  • Is their cost competitive?
  • What is the company’s financial stability?
  • What is their claim settlement procedure?

Once you find a company you feel comfortable with you should sit down with an agent and review all your available options.  You need to make sure you find a policy that is tailored to your specific needs.  Before you buy a policy make sure you read the fine print and double check the definition of disability and benefit period.  Finally, don’t forget to ask questions if there’s anything you don’t understand, because once you purchase the policy it will be too late to amend your coverage.

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