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Disability Insurance 101: Policy Design

Your Comprehensive Guide to Understanding Your Disability Insurance Policy 

Understanding your disability insurance policy is very important. There is a lot of technical information on this website.  To be concise, a term or concept might not always be defined.  This series of comprehensive posts will define all terms and moving parts in a disability insurance policy. It is broken up into three parts: Policy design (this post), disability insurance underwriting, and disability insurance companies. Alternatively, you can start here.

Part 1: The Policy Design

Designing A Disability Insurance Policy

Understanding disability insurance is not as intimidating as it might seem.  To understand what your policy does, first, you need to know the pieces that make up an individual long or short-term disability insurance policy.

Disability policies have six main components that, when viewed as a whole, comprise what you are entitled to should you go on claim. This is your policy design. Each insurance company has minor differences for these pieces, but ultimately, they are all very similar. These elements will not only affect/determine how your benefit would be paid if you went on claim, but they also have a direct correlation with the premium you pay to purchase your disability insurance policy.

The Six Primary Parts to an Individual Disability Insurance Policy 

The Elimination Period 

The Elimination period is the time you’re required to be disabled prior to making a claim and having the policy pay a benefit. From another viewpoint, where your home and auto insurance use a monetary deductible, disability insurance policies use time.  The home/auto policy requires you to pay a portion of your claim in the form of a deductible, whereas the individual disability insurance policy requires you to wait a certain period of time prior to receiving a benefit.

Your options for your elimination period will vary widely, based upon the type of policy you select (short-term vs. long-term) and the company you select (not all companies offer the same elimination period options).

The default policy design for most individual long-term disability insurance policies is 90 days.  Depending on the company, alternate options may be from 30 days to 2 years. For short-term disability insurance, you can add elimination periods as short as 7 days, which makes sense, since the benefit length (below) is often 2 years or less.

So why not opt for the shortest elimination period?  For your auto and home, the lower your deductible, the higher your premiums.  Disability insurance works in a similar way; shorter elimination periods have higher deductibles, whereas longer elimination periods have lower premiums.

If you can go 6 months or longer (up to 2 years) without a paycheck, then having a longer elimination period can save you money on premiums.  For most people, even high income producers, protecting their income past three months is important and often worth paying more in premiums.  Each person is different in what type of income loss they can sustain financially.  The good news is there are plenty of options when selecting your elimination period.

The Occupation Class 

Your occupation class plays a huge role in your disability policy.  It affects nearly every aspect of your policy from your premiums to your Policy Designdefinitions of disability (some occupational classes are not eligible for own occupational coverage) to the riders you’re allowed to purchase.

The occupation class is essentially the first step in underwriting.  For policy design purposes, insurance carriers often want details of your actual duties, not just your title/job.  There can be slight differences in occupation classes among carriers, so shop around.  It is intuitive, but the more likely you are to become disabled, the worse your occupation class becomes.

A “worse” occupational class will cause you to have less attractive benefits, more expensive premiums, and a harder definition of disability.  For example, a Certified Public Accountant will have one of the top occupational classes, whereas an unarmed bank security guard would have one of the worst.  As mentioned, these classes will vary, based on the company, so for those professions that fall somewhere in the middle of the example’s spectrum, quoting multiple carriers will be to your advantage.

Policy Definitions 

Where the rubber meets the road, your policy definitions dictate how you can make a claim.  Definitions are dictated by several factors, most notably your profession, any enhancements (riders) added to your policy, and the policy itself.

Your profession will largely guide you to the type of policy for which you’re eligible.   Like the reasons you were originally placed in your occupation class, these definitions are more flexible for less hazardous jobs.  Definitions can vary widely by policy and carrier, so it is imperative to know which one will be the best fit for your situation.

To start, there are two primary forms of how a disability insurance policy’s definition is defined: “own occ” or “any occ”.

An “own occ” definition means you can’t do the material and substantial duties of your actual job.  An “any occ” definition means you can’t do any job for which you’re reasonably suited, based on your training, experience, or education.

These are huge differences and important in policy design.  For example, a neurosurgeon who can no longer operate might be considered “totally disabled” under an “own occ” clause, but were he or she to have an “any occ” definition, they would not be (since they could teach, diagnose/consult, etc.).

These definitions can get murkier from here…

“Own Occ” definitions can vary from carrier to carrier and might need a rider to modify their definitions.  The policy definitions are called “modified”, and they typically come in several varieties:

  • Not otherwise engaged.
  • Engaged in another occupation, but making less than what you were prior to your disability.
  • Engaged in another occupation, regardless of additional income.

The first item is self-explanatory.  You’re not working, and you’re unable to do your previous job.  As to the second, this is often termed as “transitional”, meaning you’ll get some of your disability benefit to make up for what you should have been earning before.  The third is the holy grail (although not always necessary) and what most DI policies term as “true own occ”.  It means you can work in any profession that isn’t your actual occupation and make both the income from your current job and receive the full benefits from your disability insurance policy.

For many professions, having “true own occ” is a luxury, but also one that isn’t practical if it costs substantially more.  In this business, everyone wants “true own occ”, and while it is imperative to have paycheck protection, the premiums must match the need.  Most people would like to make more money, but they don’t want to be disabled to accomplish this.

The Benefit Amount 

Policy Design

Dictated mainly by your income, the amount of benefit to which you’re entitled is directly related to your income.  This part of the policy design is limited by the money that you earn.

This can be very challenging for those of us who are self-employed.  For years, our CPAs have done an exceptional job of limiting our tax liabilities, but in this situation, like applying for a mortgage, your write-offs work against you.  For the high-income professional, you must provide substantial w2 wages or a lot of 1099s, without the massive deductions to which you may be entitled.

For most carriers, expect to have about 60% of your income protected.  While this amount may seem on the lower end, please remember that, if you pay for your disability insurance with after-tax dollars, your disability benefit will be tax-free.  Depending on your state taxes, many high-income earners will net roughly the same income as if they were still working.

Another issue is benefit caps.  Group policies are notorious for providing cheap coverage that doesn’t protect their high-income earners.  Depending on your income, an individual disability insurance policy might not protect all your earnings.  Most policies will cap out at around 20-25k.

All is not lost for the high-income earner…if you’re capped out, a few carriers will offer supplemental coverage to cover your income gap.  Lloyd’s of London is one carrier that will offer this additional benefit. Lloyd’s will offer a supplemental policy on most fully underwritten disability insurance policies with no additional underwriting.

For your benefit amount, buy the coverage amount you can’t afford to be without as opposed to what might seem economical.  If you saved a couple thousand in premiums, but give up several hundred thousand in benefit, was it worth it?

Benefit Length 

Another consideration is how long you need your benefit to last. For most people, having the benefit last until their projected retirement is important.  Benefit length will vary from carrier to carrier, but a few products allow coverage to age 70, although 65 and 67 are more common ending ages.

There are many types of disability insurance.  What most people envision when they hear the term “disability insurance” is the social security version or the group coverage offered through their work.  In the private space, you’ll typically see both long-term disability insurance (which can last until retirement) and short-term disability insurance, which typically lasts from 3 months to 2 years.  Depending on the type of coverage you have, your benefit period will vary.

Your benefit length or benefit period will have a direct effect on your disability insurance premiums.  The relationship is straightforward; the longer the benefit period, the higher your premiums. Shorter benefit periods will have lower premiums.  Benefit length plays a relatively large role in the pricing of your disability insurance policy.  For instance, moving your elimination period from 90 to 180 days will often only post a modest decrease to your premiums.  The difference between an “age 65” benefit (for this example, assume the insured is 45 years old when they purchase the policy) and a 5-year benefit will be substantial.

Another factor that influences your benefit length is your occupation. Disability insurance companies restrict the allowable benefit period, depending on what occupation class you’re assigned. Typically, professions that require a high amount of manual or physical labor will be limited to a benefit period of only 5 or even 2 years.  It is not uncommon to see an insurance carrier place the limits on a wide variety of occupations.  This is a limitation faced in policy design that shopping various carriers can help mitigate.

Policy Riders

A “rider” is an added feature that changes your base policy.  This is a critical part of your policy design. Although most riders cost additional premium dollars, there are some that are free to add.  The rider changes to your policy are normally meant to provide enhancements; however, sometimes, a rider can remove benefits.

Typical riders you’ll pay for include:

Occupational Upgrades:

For example, going from a modified occupational definition to a true own-occupation definition.

Future Purchase Options:

These riders will normally allow you to purchase more coverage without evidence of medical insurability.

Inflation Options:

Including a rider that increases your benefit if you go on claim can help offset inflation.

Residual/Partial Riders:

One of the most attractive options, these riders are very important and will allow the insured to go on claim, even if he or she is partially disabled and still able to work (but must substantiate lost earnings to a certain percentage of previous earnings).

And here are a few examples of free riders:

Benefit Update:

Provides a small, guaranteed benefit amount increase (which also increases your premium).  You can decline this option, but it may cause the rider to drop off your policy.

Mental/Nervous:

As mentioned, not all riders are viewed as beneficial.  This rider limits claims due to a mental/nervous disorder to two years.  It does, however, reduce your premium.

 

These are just a few options.  For a more in-depth look at rider availability, examples on how they work, and the premium impacts, look at our Guide to Disability Insurance Riders

Conclusion 

So, there you have it, the primary pieces of a disability insurance policy. Your policy design is of vital importance so selecting the right options must involve an in-depth analysis of your needs. There is a lot to soak in here, but these features define how much coverage you have, for how long, and what it takes to go on claim.  If you have a disability insurance policy, whether it is through work or individually owned, you should understand each of these components.

If you’d like to learn more on your own, then check out Your Complete Guide To Buying Disability Insurance.  If you’re ready to have us guide you, then contact us today for a complimentary consultation to identify your needs and options.

If you alreadt have a disability insurance policy and you would like a complimentary review to make sure your coverage matches your need, please contact us or complete the quote form on the left and indicate in the comments you would like more information on your existing policy.

For more information on disability insurance policies, see the next post in this series, disability insurance companies.