Guide to Disability Insurance

In this series we’re providing everything there is to know about disability insurance, from pros and cons to the details on how it works. Watch for the pieces in this series to learn all about disability insurance.

Overview of disability insurance

If you have a car you probably have car insurance, and the majority of working people have life insurance. Health insurance is something on most people’s minds, too. But disability insurance is something most of us don’t think about until we need to—and by then it’s too late.

Disability insurance protects your ability to work and earn a living. If you get injured, sick, or become permanently disabled in a way that keeps you from working, disability insurance may come into play. According to the Social Security Administration in the US, “Just over 1 in 4 of today’s 20 year-olds will become disabled before reaching age 67.”

These are the basic options when it comes to disability insurance:

Group disability plans. These are the most common type of disability insurance and are usually offered through your workplace. The upside to these is that they’re cost-effective and you may not “feel” them coming out of your check at all. The downside is that benefits vary greatly, and many plans won’t even approach your actual pay rate. If you have a group plan, make sure you know what the benefits are so you can plan ahead for emergencies.

Individual disability plans. For people who don’t like their employer’s group plans, people who freelance, or people who work without comprehensive benefits, individual disability plans may be the only option. Just like shopping for health insurance, individual disability insurance isn’t cheap, and group plans tend to keep costs down more effectively. Also, costs are lower for younger, healthier people, so it helps to shop earlier if you can.

Supplemental disability plans. If you think your work disability plan isn’t good enough or you want to supplement your Social Security benefits, supplemental disability plans may offer you coverage that can bridge the gap.

Group, individual, and supplemental disability plans all come in a variety of forms. In fact, there are long-term and short-term disability plans in each of these categories. Since there are important differences between long-term and short-term disability insurance, let’s look at those differences now.

The basics of long-term disability insurance

Long-term disability insurance (LTD) is like income replacement insurance. It protects you when you’re unable to work due for long periods of time due to sickness, accident, injury, or other disability. The best LTD policies will pay you close to whatever you make now, after taxes.

What is a long-term disability?

A long-term disability refers to illness or injury that keeps you from working for a matter of months, or possibly years. It does not mean a permanent change in your condition, nor does it require some sort of major or freak accident. It is intended to cover any and all of your expenses, not just medical costs; that’s why it’s like replacement income.

Although we usually think of accidents first when we think of disability insurance, about 90 percent of long-term disabilities are actually caused by illnesses. In the US in 2013 diseases of the musculoskeletal system and connective tissue like arthritis made up 28.7 percent of all claims, and diseases of the sense organs and nervous system such as multiple sclerosis accounted for another 15.2 percent of claims. Diseases of the circulatory system such as heart disease made up 12.4 percent of claims, and cancer accounted for another 9.1 percent, making these kinds of the diseases the four most common causes of LTD.

Costs of LTD insurance

The average cost of LTD is about 1 to 3 percent of your annual income. To put that into perspective, If you make $100,000 a year, that’s between $1,000 and $3,000 a year, or $83 to $250 per month. According to a J.D. Power report, in 2013 the average monthly cellphone bill for Verizon Wireless customers was $148 per month, in the last quarter of 2013; it was $144, $141, and $120 for Sprint, AT&T, and T-Mobile customers, respectively, including taxes and fees.

Here’s another way to think about this. You have a choice between two jobs doing the same thing at two different companies. Company A offers you a salary of $100,000 per year for every year that you work. For every year that you can’t work due to injury, illness, or disability, your salary will be $0. Company B offers you $98,000 per year for every year that you work. For every year that you can’t work due to injury, illness, or disability, your salary will be $60,000, tax-free. Which job is better?

[reference: https://www.policygenius.com/long-term-disability-insurance/guide]

So, are people with group plans from work better off? According to Dallas L. Salisbury of the Employee Benefit Research Institute, the average cost of a group LTD policy with a short 30 day waiting period and a maximum $15,000 monthly benefit is around $16.30 for each $1,000 of coverage. In other words, it’s definitely easier; Salisbury states that individual policies with a 90-day waiting period average about $18.60 per $1,000 of coverage. Those extra 60 days are a long time when you’re sick and can’t work, and can really put you at risk if you don’t have savings.

Bottom line here: if your workplace offers LTD coverage you can buy into, it’s probably a better deal than what you can get on your own. Check it out, and invest in it if you can.

Terminology: understanding LTD policies

Some of the terminology you will see in LTD policies can be confusing. Here is what the terms mean.

Elimination/waiting period. The elimination or waiting period is the time you need to be sick, injured, or disabled before you start to receive your benefits. LTD insurance policies are all different, and they are structured on the premise that you will use savings or a short-term disability policy to cover yourself up until long-term benefits kick in. In general, the longer the waiting time, the lower your premiums are; in this sense it’s like having car insurance with a higher deductible.

Benefit period. Just like it sounds, the benefit period is how long you’ll get your benefits. Some LTD policies are shorter lasting, and will pay out for just a couple of years, while others pay you until you hit retirement age, whenever that is.

Benefit amount. This is just how much you’ll get paid each month. It will differ depending on the cost of the policy, but it will never be more than approximately 60 percent of your monthly salary before taxes.

Non-cancelable. Non-cancelable has nothing to do with your policy being canceled. It means that your premium won’t be increased.

Guaranteed renewable. Guaranteed renewable is the phrase that means your policy won’t be canceled, or, in insurance lingo, that it will automatically be renewed, guaranteed (unless you don’t pay your premiums on time, of course).

Own occupation. Own occupation coverage means that you’ll be assessed based on your ability to work in your chosen field. This is really important, because your disability may prevent you from working as a highly paid professional in your normal job, but not at some more menial tasks.

Business overhead expense coverage. This is for business owners whose disability might mean not only loss of income but business expenses like office utilities and rent piling up as they stay out of work.

Future purchase options. A policy with a future purchase option lets you to increase the amount of coverage and benefits you have as your wages go up without changing your whole policy. If you are on your way up or changing jobs regularly, this may be important to you.

Cost of living adjustments (COLA). Some long-term plans allow for COLA to match inflation over the long haul.

Retirement protection. Being unable to work probably means you’re not able to save for retirement, either. This kind of policy rider offers benefits that contribute to your retirement savings along with your other benefits.

Lifetime benefits. These policies do not stop at retirement age.

What alternatives are there to long-term disability?

Honestly, not many. Really, there are two:

Self help

Assuming you have savings, you use them. You might also be able to use charge accounts and retirement accounts. The benefit of this approach is obviously that you don’t pay anything towards LTD insurance. The detriment is that it is risky, and may result in you losing everything and still being disabled and needing help.

Network of family and friends

This is the default “plan” for most of us since we don’t really plan to get sick, have accidents, or be disabled. The idea is that your family or others close to you will help you financially if you become unable to work. The benefit of this approach is obviously that it requires no financial or strategic outlay. The drawbacks are that you burden your family and friends, and that they may not be able to help you at all.

Is short-term disability an alternative to long-term disability?

In a word, no. Short-term disability (SD), which we’ll get into in more depth below, isn’t actually an alternative to LTD. In fact, people often have both kinds of coverage.

SD starts paying out shortly after you become sick, injured, or disabled—usually starting on the eighth day. It stops after a just a few months, usually six. In other words, it covers the time up until LTD starts. SD is usually cheaper than LTD, and is often covered by your employer. However, it ends quickly, and won’t protect you against long-term illnesses, injuries, or disabilities.

Are Social Security Disability and Workers’ Comp alternatives to long-term disability?

Possibly, at least in part (for those in the US, anyway). However, this is complicated.

Workers’ Compensation requires that your illness or injury be directly caused by your work. Only 27 percent of long-term disabilities are work-related, so Workers’ Comp really doesn’t come into play in most cases. Also, many jobs don’t pay into this system; if you work for a smaller business with fewer than four employees or you work for yourself, you are not eligible for Workers’ Comp.

Social Security disability benefits might be available to those who have paid into the system long enough to qualify. However, even if you are eligible because you’ve paid in, there are other hurdles to clear. You’ll need to prove that you have been or will be disabled for at least one year, and that your disability is severe enough to a) keep you from doing the work you were doing, AND b) keep you from doing other work. In other words, if there’s some other job out there you could be doing, no matter how low the pay is or how much it might hurt your career path, you might have to take it, according to the Social Security Administration.

Is LTD coverage worth it?

This is a complex question. In reality, only you can answer it, but a guide like this can at least provide you with all of the facts and ask the right questions.

Ideally, we’d all have enough money on hand and saved to handle any situation that arose. However, most of us do not have that kind of money saved up. In the US, one-third of the population has no money saved for retirement at all, and about half of the population would have difficulty finding $400 to pay for an emergency. This lets you know that LTD insurance is something that most of us could probably use, even if we don’t have it.

The question then becomes risk. What’s at stake? And how much risk is there of needing LTD coverage at all?

Healthcare issues are the top cause of personal bankruptcies in the US. They are also the source of more collections than consumer credit cards. Disability-related loss of income was a major factor in half of all mortgage foreclosures. One in seven people in the workforce will experience five or more years of disability before retirement. On average, an absence caused by a long-term disability lasts 2.5 years. Obviously, this issue is affecting all kinds of people.

Still, we tend to think of some jobs as more dangerous or risky than others—but are we right about that? According to the SSA, in 2011 a 20-year-old had a 30 percent chance of being disabled for six months or longer sometime before retirement. And since cancer is the second most common single source of disability claims—and can strike anyone in any kind of job—you can see why anyone in any line of work might be at risk.

Another thing to think about is who depends on your income. If you have children, you’ve probably already considered life insurance. However, if you’re too ill to work, your dependents will still be relying on you and your income. For this reason, people with dependents should probably focus even more on LTD than those without dependents.

Benefits of LTD insurance in focus

  • LTD coverage reduces your risk of financial trouble should you become sick, injured, or disabled for six months or more at any time during your working life.
  • LTD benefits can be spent any way you see fit, without restrictions.
  • LTD benefits don’t have to be paid back, and there are no penalties or interest on the benefit payments.
  • LTD benefits are tax free upon receipt.
  • LTD benefits can potentially last for a very long time, depending on your policy.
  • LTD benefits protect your retirement savings.

Drawbacks of LTD insurance in focus

  • LTD coverage is expensive, and if things go well for you you’ll never use it (which is true of most kinds of insurance).
  • LTD coverage gets more expensive and less comprehensive as you get older. In other words, it might be hard to get by the time it even occurs to you to get it.
  • LTD coverage won’t cover everything, so you have to watch out for limitations. Some limitations you can’t possibly plan for.
  • LTD coverage won’t help your family if you die, so as you plan your financial strategy, keep this in mind.
  • High-quality, low-cost LTD coverage can be hard to find and shop for, especially for those with recent career changes or less consistent career histories; inconsistent or less well-documented incomes; high-risk jobs; a history of health problems; and those over age 40.

Myths and facts about disability insurance

Myth: I won’t ever need disability.

Fact: There’s a good chance you will.

Myth: Workers’ comp is all I need.

Fact: Workers’ Compensation is involved in less than 10 percent of long-term disability cases.

  • Workers’ comp only kicks in if an injury or illness happens on the job.
  • Fewer than 5 percent of disabling illnesses and accidents are work-related.
  • 90 percent of long-term disability claims are based on illnesses, not accidents.

[reference: http://www.disabilitycanhappen.org/chances_disability/disability_stats.asp]

Myth: Social Security is all I need.

Fact: Social Security disability is tough to get, and it only applies to people who can’t do ANY kind of work. Furthermore, of the 2.3 million workers who applied for Social Security Disability Insurance benefits in 2008, only 38 percent were approved. Their average monthly SSDI benefit was $1,064.

Myth: LTD insurance is for men, because men work in more dangerous jobs and earn more money.

Fact: According to Unum, the largest LTD coverage provider in the US, 60 percent of LTD recipients between 2009 and 2012 were women.

Myth: LTD insurance is an older person’s issue.

Fact: Disabling illnesses and injuries strike people of all ages. Between 2009 and 2012, fully 41 percent of Unum’s LTD recipients were younger than 50, and one-third of those were under 40 years old.

[reference: http://www.businesswire.com/news/home/20130923006004/en/Report-CFA-Unum-Reveals-Critical-Role-Workplace]

Myth: It’s just as easy to get LTD insurance on my own.

Fact: As discussed above, individual LTD policies are more expensive and typically provide less generous terms.

Myth: I just can’t afford LTD premiums

Fact: You might be able to afford them if you carefully audited your current expenses.

Writer Jennifer Fitzgerald explains what she found after conducting such an audit: “$25 per month on subscriptions for digital magazines I rarely read; $40 per month for an international data plan on my cell phone that I forgot to de-activate after my last international trip 12 months ago; and $20 per month on various fees for memberships I don’t use. That’s $85 per month I just freed up with a little bit of expense diligence, not even any belt tightening (like dining out less often). That $85 per month would pay for a long-term disability policy that would provide a monthly $1,500 benefit.”

Myth: I need life insurance way more than LTD insurance.

Fact: This is debatable.

Consider the facts: you are more than three times more likely to become disabled before you are 65 years old than you are to die. Even so, you may have prioritized life insurance far above LTD insurance. Make sure you didn’t do this because, on the whole, life insurance is less expensive.

Before you shop: steps to take before you buy LTD insurance

Before you make any decisions either way, take these smart steps so you know what you’re doing.

Understand your personal disability quotient (PDQ)

Go to WhatsMyPDQ.org to learn more about your “personal disability quotient” (PDQ). Created by the Council of Disability Insurance, this free calculator uses data from actuarial tables to determine how likely you are to need disability insurance during your working lifetime.

[reference: http://www.clark.com/new-advice-buying-disability-insurance]

Research your options through work and individually

For most people who are not in a very high income bracket (more than $200,000-$250,000 annually) group policies from employers are their best bet. If you do earn a very high salary you should invest in your own policy.

If your workplace doesn’t have a group policy or you’re self-employed, you should also research individual policies. Disability Insurance Resource Center, PolicyGenius, and Disability Insurance Quotes can provide you with insight into your options and actual quotes.

Read the fine print and understand the benefits

Look for Own Occupation policies, especially if your work requires a lot of education, training, or skill. Make sure you’ll be covered if you can’t perform your specific job duties even if you can do other work. Look for policies that are equal to 60 percent of your gross pay, because that will be close to your take home pay.

Shop around

Don’t choose the first quote you see; shop around. You can get multiple quotes through an insurance agent if you choose to.

Choose a reliable company

Invest in a policy with companies that earn a rating of “A++” from A.M. Best. This way you know they are financially strong and you can rely on them.

LTD policy questions

The following is a list of questions you can use as you shop around for LTD insurance policies. Use these questions to compare policies so you’re sure you’re getting the best policy for you.

What company is issuing this policy?

How do A.M. Best, Duff & Phelps, Moody’s, Standard & Poor, and Weiss rate this company? (The company or agent can provide you with this info.)

Is the policy noncancelable?

Is the policy guaranteed renewable?

Are the premiums guaranteed?

What are the policy’s annual premiums?

Does the policy provide own occupation protection? If so, for how long?

Does the policy require the continuing care of a physician?

If I’m able to return to work on a part-time basis, will the policy continue to provide me with some sort of partial or residual benefits?

Do I have to be totally disabled before I would be eligible to receive partial disability benefits?

How is the degree of disability determined? Is it based on a loss of earned income or a reduction in hours worked?

How is earned income defined? (It should include salaries, bonuses, commissions, and any other form of earned income.)

How is the actual benefit determined? The immediate 12-month period preceding disability or some other calculation?

If I’m receiving benefits, will my benefits be adjusted for inflation?

Can I increase my monthly benefits in the future?

Can I increase my monthly benefits in the future, regardless of my insurability?

For how long are benefits paid?

What is the waiting period before disability benefits begin?

Is there a waiver of premium rider (if you become disabled, you no longer have to pay the insurance premiums as long as you continue receiving benefits) available?

Does the policy have some sort of rehabilitation benefit?

What is the maximum monthly benefit for which I’m eligible?

What are the policy’s exclusions?

Will any pre-existing health conditions that I may have be excluded from coverage? If so, for how long?

Does the policy have a Social Security rider? (If it does have a Social Security rider, a supplemental benefit is paid equivalent to the Social Security disability benefits if they’re denied. In the extremely unlikely event that you actually receive Social Security disability benefits, your personal disability insurance policy won’t have to pay as much benefit, and therefore your premiums will be lower than a policy without the Social Security rider.)