Disability Insurance Policies

In April, I wrote about some of the factors to consider in whether or not to purchase disability insurance. This month, I thought I’d follow up with some of the policy terms, and some recommendations on what to look for. Before I begin, it’s important to set a framework. The whole point of disability insurance is to replace your income if you are unable to work. In my experience, most people will want to get back to some kind of productive activity. Disability insurance is intended to protect the income you have from being significantly reduced just because you were unlucky enough to have been seriously hurt or ill.

The Definition of Total Disability. This is probably the most CRITICAL section of your policy, as it will determine under what conditions, your policy pays benefits, as well as the premium costs of the policy. The most comprehensive policy is called an “Own Occupation” policy, which will contain a definition of disability something like “The inability to perform the material and substantial duties of your regular occupation, the insurance company will consider your occupation to be the occupation you are engaged in at the time you become disabled.”  This type of policy will continue your disability payments even if you are able to work in some other capacity.

On the other hand, a “Gainful Occupation” policy would define Total disability similarly, but would include something like: “…you are unable to perform the material and substantial duties of your occupation, or any occupation for which you are deemed reasonably qualified by education, training, or experience.” This policy could stop benefit payments if you are able to go to work in any occupation for which you are reasonably qualified. While this might not mean going from practicing law to flipping burgers, there is a lot more room here to argue about whether or not you can go back to work, and thus whether an insurance company MUST continue to pay your benefit claims.

Renewability. A “Non-cancellable and Guaranteed Renewable” policy basically ensures the insurance company can’t change a thing unless you want them to. A policy that is only “guaranteed renewable” probably won’t be changed by an insurance company, but they do have the legal right to. While they couldn’t just change your policy, they could, for example, change all policies in a given state. These changes could include policy provisions, premium rates, etc.

Residual (or Partial) Disability. According to one resource, a lot of disability claims begin and/or end in partial disability, so this is important, too. Often the policy will pay benefits in proportion to your lost income, but it may also be based on something else, like hours worked. Suppose you are in sales, and are disabled for several months. You would want the partial disability payments to be based on income, because you will have to work a lot more hours to rebuild the commission base you had before leaving work. Understand how this is calculated?

Benefit Period. This is fairly straight-forward. The benefit period is how long the company will pay your disability income. Probably the most common is “to age 65,” but shorter periods will lower the cost of a policy, and could be as short as two years. A 2006 study commissioned by UnumProvident showed that one in three workers are likely to be out of work for at least three months due to injury or illness, and once an individual has been disabled for 90 days, the average length of disability is two years. Thus you’d probably want a policy that will at least pay for three years at a minimum.

Elimination Period. This determines how long you need to be disabled before the company will start to pay benefits. So, a 90 day elimination period means that after being disabled for 90 days, you will begin to receive payments. The longer you wait for your benefits to start, the cheaper the policy. For recurring disabilities, some policies will waive the elimination period.

This column is prepared by Rick Brooks, CFA, CFP®.  Rick is Vice President for Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management.  Rick can be reached at (858) 755-5166, or by email at brooks@bfadvisers.com. Rick and his family live in Mission Hills

Category: Business