Employee Benefits - The Ideal Disability Insurance Policy

By Larry Schneider

Protecting your income, financial planners say, is the cornerstone of all financial planning.  A 40-year-old has a 45% probability of becoming disabled for a substantial time during his or her lifetime (Society of Actuaries, 1995).  Your income and ability to work are your most valuable assets.  Protecting your earnings (which could be more than $1 million for a 45-year-old earning $50,000 a year projected to age 65) should be high on your list of priorities.  The following article will help you sift through the maze of different disability contracts that are offered.

What to look for in a ideal disability policy
If every company offering a disability insurance contract had the same wording, terms, and conditions, then the agent's job would be easy; all he or she would have to think about would be simple things, like whether or not he liked the company's logo, its commissions, and the like.

Unfortunately, evaluating, selecting, or recommending the right contract is not so easy.  There could be 30 or more considerations, terms, etc. that make up a contract (analogous to the thousands of parts that make up an automobile), each affecting benefits, how much, how long, and under what conditions and circumstances a claim will be paid.  Most companies offer enough similarities for comparison in about 15 or 20 components.

Let's look at seven of the most important differences, roughly in the same order in which they appear in most contracts:

1. GUARANTEES: One of the most dramatic changes the industry has made in the past several months is the emphasis on guaranteed renewable only policies.  This change enables carriers to raise rates and thus remain profitable.  The agent should try, however, to get his prospect a non-cancelable (non-can) and guaranteed renewable policy. Enough companies still offer non-can policies, which guarantee the insured's rates to the age of   65.  Other carriers have removed their non-can policies from the market or use this feature only with a loss of earnings policy.

2. DEFINITIONS: The contract definition of sickness should say "when first manifested itself" rather than "when first contracted." The difference between the two is significant, especially if the disability is cause by cancer, for example.  Under the first definition, if cancer existed when the policy was issued, but it had not yet produced symptoms nor caused a prudent person to seek medical attention, it would be covered.  Under the second definition, it would not if it could be proven to have existed prior to the policy's effective date.

The best definition for total disability is "own occupation" or "own occ."  Although this definition is available for many occupations (but not all), it is not always necessary, nor is it always available for the full benefit period, and in many cases it should be.

This definition might be necessary for someone whose skill could be transferred to another occupation, for example, a surgeon.  Without this kind of definition, he or she could be expected to teach or become involved in a related field of medicine.  As a result, the surgeon might not be considered totally disabled and instead might be paid under the residual benefits provision.

There are three own-occ definitions and one other disability definition.  These definitions primarily are based on occupations that reflect a particular carrier's claims experience.  These definitions, from most to least liberal, are:

• Own occupation � This definition pays even if the insured is working elsewhere in another occupation.  Some carriers even offer an own-occ specialty definition.
   
• Own occupation, not gainfully employed elsewhere � A policy with this definition pays if the insured can't do the duties of his or her occupation and is not working elsewhere.  Working or not then becomes the claimant's choice.
   
• Own occupation, for a period of time, thereafter unable to work elsewhere � This is a split definition that gives true own-occ (see the first definition above) for a period of time (for example, five years), then changes to unable to work elsewhere by reason of education, training, and experience.
   
• Loss of earnings � This definition has been around for a long time, but many more carriers have recently chosen to stipulate this in lieu of the own-occ definition.  Loss of earnings is the same as residual (proportionate) benefit.  If during a disability the insured who has a 30% loss in income, they'll receive 30% of the monthly benefit.  care of a physician, they will receive 30% of the monthly benefit. While this policy does pay proportionately, please note that the insured starts off with an initial 40-50% shortfall - since participation tables only allow approximately 50-60% of pre-disability income to be covered tax-free (depending on the income of the insured, their occupation, and when the policy was issued). Higher issue limits are available if the premium is employer paid. However, these benefits are taxable!

3. BENEFIT PERIOD:  This represents how long someone will be paid in the event of a covered disability, but once again, not all benefit periods will be the same, all else being equal.  For example, with regard to benefits to be paid for a lifetime, different configurations are available or are imposed based on occupation and age at the time of disability.  Some of these onset ages are as follows:

• Lifetime benefits � only if disabled before age 60 (sickness)
• Lifetime benefits � only if disabled before age 65 (accident)

If a company makes any or all of the above available as an option (and some do have more than one), the longer the "window of opportunity" stays open, the higher the cost.

I might add at this point that this option rapidly is disappearing from the landscape, and I for one contend it shouldn't.  Some carriers offer a graded lifetime benefit instead, which simply states the insured might get some percentage of the base benefit paid for lifetime, depending on the disability onset age.

4. RESIDUAL/PROPORTIONATE DISABILITY BENEFIT: Most contracts read almost alike for this benefit except for some of the following terms and conditions, which can make a difference in terms of how much of a claim will be paid:

• Pre-disability earnings period: Typical contracts state that the company will consider the previous 12 months or any two consecutive years within the last five, whichever is more favorable to the insured. There are also other combinations.
   
• Pre-disability income included or excluded for the calculation of loss/earnings: This can be a significant factor if the claimant is in the service industry business (e.g. accountant, attorney, etc.) and has some accounts receivable (pre-disability earnings) paid during a period of disability. If the contract does not allow these to be excluded, then the calculation will generate a lower loss of income and as a result the payment will be smaller.
   
• Qualification period: This is the number of days the insured must be totally disabled before the residual benefits can be paid. Companies that have this restriction usually require 30 days. Most companies do not impose this qualification period and also allow periods of residual disability to count toward the elimination period.

5. RECOVERY/EXTENDED TRANSITION BENEFIT: Basically, this recovery benefit means a person who no longer is under claim (under a physician's care) will be paid as if he/she still were (even though he has returned to work full time). This enables an attorney or other professional to return to work and be paid while he rebuilds his/her practice. Another example would be a Certified Public Accountant (CPA) who broke a wrist during tax season (when he/she earned 80% of his/her annual income) and recovered perfectly after April 15 for the remainder of the year. Benefits under this provision would continue to be paid even though the accountant was fully recovered until their income reached 80% of pre-disability earnings. Again, some companies offer this benefit, but for diiferent periods. Many companies offer this for either 12 or 24 months, and some offer it for the full benefit period.

6. FUTURE INCREASE OPTION BENEFIT: Most companies offer this option; however, once again there are these differences to watch out for:

• Cut-off age for having this option issued as part of the coverage in the contract. Most companies will not offer this after the insured's age 50, although a few companies will issue it up to 55.
   
• Cut-off age for exercising the option and whether or not the option can be exercised and paid during a period of disability. I haven't seen any company allow it to be exercised past 55. Most, if not all, use a formula as to how much can be exercised at any given time, participation tables not withstanding. A few allow all or part to be exercised and paid, along with an existing claim.

7. COST OF LIVING ADJUSTMENT (COLA) BENEFIT: Some differences that exist between companies fall into the following categories:

• Basis for increase, that is, indexed to some standard such as the Consumer Price Index or guaranteed.
• Conversion of these benefits to the base benefit after returning to work, prior to what age and at what cost, if any. This is especially important if the original (or a new) disability could reappear or if there was no future increase option and the insured wanted the new claim to begin with the last amount paid.

8. MISCELLANEOUS: There are a couple of other related contract components that should be considered when analyzing a contract, but because they are less significant, I will not elaborate. These are:

• Conditionally renewable -- most policies are renewable to 75, while others are renewable for the insured's lifetime (if the insured is gainfully employed for a minimum of 30 hours weekly).
   
• Loss of income necessary to be deemed totally disabled (most contracts say 75%, while a few use 80%) -- the lower the percentage, the better the contract.
   
• Recurrent disability -- some contracts say six months must elapse, while others say twelve. Which is better depends on the length of the benefit period. If the benefit period has expired, then six months is better for the following reasons: If the insured can return to work for six months and has a relapse, then the benefit period starts all over again. With a 12-month provision, the elimination period, or in the case of a relapse, would be connected.

CONCLUSION: The insured should have their policy reviewed by a real specialist in view of the fact that the disability insurance industry is in the midst of major changes. Recently issued policies or even some older ones might contain provisions that will make it more difficult to have a claim paid. The window of opportunity is beginning to close for the better contracts.

Women in particular have been hard hit with the introduction of sex distinct rates which have replaced unisex rates, resulting in premiums that are approximately 30% higher than men.