Disability-Income Insurance

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 age 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.

Total Disability

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 1^st 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.

Partial Disability

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. The amount paid = the percentage of the total disability payment = 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.

Accidental Death, Dismemberment, and Loss-of-Sight Benefits

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 Contract Provisions

Disability insurance contracts, like most insurance policies, 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.

Common Optional Benefits

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 time minus any benefit payments. This is not a worthwhile option to buy, because you receive less than if the money used to pay for the return-of-premium rider was invested instead.

Other Sources of Disability Income

There are other sources of disability income besides insurance. One obvious source is savings — if you saved your money that you would otherwise pay in premiums for insurance, you could save quite a bit in a short time. And one thing that would extend your savings is being frugal while disabled. Cut back on nonessentials and see if you can save money on essentials by looking for better prices. Often, when people are making good money, they don't shop around as much or take a hard look at how they can lower costs. Usually, because they don't have the time. When you become disabled, you will have much more time, so you can do things that you probably wouldn't have done before, like clipping coupons for savings.

Roth IRAs can also be tapped for disability income. Disability is one of the purposes that allow you to withdraw any amount, including earnings, without paying a tax or a penalty.

If you are an employee, any injuries on the job should be covered by worker's compensation. However, worker's compensation doesn't cover self-employed people. Additionally, about 1/3 of employees are provided with disability insurance from their employer that does cover injuries off the job, but the income it provides and the time provided vary widely.

Everyone who pays social security taxes is covered by Social Security, but the eligibility rules for disability are strict, there is a 1 year waiting period before you can receive benefits, and if you have to appeal a rejection that could take even longer.

If you are at least 62 years old, but you want to delay collecting Social Security benefits to receive higher monthly payments later on, you could collect Social Security up to 1 year while you are disabled, then repay the amount after going back to work. By repaying the Social Security, you can then wait until you want to collect it, and still receive the higher payments just as if you never collected it.

Disability Statistics

Statistics vary widely because of the differing definition of disability. Defining disability more loosely results in a higher statistic of disability. However, regardless of how it is defined, its incidence does increase sharply as one ages, and it is higher for women than for men because of potential complications from pregnancy.

According to this NY Times article, Your Money - Deciding on Disability Policy Is a Numbers Game - NYTimes.com, the Council for Disability Awareness posted on its website that there are 31 million injuries each year. This statistic actually originated from the National Safety Council, which describes a disability as any injury that interferes with normal activity beyond 1 day, such as a sprained ankle — it does not mean it was a disability that prevented the person from working.

Some sources, especially those published data and websites that are supported by disability insurance companies, stated that the odds that a 25 year old would suffer a disability before age 65 that would prevent him from working for 90 days or more is as high as 80%, but, according to actuaries who have studied the incidence, it is about 30% for the general population. However, nonsmoking white-collar workers with no chronic conditions have a much lower incidence of disability: 10%.

And the actual statistics may be lower if you consider the fact that there are probably many who fake disability to receive income and that those who buy their own disability policy are more likely to file claims. In fact, doctors who buy their own disability policies are much more likely to file claims than the general population. Hence, if you are a white-collar worker who is not a doctor, your chances of becoming disabled for 90 days or more is even less than 10%.

One thing to consider when divining your chances of becoming disabled is to look at what you do that increases your chances of disability. For instance, motorcycling would most certainly increase your odds of disability.