Your disability policy’s elimination period impacts two major components of your coverage. For one, your premiums are directly affected by your elimination period. In all cases, the shorter the elimination period, the more expensive your premiums are. The second impact comes becomes important when you need to go on claim. The longer your elimination period, the less benefit you’ll receive, since the policy won’t pay until your elimination period is satisfied. If you would like us to analyze the elimination period of your existing disability insurance policy to see if it fits your goals, please contact us.
What is an Elimination Period?
One of the most often overlooked features of a disability insurance policy is the elimination period. Your elimination period is a period of time, expressed in days, when you pay your loss of income from your own funds. It is essentially a co-pay, a cost (paying your own bills/expenses) you incur before your benefit kicks in.
To make a comparison, your home and auto insurance has a deductible. Whether it is $250, $500, or $1,000, it is an amount you need to pay before your insurance will cover the rest. Your elimination period functions in a similar fashion. Instead of having a dollar amount, your elimination period requires you wait a specified (which you choose when you purchase your policy) amount of time before the benefits are paid.
An elimination period is something every disability insurance policy has. Whether you own short-term individual disability insurance, long-term individual disability insurance, or group coverage, they all require you to have a period of time for which you’re not entitled to benefits. If you own personal (individual) coverage, the choice of how long your elimination period lasts is up to you.
How Your Elimination Period Impacts Your Premium
When you purchase a disability insurance policy, one of the first things you need to decide is how long you’re able to go without the income from your job or business. The default elimination period for a long-term disability insurance policy is typically 90 days. For a short-term disability insurance policy, you might see elimination periods as short as 7 days, but more likely, around 30 days.
So how does your elimination period affect your premiums? The short answer is not a lot. If you stay with the default options, going out further (meaning extending the elimination period) has a relatively small effect on the cost of your policy. On the other hand, going with a shorter elimination period can be very costly.
What’s important is that you analyze your financial situation to determine how long you can legitimately go without a paycheck. The more financial reserves you possess, the longer your elimination period can be.
Elimination Period Example:
Kyle F. is a 40-year-old gastroenterologist, who earns $450, 000 annually. He has cash reserves of approximately 125k. His monthly expenses total a little over 20k per month. He can reasonably go about 6 months without income before having to use other assets or resources to maintain his lifestyle. The question then becomes should he choose a 90 or a 180-day elimination period?
Since disability insurance income is tax free, Kyle doesn’t need 100% of his income to be covered, just the majority of his monthly expenses. Using The Standard in this example, the premium for his occupation with no riders will cost approximately 9k per year. Since the average disability insurance policy costs from 2% to 4% of one’s gross income, this policy is on the lower end of typical costs. He has 17k of tax free benefits paid if a claim occurs. This pricing/policy design includes a 90-day elimination period. So how much could Kyle save should he opt for a 180-day or 360-day elimination period?
Because Kyle has a 6-month emergency fund, he could save over $700/year on his long-term disability insurance policy. So, does it make sense for him to choose this option? Let’s go to the math:
Kyle’s policy premium cost for a 90-day elimination period is $9,010 annually. Should he opt for a 180-day elimination period, the cost would drop to $8,263.70. That is a difference of $746.30. So, since his benefit is 17k per month, 90 days (the difference between 180 and 90 days) is worth approximately 51k in tax free income. Should Kyle go on claim for over 6 months, he would have to own his policy for 68 years before he would be better off taking the long elimination period. That fact doesn’t even consider he has to spend his own money for an additional 90 days (vs. the typical 90-day elimination period).
Should he opt for a 365-day elimination period, he would only pay $7,299.80. That is an annual savings of $1,710.20. Again, the same factors prevail. The nine months of difference between the 90-day elimination period vs. the 365-day elimination period equals $153,000. If he eventually makes a claim, Kyle must own his 365-day elimination for 89 years before he would break even versus opting for the 90-day policy.
Should Kyle opt for a shorter benefit period (60 days), his premium would increase to $12,340.30. That is an increase in potential cost of $3,330.30. Since the 60-day elimination period is only 30 days shorter than the 90 day, his total benefit is only 17k less. That means in a little over 5 years, he would save money by opting for a 90-day option should he go on claim after that.
The elimination period of a disability insurance policy directly affects the premiums. Choosing the varying periods comes down to basic math. Should you not have a substantial financial reserve, the shorter elimination periods are preferential. Even if you do, there may be situations where the leverage you receive from taking a shorter elimination period will make taking that option the best decision overall.
The most important fact to note is this: No disability insurance client is the same. Each of you have different financial situations, goals, and overall objectives. Purchasing a plan from an unbiased, independent expert is the best way to get the proper coverage in place. Please contact us today or fill out the quote form on the left for a complementary analysis.