We hate to think about it, but all of us are susceptible to the risk of disability. Sickness or injury can easily force us away from our work and income, and it doesn't take long for monthly bills, mortgage payments and car payments to create a financial crisis.
A surprisingly large number of people will miss an extended amount of work due to a disability. Based on the "Commissioners Disability Table, 1998", nearly one in seven people will miss more than five years of work due to a disability. Roughly 50% of all mortgage foreclosures and nearly 20% of personal bankruptcies in 2001 were caused by disabilities, based on reports from Health Affairs.
With these frightening statistics in mind, it begs the question, how you would support yourself if you couldn't work due to a disability? Luckily, there is protection available in the form of disability-income (DI) insurance. Unfortunately, DI policies can often feel like they're written in a foreign language. Read on as we show you how to translate your DI policy from legalese to English, so you can be confident when you sign on the dotted line. (To begin with the basics, check out Understand Your Insurance Contract.)
Even seemingly minor ailments such as broken bones and nagging medical conditions can lead to temporary or permanent disability. Any type of disability can have a disastrous effect on your earnings, savings and lifestyle. So, to protect yourself, it's imperative that you understand the key features of every disability income insurance policy.
Long Versus Short-Term
Insurance companies provide both short-term and long-term disability insurance plans. Long-term DI insurance steps in when you are disabled for more than six months until the age of retirement. Generally, during the disability, short-term coverage pays approximately 70-80% of your income while long-term disability insurance will pay around 40-60% of your income. As a rule, a complete medical check-up is required to be eligible for this insurance.
Normally, a DI policy should be bought when you're young, since old age or poor health can result in refusal of insurance or higher premiums. In the policy, the premiums constitute 1% to 4% of your annual income depending on your age, gender and occupation. The coverage will vary according to the job you have, selection of benefits and budget. If your job is more likely to cause disability, the policy will definitely be more expensive.
When purchasing a policy, make sure that you understand how it can be renewed. Here are the most common phrases you'll see:
- Non-cancelable option: Renews your original policy without any increase in premiums until the age specified.
- Guaranteed renewable option: The insurance company will revive your policy regularly, but it can raise premium rates anytime.
- Conditional renewability option: The insurer can add extra conditions or restrictions anytime or even increase your premiums.
Every company has its own definition of partial disability and total disability. Make sure you study and understand these descriptions. The most flexible definition of total disability is "own-occupation disability." This implies that if you lose your job due to disability, you can work at other jobs on a part-time basis and qualify for the disability benefits as well. There are less flexible disability definitions and it's important to understand the distinction.
|Example - A doctor is injured and is unable to continue her work, but she takes up a part-time teaching job at a medical school.
If she had an "own-occupation disability" policy, she could earn part-time income as well as receive full disability benefits. However, if she had an "any-occupation disability policy" or "modified own-occupation disability policy" she would not receive any of her disability benefits, because she was still capable of getting a part-time job (for the purposes of the policy she will not be considered totally disabled.)
DI policies also often have additional riders. Here are some you could run into:
- Residual disability provision - In case of partial disability, you are entitled to receive a specified percentage of the income lost during the disability. For instance, a medical practitioner, who earns $6,000 per month and has a $3,000-per-month full-disability benefit, suffers an injury. When he returns to work, his monthly income is reduced to $3,600 (a 40% drop) because his partial disability limits his productivity. The insurance company would then pay 40% of his entire $3,000 disability benefit i.e. $1,200 a month.
- Inflation protection - This rider is essentially a cost of living adjustment. The policy's benefits are adjusted for inflation by linking the policy to the relevant consumer price index. However, many insurers restrict the increase to a maximum percentage, say 4% a year. The company may also put an upper limit to the maximum benefit paid.
- Future increase option - As your income increases, this option permits you to buy extra coverage up to a certain age without the need of further medical exams.
- Automatic increase rider - This rider offers an automatic increase in the monthly benefits for a specified period of time (usually five years). The increase in the benefits, on an average, is compounded at 4% interest rate. This rider is custom-made for those who have seasonal rises in their salaries, as the coverage also increases irrespective of any changes in the health, occupation or income.
- Waiver of premium - During the disability, the waiver of premium rider provides relief from paying premiums for a certain amount of time, usually 90 days or the duration of the elimination period. (To read more about waiver of premium rider, see Let Life Insurance Riders Drive Your Coverage.)
Many disability insurance policies provide an additional "capital sum benefit". This is where a lump sum is paid for certain specified losses, such as loss of sight in an eye, or a severed hand or foot. To speed up a return to the workplace, many policies also offer a rehabilitation benefit. Under this benefit, your insurance company pays some of the expenses if you are registered at an authorized rehab clinic.
Another thing to watch for is the elimination or waiting period. This is a period of time, usually 30 days to one year, during which you are not entitled to receive any benefits. Not surprisingly, a longer waiting period attracts lower premiums.
Finally, there are "policy exclusions". This is a list of ailments that your policy will not cover you for. These are often pre-existing conditions and chronic disorders such as backache, heart disease and arthritis. Other common exclusions are disabilities due to war and injuries incured during commission of a crime or suspension of professional license.
Alternatives to Private Insurance
Certainly, there are state-run DI programs and group (employer-sponsored) DI programs that you can call on, however, in many cases, these programs won't apply to your situation or they won't provide enough money to cover your lost income. (For more on private disability insurance versus social security and group insurance, see Protecting Your Income Source.)
Individual disability insurance is a comparatively better option than group disability insurance. In group disability plans, termination of employment automatically cancels the policy. Also, the benefits are limited and taxable if your employer is paying the premiums. In addition, the benefits paid under the group disability insurance plans are lowered by the benefits you receive from social security disability plans and state cash sickness programs.
Of course, you can apply for Social Security DI insurance. But, remember, to qualify for it, you need to have worked at your job for at least 10 years before you became physically disabled. Secondly, the requirements of this insurance are so stringent that few people end up receiving the benefits. (For further insight, check out our Introduction To Social Security.)
The truth is individual disability income insurance gives you control over your individual circumstances. Group and social security options are less reliable. Individual disability insurance, though expensive, does not have any severe drawbacks - you pay the premiums, get the coverage and receive the tax-free benefits if you become disabled. This insurance may not avert the disability, but it can restore your peace of mind.
For related reading, check out Long-Term Care Insurance: Who Needs It? and Five Insurance Policies Everyone Should Have.