The Ins-and-outs of a Disability Policy

What are the common disability insurance terms I need to know?

Three basic plan design terms that you'll see on applications are EP (Elimination Period), BP (Benefit Period) and Benefit Amount. Here's what they are:

  1. Elimination Period (EP): Also known as the "waiting period," this is the period of disability that must elapse before benefits commence. For example, if Sam has a policy with a 90-day EP and is disabled on January 1, he will be eligible for benefits 90 days later — roughly April 1. Typical EPs are 60, 90 or 180 days. Choose an EP that is appropriate based on how long you could realistically sustain your lifestyle without the insured's income. Disability insurance policies with shorter EPs are more expensive than those with longer EPs. 
  2. Benefit Period (BP): The benefit period is the length of time that disability insurance benefits will continue from the date they begin. Typical BPs are two years, five years, or to age 67. The most desirable BP is to age 67. It is also the most expensive.
  3. Benefit Amount: The benefit amount is typically 60 percent of gross pay (or 83 percent of net pay, assuming a 28 percent tax bracket), up to a limit of $15,000 - $20,000 per month. However, if you require more than $15,000-$20,000 per month, there are carriers that can offer  coverage for up to 65 percent of even the highest incomes. 

What is a "disabling definition" and why is it important?

The disabling definition is the most important, central part of the disability insurance policy. Think of it as the heart — without the heart, nothing else works. Not all definitions are created equal. Here's how they work, in order of desirability:

Most desirable: Own-Occupation Definition (sometimes referenced as True Own-Occ)

Common policy language: "You are unable to perform the substantial and material duties of Your Regular Occupation; and you are under the regular care of a Physician appropriate for your Injury or Sickness."

What it means: The insurance company will consider your client's occupation to be the occupation he/she is engaged in at the time he/she became disabled. It will pay disability insurance benefits even if your client returns to work in another occupation.

Example: If surgeon Dr. Brown develops a tremor that prevents him from practice as a surgeon, he can collect disability benefits even if he returns to work as a family practice physician. So, for example, as a surgeon he earned $300,000 per year. He had a disability insurance benefit of $180,000 per year. While collecting DI benefits of $180,000 per year, he can earn an income of $150,000 per year (or any other amount) as a family practice physician. 

Second most desirable (and most commonly used): Modified Own-Occ definition

Common policy language: "You are unable to perform the substantial and material duties of Your Regular Occupation; and you are not engaged in any other gainful occupation; and you are under the regular care of a Physician appropriate for Your Injury or Sickness."

Using the same example: Once Dr. Brown returns to work as a family practice physician, he can no longer collect full disability benefits. His disability benefit will be based on a percentage of lost or reduced income. In this case, his annual benefits of $180,000 would be reduced to $90,000 due to having a 50 percent loss of income. Remember, his income is now $150,000 instead of his pre-disability income of $300,000.

*The Modified Own-Occ definition still provides solid protection. and is appropriate for most non-specialized occupations. Some carriers offer this definition as a benefit rider. 

Least Desirable: Any Occupation definition (otherwise known as Gainful-Occ)

Common policy definition: "Because of Injury or Sickness you are unable to perform the material and substantial duties of Your Occupation, or Any Occupation for which you are deemed reasonably qualified by education, training or experience."

Using the same example: The insurance company determines what type of work is suitable for Dr. Brown. If Dr. Brown were deemed suitable for other work due to his prior education, training or experience, he would not be eligible for any disability insurance benefit. Would the insurance company expect him to flip burgers? Probably not. But, why take the chance?

*These definitions are most commonly found in Group Long-Term Disability policies, or in add-on policies that come as part of a multi-line coverage bundle. If you already have a policy through a sponsored plan, check the definition. If it's Any Occupation, make sure to educate yourself of the risk involved and consider supplementary protection. These should never be offered on a stand-alone basis.

What provisions are of most benefit?

If you think of the disabling definition as the heart of the policy, then think of provisions as the legs. "Renewal" provisions move forward over the years, while the "what if" provisions keep the policy running when and if your client becomes disabled.

There are four types of "Renewal" provisions:

  1. Non-Cancelable and Guaranteed Renewable (most desirable): This provision guarantees that after a disability insurance policy is placed in-force, there will be no changes to the premium or to the policy benefits through age 65 — regardless of the insured's working status, health or income level. This is THE iron clad, no-changes policy that you want your clients to have.
  2. Guaranteed Renewable (good): The insurance carrier cannot change the premium or the benefit for an individual, but it can make a change to the premium for an entire group of policyholders, categorized by state, underwriting class or policy year. The change would need to be approved by insurance regulators before going into effect. Use guaranteed renewable disability insurance policies to bring down the cost if your client objects to the price of the better, non-cancelable and guaranteed renewable policy.
  3. Conditionally Renewable (less desirable): This provision is found in group and association plans. It states that the policy is renewable only if the insured continues to meet certain conditions outlined in the policy. The most common condition for renewal is maintaining full-time employment (group) or membership (association). The carrier may increase the premium at the anniversary date or at prescribed age bands, such as five-year increments.
  4. Optionally Renewable and/or Cancelable (least desirable): These provisions allow the insurance carrier to change the terms or cancel the policy at an individual level. This type of policy should be used only if nothing else is available. It provides immediate protection — but no guarantees.

"What if" Provisions

There are seven types of "what if" provisions. Almost all non-cancelable and guaranteed renewable disability insurance policies issued today will automatically include these provisions.

  1. The Presumptive Clause: What if there's permanent loss? This provision says that the policy will waive the elimination period and begin paying benefits from the first day of Presumptive Total Disability. The insured is presumed to be totally disabled if he/she suffers the permanent loss of (a) the sight of both eyes; (b) the use of both hands; both feet or one hand and one foot; (c) speech; or (d) hearing in both ears.
  2. The Recurrent Disability Clause: What if there's a recurrence? This clause defines how the carrier will respond to recurrent bouts with the same disabling illness or injury. For example, if Joe claims disability for cancer, gets treatment and then returns to work, and then seven months later suffers a disabling cancer relapse, how will the waiting period and benefit period be handled? Many disability insurance policies state that if the same disability recurs within six months following cessation of benefits, the recurrence will be treated as a continuation, and the elimination period and benefit period do not start over. Some policies allow for a waiver of the elimination period in the event that any disability occurs within one year of the first. 
  3. The Concurrent Disability Clause: What if there are multiple causes of disability? This provision says that benefits will be paid for one disabling condition at a time. Even if there are multiple causes of disability, the policy will treat the culmination of causes as one disabling claim.
  4. Waiver of Premium Clause: What if the insured can't afford to pay the premium while disabled? This clause waives any premium due after 90 days of disability. Some companies refund the premium paid within the first 90 days. So, when Joe is disabled by cancer on January 1, he should continue to pay his premium that is due by the first of each month. Once his disability exceeds 90 days, the insurance carrier will refund any premium paid during the EP. However, if Joe's premium was paid on an annual, semi-annual or quarterly schedule and was not due during the first 90 days, he would not be eligible for a refund. He also would not have to pay his premium if it came due after the first 90 days, assuming that he remained disabled.
  5. Rehabilitation Benefit: What if the insured needs occupational or physical rehabilitation? Many disability insurance policies now contain a very valuable rehab benefit that helps workers return to suitable occupations as soon as possible. This may include retraining, counseling and physical rehabilitation. The benefit is paid in addition to monthly disability benefits.
  6. Transplant / Cosmetic Surgery Benefit: What if the insured suffers disability resulting from complications with an organ transplant or cosmetic surgery? This clause pays regular sickness benefits in the event of organ transplant or cosmetic surgery related disabilities.
  7. Survivor Benefit: What if an insured dies while collecting disability benefits? This provision pays the benefit to a named survivor in the event of the insured's death. Survivor benefits are typically payable for a period of three months after the insured's death — only if the insured received total disability benefits under the policy.

How can I "dress" my policies for success?

Think of benefit riders as designer wardrobes for your disability insurance policies. These are the clothes that will really set your offering apart from that of your competition and allow you to tailor your offering to the unique needs of each client. Never go to an appointment without some carefully chosen riders in your back pocket. Here are nine common riders.

  1. Own-Occupation or Modified Own-Occupation Definition: Same as the Own-Occupation disabling definition discussed earlier, this rider pays benefits even if the insured is gainfully employed in another occupation. This rider is often only available for middle management through executive classes as well as traditional professionals.
  2. Residual Benefits: This rider is essential because in many cases, insureds can work part time, but not full time. The Residual Benefits rider pays a percentage of monthly earnings if the insured suffers a loss of income of 20 percent or more. This eliminates the "all or nothing" benefit structure and can help facilitate a friendlier, more gradual return-to-work experience. For example, if Shirley was making $50,000 annually, was disabled and then returned to work part time earning $25,000, she would have a 50 percent loss of earnings and would continue to receive a 50 percent disability benefit.
  3. Future Purchase Option / Future Increase Option: This option (otherwise known as guaranteed insurability) allows insureds through age 51 to purchase additional coverage — regardless of health — without the need for a medical exam or blood tests. Some disability insurance policies allow insureds to turn back the clock, allowing additional benefits to be purchased at the policy's original rates.
  4. Supplemental Social Insurance Benefit (SSIB): If an insured does not qualify for Social Security benefits, this rider increases the monthly disability benefit by up to $2,000. Consider using this rider on the blue-collar occupations where premiums are higher or when budgetary constraints become an issue. The SSIB rider will provide the dollar amount benefit at less cost than the base benefit as the carriers share the risk with the Social Security Administration. Simply put, if the Social Security Administration does not pay a benefit, the carrier will.
  5. Cost of Living Adjustment (COLA): This option applies to those who are disabled for more than one year. It automatically increases the amount of coverage each year to keep up with inflation. Some disability insurance policies increase by a fixed amount each year while others are indexed to inflation. COLA is of particular importance to young clients with longer life expectancies. For example, a COLA is much more important to Ryan who was permanently disabled at age 26 than it is to Mel who was disabled at age 56.
  6. Automatic Increase Rider (AIR): This rider increases the monthly benefit for the first five years to keep pace with inflation. The AIR will only increase the benefit while not on claim where the COLA rider requires the client to be on claim in order for the benefits to increase.
  7. Return of Premium: In some states, carriers offer a Return of Premium option, with which an insured with favorable claims experience becomes eligible for a refund of part of the premium paid. Some companies refund money periodically throughout the policy period, while others refund at age 65.
  8. Catastrophic: This rider pays an additional benefit if the insured is receiving total disability benefits and is unable to perform at least two activities of daily living (ADLs); has a severe cognitive impairments; or is presumptively totally disabled.
  9. Non-Disabling Injuries: If the client suffers injuries requiring medical treatment prescribed by a physician or dentist, the carrier will pay the expense of such treatment up to one half of the monthly benefit amount (or stated benefit amount). No EP is required.

What do I need to know about exclusions and limitations?

In a nutshell, you need to know that exclusions and limitations exist. Exclusions and limitations vary by policy. The most common exclusions and limitations are Mental & Nervous, Alcohol & Drug (MNAD) claims; claims caused by crime; and claims caused by war. Some policies do not exclude MNAD claims, but they do limit the Benefit Period to two years.  If there is an existing condition, a carrier may still offer coverage, but exclude eligibility of future disability claims based on that condition.

Noah Schwartz CFP