Disability

What it really means.

On vacation, you meet a guy on the golf course looking to make a foursome. He's not too old, and he doesn't look too wealthy. As the round progresses, you find out he's on permanent disability. The hard-working part of your makeup is skeptical. "How can he be disabled and play golf? It sure looks like he scammed his way into permanent vacation."

This is an understandable reaction. Because, unlike death, disability is a condition that leaves room for interpretation. And because there's a grey area, some people have abused the idea.

But don't let the cheaters get in the way of understanding the reality of what a disability is and what impact it could have on your financial future. Setting aside the specifics that define a disability, the question is: What would happen if you suffered an injury or illness that prevented you from working for an extended period of time? How would you pay your bills if there were no earnings for a month, or two months or even a year? For most individuals, the ability to continue earning an income is vital to their financial success. And disability is a major threat, arguably the one event most likely to wreak havoc on your financial plans. According to Insurance.com, the following events occur with the following frequency:

  • Home fire— one out of every 88 homes.
  • Serious auto accident— one out of every 70 autos.
  • Death— one out of every 106 people.
  • Disability— one out of every eight people.

Here are some additional statistics:

  • A 30-year-old woman has a one in three chance of suffering a long-term disability before her planned retirement.
  • One in seven employees will be disabled for five years or more before retirement.

Those numbers, while sobering, can be misleading. The chances of being disabled can decrease significantly for those that are healthy and work in low-risk occupations. In addition, some government programs, such as Social Security and worker's compensation (which only applies to job-related disabilities), are already in place to automatically provide some disability benefits. About 40 percent of employers nationwide provide some form of disability income insurance.

If you are healthy, and working in a low-risk occupation, it's tempting to think: "I can do without personal disability income insurance. All I would end up doing is subsidizing those people who are cheating the system.

You can continue to ignore the facts and hope you stay lucky, or you can make a rational assessment of your need to protect your income by getting some coverage. Here's a brief overview of some specific issues in disability coverage:

Short-term vs. long-term disability policies

Short-term disability policies cover temporary disabilities (a broken leg, an illness, etc.) for a limited period of time. The benefit period for short-term coverage can last anywhere from a few months to a year. This type of coverage is often offered by employers.

Long-term coverage is tailored to respond to greater disabilities, the types that may cause someone to be unable to work for longer periods, usually more than six months. Benefit periods usually range from two years to age 65, and some policies will even guarantee lifetime payments for disability. Long-term coverage may be on an individual or group basis.

Individual vs. group coverage.

Individual disability income insurance applies to one person. Based on application information, including occupation and medical history, the insurance company evaluates the proposed insured, and decides whether or not to offer coverage, or perhaps to offer restricted coverage (i.e. no benefits paid for back injuries, etc.) The individual owns the policy, usually pays the premium and deals directly with the insurance company in the event of a claim. Generally, as long as premiums are paid, the coverage is maintained. The coverage is portable— that is, the individual can keep the coverage regardless of changes in employment.

Group coverage is usually obtained through an employer or professional association. Premiums may be paid by the employer, the employee or shared. A change in employment, a management decision or an insurer's refusal to continue coverage for the entire group may terminate the insurance.

Amount of monthly benefit

Most disability coverage is designed to replace a percentage of your monthly earning, usually between 50 and 70 percent. This limitation of benefits helps provide incentive for recovery.

Benefit period

As mentioned earlier, some long-term coverage pays benefits for only two years, while others guarantee disability payments for a lifetime. Other typical benefits periods are five years and "to age 65." The cost of coverage will be directly related to the benefit period. The longer the benefit period, the higher the premiums.

The elimination period

This is the length of time you must be disabled before benefits are paid. Elimination periods can be as short as 30 days or as long as two years (720 days). The most common elimination periods affect the cost of coverage; premiums decrease as the elimination period increases.

Definition of disability

Different policies have different definitions of disability. For some, disability means you are unable to perform the material and substantial duties of your occupation or profession. This "own occupation" definition could be the explanation for the guy you meet on the golf course— he might be able to play golf, but can't install telephone cables.

For some policies, disability means you are unable to work at all (any occupation). In addition, other definitions of disability vary by company and contract. In general, the more liberal the definition of disability, the higher the premiums. Comparatively, group coverage usually has tighter definitions of disability than personal contracts, making it harder to collect benefits.

Tax issues

Depending on who pays the premium, the disability benefits can be either taxable as income, or exempt from taxation. If the insured pays (with after-tax dollars), benefits are received income tax-free.

Often disability income insurance is a reluctant purchase, especially if the premiums come out of your pocket. You are paying for protection against something you would naturally avoid. But if you have people who depend on your income for food and shelter, the premiums do buy them a little security, which they deserve.