Managing Risk: The Basics of Disability Insurance

Last year, we published blog posts explaining the basics of estate planning and life insurance, encouraging clients to consider how best to protect and provide for loved ones in the event of an untimely death.  However, according to statistics from the Social Security Administration, those entering the workforce today are more likely to face a period of long-term disability during their careers than to pass away, and fewer workers have protection for themselves and their families in the event of disability than in the event of death.  The odds of becoming disabled at some point in your working career are about 1 in 3, and some of the most likely causes of disability include arthritis, back pain, heart disease, cancer, depression, and diabetes.  Those dealing with a disability often face the prospect of increased medical bills and other expenses at the same time as they experience an interruption in income, and the average disability claim lasts over two and a half years.  Given the damage that a disability can do to one’s finances, we strongly recommend considering disability insurance and investigating the options available to you, as discussed below.

Who.  Unlike life insurance, which aims to protect your dependents if you are no longer around to provide for them, disability insurance would benefit you by protecting your income if you become disabled.  Therefore, it is relevant for all income earners, whether you have dependents or not.  Unless your income is not necessary to your household because, for example, you could comfortably live on your spouse’s salary or you have already built up sufficient assets to support your lifestyle for the rest of your life, you should consider obtaining disability insurance. 

What.  Disability insurance policies pay a portion of your salary (typically, 40% to 65%) as a monthly benefit in the event of a qualifying disability.  However, there are a number of different policy options that influence the value of your benefit and what constitutes a qualifying disability.

• Private vs. Employer Policy.  Some employers provide disability policies, which is often a relatively affordable way to obtain coverage.  However, there are different tax implications for a private versus employer policy.  The premiums for private disability policies are paid with after-tax dollars, so the benefits (if you become disabled and collect them) will not be subject to income tax.  By contrast, the premiums for employer policies are often paid (either by you or your company) with pre-tax dollars, so the benefits will be subject to income tax.  In addition, employer plans sometimes have a cap on benefits and do not cover income other than salary (such as bonuses and commissions), which reduces the percentage of your income that the policy will replace in case of disability.
• Short-Term vs. Long-Term.  Short-term disability policies replace a portion of your income for a short period of time (e.g. 3 to 6 months) in case of illness or injury, generally starting after you exhaust all or at least a portion of your sick leave.  Long-term disability policies kick in after short-term disability has been exhausted and last for a longer period of time (e.g. 2 to 5 years).  A long-term interruption in income represents a greater risk to your finances than a short-term one, so long-term disability insurance is a higher priority.  Hopefully, even if you do not have employer benefits to cover a short absence due to disability, you have an emergency fund that would be sufficient to weather any temporary storms.
• Own Occupation vs. Any Occupation.  The breadth of disability coverage varies considerably, depending on whether disability is defined as “own occupation,” “any occupation,” or a hybrid of the two.  “Own occupation” means that, with your disability, you are unable to perform the duties required in your current line of work.  “Any occupation” means that you are unable to do any kind of work–which is obviously less preferable for those in skilled professions.  Many policies use a modified or hybrid definition, in which you may be covered if you are unable to perform the duties of work for which you are “suited given your experience and education,” or you may be covered under an “own occupation” definition for a period of time, then switch to an “any occupation” definition thereafter.

How Much.  How much income protection you obtain in case of a long-term disability will likely be dictated by how much you are willing and able to pay in disability insurance premiums as well as limits by the insurance companies on the level of coverage they are willing to offer.  (They would prefer that you go back to work so the insurance companies typically will not insure more than 70% of your income.)  In addition to the percentage of your salary the benefit will replace, there are a number of other features to consider, including whether the policy excludes certain medical conditions from coverage, whether the insurance company can increase your individual premiums, the length of the benefit and waiting period, and whether the benefit is subject to a cost of living adjustment.  Obviously, the more favorable the policy features to you as the insured, the higher the premiums.  Whether each feature is worth the expense will depend in part on your age, level of assets, marital status, etc.

If you investigate disability insurance options and determine that, despite the benefits, they are simply too expensive for your budget, you could consider critical illness insurance or accident insurance, which generally pay a modest lump sum in response to a specific medical event.  These do not offer as broad protection as disability insurance but may be better than just rolling the dice and foregoing any type of coverage.  In addition, Social Security Disability Insurance (SSDI) may provide some protection if you have worked long enough to qualify (around 10 years), are unable to do any kind of work due to your disability, and are expected to be disabled for at least a year, but again, the benefits will not be as substantial as under a private or employer disability insurance policy.  As always, please call us with any questions.  We are here to help, and unlike your insurance broker, do not have any incentive to advocate a particular option over any other!