A few weeks ago I was preparing a webinar presentation for a group of clients regarding Disability Insurance. Somewhere in the middle of the presentation I entitled a slide point #1: You are not stupid, as I was sure many of my attendees felt as I had that the subject might invokes feelings of intellectual inferiority. For me it wasn’t until several years and many client assisted enrollments that I had an epitome: I am not stupid, disability insurance is overly complicated! I deeply wanted to convey this to my attendees, however my business partner discouraged me from using such language in fear that it may invoke a condescending tone. So I removed it. Not more than three weeks later however, a client called in to go over his benefit options. After I had explained the possible features and benefits of his disability insurance choices he replied with, “I am stupid when it comes to this stuff”. His statement made me feel validated in my suspicions that the coverage is over complicated. I can’t help but feel that the insurance industry owes a debt of apology for not creating a more simplistic product with intuitive language.
But the irony remains that this coverage, while the most confusing, is also the one that nearly everyone needs. The Council for Disability Awareness reports that approximately 3 out of 10 will have a disability that keeps them out of work for a significant period of time. I wonder what those numbers would be if they accounted for shorter claim periods as well. So in this article I will attempt to distill some of the complexities regarding disability coverage and arm you with the information you need to know to save you from not only common misunderstandings, but also a possible major financial loss.
Point #1: A misleading name
This is where I would have earlier made my point you are not stupid, but since I sincerely hope you picked that up in the previous section and since you are not stupid, I want to take a moment and rail against the very name disability coverage as I am confident you will see my logic here. Calling the coverage disability insurance is such a poor choice of words because truly you are not insuring your disability! Who named this and how can we fix it? I realize this is partly a personal irk, but please understand you do not insure a car accident – you insure your car. You likewise do not insure cancer but you insure your health. You do not insure your death but you insure your life. And you do not insure a fire you insure your home. Now here is where I am going are you ready? You do not insure your disability you insure your INCOME. That is what we are insuring from a potential loss, your current and future income. And if you look at your earning power over time this is probably the most economically valuable asset you own: your ability to make money. Yet insuring your income is so often overlooked and neglected. Possibly this is because it was fitted with such an unfortunate, misleading name. If you are a young doctor or lawyer you likely will be making millions over the course of your career, so insuring that along with a car or house makes perfect economic sense. Unless the premiums are simply unaffordable I would consider it a major omission to insure a car that has a depreciating value, but not your income that likely as an appreciating value. So for my own sake and yours I will be using the term income insurance for the remainder of this article because that is what it actually does, insure your income.
Point #2: Accident vs Income Insurance
I have sold a fair amount of life coverage. It almost seems to happen like clock-work when someone will say to me “oh you know what? I have life coverage already! I totally forgot I am covered for $1,000,000 through my bank and they only charge me $15/mn, way less than what you are offering”. To this I respond, that is great. You know what you have? An accident-only policy. For that coverage to pay out you need to be in an accident. You know how you are most likely to die? Statistically speaking, heart attack, cancer, or respiratory disease. So after you die from one of those common, natural, likely conditions you are going to need a loved one to pick up your body and throw it on top of a car wreck in order to pay out! I realize I am being a bit facetious here, but the point is a lot of people think they have coverage that they simply do not have. Now when it comes to income insurance we are trying to pay your normal income month over month while you are unable to work due to disability. This is NOT the same as an accident plan. A real income insurance policy will match all or part of your income whereas your accident, hospitalization, critical illness, or cancer coverage does not do this. Those plans are nowhere near as robust, and pay a cash benefit if you are treated or diagnosed with a specific condition. Income insurance protects you if you can’t work for an extended period of time due to a disability. Remember your finances don’t care if you are in a pinch because you chopped off a finger or were diagnosed with cancer; if you can’t work you can’t work and need money. That is why income insurance is a much more durable coverage than something that pays out due to specific event or accident.
Point #3: Do You Have State Coverage
Here in California there is state income insurance (DI) under the Employment Development Department (EDD). However it is important to note that if you are self- employed you must elect to enroll into the program (Elective Coverage) whereas any W2 employee pays in automatically. In my experience 99% of the self-employed I have encountered do not pay into state benefits. If you are self-employed and considering enrollment you should be aware of how the program works. You need to be paying in for at least six months before you can make a claim. Premiums are paid quarterly and the benefit period runs (how long you are out on claim) for a maximum of 39 weeks, whereas a W2 employee would receive a full 52 weeks. Also know that benefit period determination have a lot to do with your doctor who normally fills out paperwork stating how long your recovery needs to be. Also be aware that enrollment to CA state elective coverage requires the participant to stay in the program for at least two and half years. Benefit amounts are calculated based off a highest quarterly earnings in a “base period” determined by a 5 quarter look back. At the time of this writing the max benefit amount is $1,104/week so for higher wage earners it may make sense to pick up a private policy in conjunction with these benefits or for self-employed to forgo the state program altogether and enroll in private coverage. Coverage also includes Paid Family Leave with a six week max benefit period that would include the birth of a new child. To learn more about CA state benefits click: http://www.edd.ca.gov/disability/About_the_State_Disability_Insurance_(SDI)_Program.htm
Point #4: Short Term vs Long Term Coverage
There are two main types of coverage; Short Term that typically cap any one claim payout at a maximum term of 1-2 years, and Long-Term Coverage that could run all the way to age 67 on a claim. Coverage with the State of CA would be considered short-term as it pays out for a maximum claim period of 39 weeks for self-employed enrolled or 52 weeks for W2 Employees. Another important distinction between short-term and long-term is the elimination period or the length of time before benefits start to pay out. A long-term plan typically has an elimination period of 90 days whereas a short-term can payout much faster. So the question I ask my client is: how long can you last off your liquid savings if a doctor says to you that you can’t work for 1 year or more? If you can’t make it at least 60 days than a short-term benefit would be needed. The longer the elimination period the lower the premium. The state of California has a 7 day elimination period on their benefits.
Point #5: When you show taxes.
If you apply for a private income insurance plan you will show your taxes at point of application. The amount of benefit is normally 60% of your taxable income barring another coverage in force already and your benefit is tax-free if you are paying premiums with post-tax dollars. If your benefit is coming through your employer or a payroll provider your taxes/earning will be looked at if a claim is made. I haven’t seen a carrier that would require taxes/earning to be examined at both point of claim and application. The important point that should be made here for payroll/employer benefits is that your application needs to list your income as accurately as possible since it will be examined at point of claim should that happen. If you are self-employed the income number is your taxable income listed on schedule C. This is the amount you tell the government you make. So if you make $100,000/yr of income your benefit would be $60,000/yr tax-free if your premiums are paid post-tax and again barring any other benefit already existing.
Point #6: Own-Occupation vs Your Occupation
This goes along with point #1 where I harp about the language income insurance uses and how it can be counter intuitive but what you need to know here is that a policy that is considered “your-occupation” restricts you from working while you are on claim for any occupation. Own-occupation policies, only available with long-term coverage, could pay benefit while you work if you end up working in an unrelated occupation. The definition for own occupation is: 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, they will pay the claim even if you are working in some other capacity. An example of this is a surgeon who cannot work because of loss of use with the hands. While on claim that same surgeon could go into teaching and earn income since it is a totally different from the material and substantial duties of regular occupation. I personally remember the difference between Own-Occupation & Your Occupation, by thinking Oh yes I can still be working if it is an own-occupation plan.
Point #7: Know your riders
Some of these are also counter-intuitive but knowing your riders could make a big difference when getting coverage. Here are the big ones explained that you need to be aware of.
Residual benefit rider – This benefit maybe also called partial disability rider, but basically it provides a partial benefit if you are unable to work full-time but can on a part time basis.
Non-cancelable rider – This rider locks in the cost of coverage. While this is normally a rarity since a carrier must raise coverage across an entire block of business it is possible and so this rider would prevent that increase for the life of the policy.
Future Increase Option – This basically is insurance on your insurance allowing you to buy more coverage regardless of your health as long as your income justifies the purchase.
Cost of Living Rider – This increases the amount of benefit paid based off an index or percentage. This benefit only kicks in however if you go on claim and generally is not worth buying unless the insured is young and ends up on an extended claim.
Automatic Increase Rider – This rider increases the amount of benefit each year by a percentage for the first 3-5 years that the coverage goes into force to compensate for raises, inflation, etc. It also accordingly raises the cost of coverage. Each year the insured has the option available to accept or decline the increase.
Waiver of premium rider – this is normally included at no cost and basically allows the insured to stop paying the premium after being on claim for a certain length of time, normally 3 months.
Return of premium – don’t like betting on being disabled? This allows all the premiums paid to go back to the insured minus claims at the end of the term, normally age 65.
Point #8: Know your exclusions
About 8 years ago I was diagnosed with MS. I was not expecting this and thank God I am managing quite well, but years later I picked up my Income Insurance Coverage. Any claim I try to make having to do with MS is excluded for the life of my coverage. It will not fly. Once your policy is issued know that you may have exclusions and they would be listed in your policy. Also, be aware that while Health Care Reform did away with waiting periods on pre-existing conditions for health insurance, they still exist on Income Insurance and fairly so I dare add. People call me asking if we can cover a surgery that will be done next week leaving them out of work for 3 months. The general rule is that anything that has been treated, diagnosed, sought counsel, or been taking medication for in the past year is going to have a 1 year waiting period before being covered on a short-term coverage. But consult your policy at point of issue and application. The last thing I want for any of my clients is for them to think they are covered for something when they are not so I try to be as explicit as possible.
Point #9: Does it off-set?
Okay now that we have covered a lot of ground here the last point that I must make to find out if your coverage will off-set with any other benefits such state Income Insurance (DI) or Federal (SSDI). Here is what you need to know: many short-term benefits will off-set if you are eligible for State Coverage. If you are self-employed you likely do not pay into the state program so are not eligible. If you manage to qualify for SSDI then your Long-Term benefits may off-set, although you should be aware that SSDI benefit are difficult to obtain since the definition of disability is very strict. If you have a long-term policy and you are eligible for state income insurance, then you possibly could receive both since it is for a limited time and long-term coverage does not stringently seem to look at state benefits too closely. However, each carrier maybe different. If you receive benefits from a worker’s comp claim then your benefits may also offset. The general rule is that your tax-free benefit is likely not going to exceed 60% of your taxable amount. So if you get State, Federal, or Workers Comp then your personal coverage could be off-set.
Bottom line: as with nearly all insurance, financial planning, and matters of importance it is beneficial to be proactive.
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