What is disability income insurance?

Disability income insurance is insurance that pays benefits when you are unable to earn a living because you are sick or injured. Like all insurance, disability income insurance is designed to protect you against financial disaster. Most disability policies pay you a benefit that replaces part of your earned income (usually 50 percent to 70 percent) when you can’t work.

Example(s):   Lola, Lorraine, and Leslie were friends who never expected to become disabled. One day, however, Lola broke her leg in a car accident and wasn’t able to work as a dance instructor for five months. Because she didn’t have disability insurance, she fell behind on her mortgage payments, and the bank threatened to foreclose on her house. A few days later, Lorraine became ill and couldn’t work for weeks. With no disability insurance, she was forced to rely on her family for support. Fortunately, Leslie was prepared. She had purchased a disability insurance policy. When she suffered a stress-related heart attack, her disability benefits allowed her to pay her expenses while she recovered.

Who needs disability insurance?

The odds are … you do

Your chances of being disabled for longer than three months are much greater than your chances of dying prematurely. One reason for this is that medicine has made treatable many illnesses and injuries that formerly would have killed you. Although this is good news, it increases your need to protect your income with disability insurance.

Working individuals

What would happen if you suffered an injury or an illness and couldn’t work for days, months, or even years? If you’re single, you may have no other means of support. If you’re married, you may be able to rely on your spouse for income, but you probably also have many financial obligations, such as supporting your children and paying your mortgage. Could your spouse really support both of you? In addition, remember that you don’t have to be working in a hazardous position to need disability insurance; accidents happen not only on the job but also at home, and illness can strike anyone. Everyone who works and earns a living should consider purchasing disability income insurance.

Example(s):   Bob worked as an accountant, a relatively nonhazardous occupation. However, on Christmas Day, he broke both wrists when he slipped and fell on a patch of ice. Since his injury was not work-related, he was not eligible to receive workers’ compensation insurance. In addition, he was not covered by an individual or group disability policy. His wife was working full-time as a seamstress but was not able to support Bob and their children on her salary alone. Within a few weeks, they were in financial trouble.

Caution:  If you work part-time, work in a hazardous occupation, or are self-employed, you may have a hard time buying a private disability policy. If you can purchase one, it will likely be expensive. You may have to rely on your group employer or association issued disability policies. (See Questions & Answers.)

Nonworking individuals

If you don’t work because you took an early retirement, or you live off your investments, you may still need disability income insurance. Although your income may remain constant after you get sick or hurt, your expenses may rise dramatically. You may need round-the-clock medical care or part-time help, and you may need special equipment. In addition, you may need to pay high medical insurance deductibles. If you don’t have enough income or savings to meet those needs, you may financially burden your family. Many policies may not pay benefits, however, unless a disability results in a loss of income.

Caution:  You may find it difficult or impossible to buy an individual disability policy that will pay benefits if you don’t work because disability income insurance is designed to replace the income you lose as a result of not being able to work and maintain your current lifestyle. In addition, in the eyes of the insurance company, you have no financial reason to get better; after all, your income stream from investments won’t change. Your only option may be to buy an association policy (if available) or to buy a policy before you retire (unless disability benefits end at retirement). Even if a disability income policy is available to you, you should read it carefully to determine whether it will pay benefits to an individual who is not working at the time the disability occurs.

Business owners and employers

If you own a business, disability insurance can protect you in several ways. First, you can purchase an individual disability policy that will protect your own income. Second, you can purchase key person insurance designed to protect you from the impact that losing an important employee will have on your business. Third, you can purchase insurance to fund a salary continuation program that will help you reduce your income taxes while protecting key employees at the same time. Fourth, you can purchase business overhead expense insurance to ensure that if you get sick, your business will stay healthy. Finally, you can purchase a disability insurance policy that will enable you to buy your partner’s business interest in the event that he or she becomes disabled.

Types of disability insurance

In general, disability insurance can be split into two types: private insurance (individual or group policies purchased from an insurance company) and government insurance (social insurance provided through state or federal governments).

Private disability insurance

Private disability insurance refers to disability insurance that you purchase through an insurance company. Many types of private disability insurance exist, including individual policies, group policies, group association policies, specialized group policies, and riders attached to life insurance policies. Depending on the type of policy chosen, private disability policies usually offer more comprehensive benefits to insured individuals than social insurance. Individually owned policies may offer the most coverage, followed by group policies offered by an employer or association.

Government disability insurance

Workers’ compensation and Social Security are two well-known government disability insurance programs. In addition, some states, including California, Hawaii, New Jersey, New York, and Rhode Island, along with Puerto Rico, have mandatory disability insurance programs that provide disability benefits to resident employees. If you are a civil service worker, a military servicemember, or other federal, state, or local government employee, there are many disability programs set up to benefit you. In general, however, government disability insurance programs are designed to provide limited benefits under restrictive terms, and you should not rely upon them (as many people do) as your main source of income if you are disabled.

How does disability income insurance work?

You become disabled

What does being disabled mean? If you’ve ever seen an apparently healthy man or woman park in a handicapped spot at the mall, you know that a person can be disabled without using a wheelchair or showing any outward signs of illness. Any disease or injury that is severe enough can cause disability. For insurance purposes, being disabled means having a mental or physical condition that impairs (either permanently or temporarily) your ability to work. In general, to be considered disabled enough to receive insurance benefits, your condition must be medically certifiable, expected to last for a certain period of time, and (depending on the policy or type of insurance) impair your ability to do your own job, any other job, or both.

Example(s):   Elise is an architect. She develops muscle spasms and is no longer able to write, draw, or use a computer. As a result, her insurance company covers her disability because her physician reports that she is unable to perform any duties of her occupation for at least six months while she undergoes therapy.

Caution:  Government disability insurance definitions may be much more restrictive than private insurance definitions of disability. For example, to receive benefits under workers’ compensation, your sickness or injury must be work-related. When reviewing what coverage you may be entitled to if you become disabled, pay close attention to how the insurance policy or source defines disability.

You apply for benefits, then wait

Once you become disabled and apply for benefits, you have to wait for a certain amount of time after the onset of your disability before you receive them. If you are applying for benefits under a private insurance policy, this amount of time (called the elimination period) ranges from 30 to 720 days, although the most common period is 90 days. If you are applying for benefits under a type of social insurance, your waiting period may be over six months (for Social Security). After you satisfy the elimination period, you will begin receiving a monthly disability benefit that usually replaces 50 to 70 percent of your earned income.

You receive benefits, but not usually forever

You can purchase private disability insurance policies that guarantee lifetime coverage, but they are very expensive. Most people buy either short-term policies (benefits are paid for up to two years) or long-term policies that pay benefits up for a few years or up until age 65. In fact, many injuries or illnesses do not disable you permanently; you may be able to go back to work full-time after a rehabilitation period or return to work part-time. Most private and social insurance programs encourage you to go back to work either by paying you partial or full benefits while you try to work or by continually reevaluating your disability. In addition, they usually pay for any training or rehabilitation you might need to help you get back to work.

Example(s):   Clark is seriously hurt. He begins receiving Social Security disability benefits five months after his accident. One year later, he wants to go back to work, but isn’t sure he can make a living as a carpenter anymore. According to work incentives established by the Social Security Administration, Clark is able to go back to work for a nine-month trial period without losing any of his benefits. At the end of that period, Clark found that he could resume his career as a carpenter, and his disability benefits ended.

Strengths of disability income insurance

Can protect a disabled person from financial ruin

Typically, people buy property and casualty insurance to protect their possessions (houses, cars, and furniture) and life insurance to provide income for their survivors. However, many people don’t think about protecting their income with disability insurance. But how well could you live without your income? Disability is an unpredictable event, and if you become disabled, your ability to make a living will be restricted, at least for the short-term. Although you may have enough money in the bank to meet your short-term needs, what would happen if you were unable to work for months, or even years? The real value of disability insurance lies in its ability to protect you over the long haul.

Individual policies can be tailored to meet individual needs

Although government disability insurance programs are generally inflexible because they are designed to meet the needs of the masses, private individual policies can be tailored to meet your needs.

Example(s):   Mr. Mason has adequate savings to meet his income needs for six months in the event he becomes disabled, so he buys a disability insurance policy with a 180-day elimination period that will pay him benefits for two years. However, his next-door neighbor Mr. Dixon wants his disability benefits to begin sooner and last longer, so he buys a policy with a 30-day elimination period that will pay him benefits until he is age 65, if necessary.

Tradeoffs of disability insurance

Individual policies can be expensive

Ask anyone why he or she doesn’t own an individual disability income insurance policy, and you’re likely to hear this answer: “Because it’s expensive!” Although you pay for government insurance through your taxes and your employer may pick up part of the cost of a group disability policy, quality individual disability policies cost a lot more money. You can try to lower the cost of an individual policy by reducing the benefit period, increasing the elimination period, or getting rid of features that you originally wanted. However, if you do this, you may end up with a policy that doesn’t meet your needs.

Disability claims can be hard to evaluate

If you get in a car accident, your insurance company will want a copy of the police report as proof of damage, and you’ll receive a check in a few days or weeks. If you die, your insurance company will ask your beneficiary for a copy of your death certificate, and your claim likely will be paid quickly. If you become disabled, however, not only will you have to prove that you actually got hurt or got sick, but you’ll have to prove that your injury or illness is expected to outlast your elimination period. This means that your disability will have to be certified by a physician, and you’ll have to wait (sometimes for months) before you receive any money from the insurance company. In addition, while some claims are easy to evaluate, some are more difficult, especially mental illness claims.

Disability insurance is complex

Both private and government disability insurance are complex because the needs of humans are complex. In addition, injury or illness is unpredictable. As a result, governments and insurance companies have designed insurance programs with many restrictions and–in the case of individual disability insurance, at least–many options. When you purchase a disability policy, you may have to spend a lot of time evaluating your future needs and weighing what coverage you can afford to buy against what coverage you’d like to have. Then, you’ll have to compare individual policies and determine what coverage you are already entitled to through your employer or through the government.

Questions & Answers

If you begin receiving Social Security disability benefits, why do you receive a reduced benefit from your individual disability income insurance policy?

Disability insurance is designed to protect your earned income, not to pay you extra income in the event you become disabled. Because insurance companies know that you may (but often do not) collect other disability benefits, they usually give you the option of buying a rider (in your case, a Social Security offset rider) to your policy that will pay extra benefits to you before benefits begin or if Social Security denies your claim. However, if you do receive Social Security benefits, your policy benefit will be reduced proportionately.

If you are self-employed or work part-time, why is it difficult to purchase disability income insurance?

If you are self-employed, you may have a hard time buying a disability income insurance policy if you haven’t been working very long or if you have inconsistent earnings. This makes your risk of disability–and the amount of income you need to replace–difficult to determine, and you may pose a higher risk to the insurance company as a result. However, once you’ve been established for two to three years and can show earnings over a certain amount (usually $12,000 per year at the minimum), you should be able to qualify for disability insurance. If you work part-time, you may find it difficult to buy a policy because many insurance companies require that you work more than a certain number of hours to qualify for disability insurance, as well as earn more than a certain amount annually.