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Disability-income insurance pays the insured a monthly income if the insured becomes disabled because of disease or accident. Disability-income insurance can also be purchased as a rider to many life insurance policies. A disability-income rider generally pays a specified amount per $1,000 of life insurance, up to a maximum amount.
To reduce moral hazard, disability-income insurance generally pays only 60 to 80% of the insured’s earnings before disability; otherwise, it may motivate some insured’s to malinger, which reduces the insurance company’s profits and increases premiums.
While many more people have life insurance than disability-income insurance, actuarial studies have found that an extended total disability is much more probable than dying before the age of 65. Disability not only causes a loss of income, but usually incurs medical and care expenses, and can reduce savings and other financial assets significantly.
All disability-insurance policies pay for total disability, which is defined specifically in the insurance contract. Most policies only pay for total disability, although there are some that will pay for partial disability.
Total disability, as used in insurance contracts, has several definitions, but all definitions include that the cause of disability must be either from accident or disease.
The most liberal definition is the inability to perform each and every duty of the insured’s occupation. Many contracts use this definition at least in the beginning of the period of disability, usually the 1st 2 years.
A more restrictive definition is simply the inability to work at any occupation that is suitable for one’s experience, education, and training. In many disability insurance contracts, this definition applies after the initial disability period when the more liberal definition of disability applied.
Thus, with many disability contracts, the insurance company may pay an insured surgeon if she injures her hand and is unable to perform any surgery, but if the impairment lasts longer than 2 years, then the insurance company may only continue paying if she was unable to do anything related to surgery, such as teaching.
Another definition commonly used for insureds engaged in hazardous occupations is the inability to work at any gainful occupation. Many courts have expanded this definition to include any gainful occupation that is suitable to their experience, education, and training.
Many contracts also pay for presumptive disability, which is a disability that impairs one’s ability to do just about anything, such as blindness in both eyes, or the loss of 2 limbs.
Some contracts provide partial disability (aka residual disability) benefits, or partial coverage can be purchased as a rider, that covers the insured when the insured can do some duties and earn some income, but cannot work full-time at full capacity, and suffers a loss of income as a result. A loss-of-income test is generally used to calculate payments. If the insured loses any income because of injury or disease, then the insurance company will pay a specified percentage of the loss of income, up to a maximum amount specified in the contract. Generally, the amount paid is equal to the percentage of the total disability payment that is equal to the percentage of lost income. Thus, if a person earns $4,000 per month and has a disability policy that would pay $2,000 per month for total disability, then the policy would pay $1,000 per month for a 50% loss of income.
Because of the permanence of death, dismemberment, and total blindness, some policies will pay the insured a lump sum instead of monthly payments for these tragedies.
Disability insurance contracts, like most insurance policies, can vary widely, but most have the following common provisions.
An elimination period that can range from 30 days or more. The elimination period (aka waiting period) is the initial period of disability when benefits are not paid. Think of the elimination period as a time deductible instead of the usual money deductible, but offers the same advantages for the insurer. It helps to eliminate small claims, and reduces premiums by reducing the potential payout. Because most disability is short in duration, premiums can be substantially less simply by choosing a longer elimination period. For instance, extending the elimination period from 30 days to 90 days can reduce the premium by more than 50%.
The benefit period is the maximum length of time that disability benefits will be paid. Typical benefit periods are 2, 5, or 10 years, or they can extend to age 65 or 70. It is generally better to buy a policy with a longer benefit period, because the price per month is much less for a longer term policy, and while most disabilities are brief, the longer the insured is disabled, the more likely it will be permanent.
Most policies provide a waiver-of-premium provision, so that disabled insureds do not have to continue paying premiums while disabled, and may even remit premiums paid during the waiting period.
Sometimes the insurer will pay a rehabilitation benefit, which is payment for rehabilitation in addition to the monthly income payment.
The most common optional benefits for disability insurance include the following:
A cost-of-living rider that increases benefits periodically that is commensurate with general price increases as measured by the Consumer Price Index. Increases in income are usually limited to 5% per year, and the total increase is usually limited to double the initial value of the policy. This rider will increase the cost of the premium by 25% to 40%, but it does make good sense for a policy with a long benefit period.
An option to buy additional insurance without providing evidence of insurability is a good option for growing families that would need more coverage as increasing incomes allow and that would cover increased expenses.
There is also a return-of-premium rider that pays back a certain percentage of the premiums over a specified length of time minus any benefit payments. This is not a worthwhile option to buy, because, in most cases, you are receiving much less than you could have earned if you had just invested the money that would have been used to pay for the return-of-premium rider.
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