Disability insurance or disability income insurance (abbreviated DI in the industry), is designed to compensate the policy holder for income lost if the holder becomes disabled. DI usually also covers additional services such as rehabilitation. DI is one in a spectrum of protection measures available to individuals or groups.
Group DI policies may have upper limits on their income protection provisions; sometimes it turns out to be difficult to realize a benefit under such policies because of elaborate and government-imposed review processes. Private DI policies were once available providing very high compensation replacement; insurance companies have changed their products since the 1990s in order to protect themselves against claims losses, but private policies can still be purchased with higher benefits than group policies.
Protection against disability in the workplace takes several forms, some at the option of the employer, some provided under state or federal law: 1) most employees have legally mandated sick leave privileges; 2) many employers offer short-term disability (STD) insurance in addition; private STD insurance is available but said by industry observers to be difficult to get for reasons laid out below; 3) worker’s compensation programs are provided by state governments paid for through levies on employers; in most states the compensation is two-thirds of wages earned; other benefits (like retraining) may be provided; 3) Social Security disability insurance becomes available after an individual has been unable to work for a year; only those totally disabled are eligible; and payments begin six months after eligibility has been established; the amount paid, like Social Security itself, is based on past earnings but does not necessarily match them; 4) long term disability (LTD) group plans are offered in about 40 percent of medium to large-sized companies, according to Kiplinger’s Personal Finance; far fewer small companies offer such insurance.
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Individual disability insurance, according to Peter C.
Katt, an industry advisor, writing in Journal of Financial Planning, ran into turbulent times in the late 1990s because of mistakes made in the 1980. These problems are still affecting DI companies and those wishing to buy policies.
The DI industry developed insurance products for individuals with high income some of which was badly underpriced in the 1980s. These came to be known as “own occupation” policies in which a person was deemed to be totally disabled if he or she could not perform the duties of his or her “own occupation.” Thus, using one of Katt’s examples, an orthopedic surgeon unable to stand during long operations because of persistent back pain would be deemed “totally disabled” and deemed entitled to collect up to 60 percent of his or her weekly compensation until retirement age—even though this same person could easily, by switching to general practice, earn a very decent income if not at the peak level as a surgeon. Such policies became very popular with physicians, specialists, and lawyers. “DI companies fell all over themselves providing narrower definitions of such occupations.” Claims experience later showed that the incidence of such narrowly defined disability was much higher than anticipated, the premiums charged too low to sustain the business, and therefore new DI policies are tailored much more in favor of the insurance companies in the mid-2000s.
Own occupation coverage may be limited to some period of time after the disability. Thereafter an “any occupation” clause comes into effect. Thus, for instance, a surgeon who must occasionally sit down is obliged to practice some other branch of medicine rather that sit back and collect high DI payments until age 65.
Costs of Individual DI An individual thinking of purchasing individual DI should anticipate paying around 2 percent of his or her annual gross income in premiums for income benefits equivalent to between 45 and 50 percent of gross income, this benefit beginning 90 days after the disabling event and lasting until retirement at age 65—assuming that the individual has no other work activity that produces income. These data are based on quotations obtained in 2006 for a hypothetical 51-year old non-smoking, non-drinking individual earning $250,000 a year in an administrative position. The average of premiums quoted was $4,620 per annum and the average monthly benefit at $9,797, equivalent to 47 percent of gross income.
Group Long-Term-Disability Packages Group coverage generally replaces 40 to 60 percent of the insured person’s income, but usually only up to about $5,000 a month.
This compensation is fully taxable if the premium is paid by the employer, but the company is permitted to deduct the premium as a business expense. Group plans are relatively inexpensive but are designed to limit what is covered and to make benefits payable as predictable as possible for the insurance carrier. Definitions of disability are limited, any external income or benefits the claimant receives may be deducted from benefits, and certain conditions are excluded. The claimant’s ability to sue the company must take place under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA). As Mark F. Seltzer reported in Physician’s News Digest, the law surrounding ERISA-managed appeals processes has come to favor the insurance carrier.
Insurance works most rationally in a real life situation in which a particular claims event (e.g. a death) is very difficult to predict but the aggregate of such events can be projected statistically with fair precision. In such circumstances the insurance carrier can rationally calculate a reasonable premium which will ultimately pay the claimant what is contractually defined while permitting the carrier to have a profit.
Disability does not seem to fit the insurance model very well because it is less predictable and much more difficult to define and prove. The Social Security Administration states that 3 of 10 individuals may become disabled in their working years before reaching retirement age. But the agency does not have very specific definitions of the nature of disability or its duration, both of which have complex causes and factors.
Human disability may have as its cause what seem to be a nearly infinite number of interacting physical and mental disturbances the onset of which is almost impossible statistically to project to a population. And if the liability of the insurance carrier is, furthermore, income protection, the nature of the disability that may strike a policy holder does not necessarily link closely to the policy holder’s earnings. There are definitional problems.
Disability to perform one’s “own occupation” is contrasted to performing “any occupation.” And the literature in the field bristles with complaints about the adequacy of definitions in distinguishing between actual and subjective disability—not least the medical basis of something like chronic fatigue syndrome.
In this situation generally, the natural outworkings of socially provided protection schemes tend toward unsatisfactory outcomes. On the private side, insurance carriers attempt to limit exposure by a combination of high premiums in private policies and delimited benefits in mass policies. On the public side, minimal protection is provided but only in cases of total disability, which is the Social Security disability outcome.
Under the circumstances, DI is one option—and not a very satisfactory one—the small business owner can examine as a hedge against personal disability. An aggressive saving plan may be another. Substantial time in soliciting bids, in using legal resources to examine offered policies, and in researching alternatives to such expenditures are in the picture. In a well-run and profitable small business, an internal legal arrangement which will provide some limited income to the disabled owner at company expense may sometimes be the best solution whether or not it involves DI.