Disability 101
Wouldn’t it be nice if the need for disability insurance was non-existent? Well it is for those who have a financial net worth of twenty million or more. Unfortunately, that group represents less than 1% of US families, leaving the balance of the families somewhat on their own to deal with the issue of financial complications derived from a disabling event to the family bread winner. On the surface, dealing with this issue might seem like a daunting task, but when it is broken down into a few basic categories, it becomes much easier to understand. Once understood, it becomes much easier to assess your personal situation, ultimately leading to the development of a plan that works for your family. Here are the categories:
General Need:
Many people purchase life insurance to protect and provide for their family in the event of a premature death to the bread winner. In a sense, life insurance replaces your most valuable financial asset, your income. Your ability to earn an income is the foundation providing for the necessities of life including lifestyles, goals and dreams. Disability insurance does the same thing by protecting that same asset, your income.
Here are a few statistics according to the Society of Actuaries:
- People in their working years are more likely to become disabled for ninety days or more than they are of dying.
- Your chance of missing at least 90 days of work due to a disability is just under 1 in 3.
- An illness or accident will keep 1 in 5 workers out of work for at least a year before the age of 65
While these might be surprising statistics to some, an even more surprising statistic relates to the causes of these disabilities. It is widely held that most people think disabilities are caused by accidents, when the reality is that most are caused by illness. Irrespective of the cause of disability, the results of a disability can be devastating to a family’s overall financial wellbeing.
Personal Need:
While there are a wide variety of reasons why someone should consider the purchase of disability insurance, the primary reason is indisputable. If your inability to work due to a disability-causing accident or illness will create a financial hardship for your family, you need to consider disability insurance. That’s the easy part. The difficult part is quantifying the financial hardship. This is best accomplished by first defining your financial needs (cash outflow) then matching them against your financial abilities to pay (cash inflow). Sources of these funds include your savings, public disability insurance programs, or disability benefits you receive through your employer. If your financial ability cannot adequately cover your financial needs, you need to consider a private disability insurance plan. Here’s an outline that can help you better visualize your needs and abilities:
- Financial Needs (“cash outflow”)— Family financial needs can be categorized as current ongoing living expenses and the need to set aside funds for retirement purposes. While they are both vitally important in a family’s overall financial plan, the most immediate concern in a disability situation are the current ongoing living expenses. The rationale here is that most disabilities are not permanent and it is therefore assumed that at some point you will return to the work force, regaining your ability to earn income again. Here is a list of some of the more basic ongoing living expenses:
- Food—You should have a good estimate of this monthly expense based on the recent past
- Shelter— mortgage payment, property taxes
- Utilities— You should have a good estimate of this monthly expense based on the recent past
- Insurance— Homeowner’s, auto, life & health
- Credit Card Payments— You should have a good estimate of this monthly expense based on the recent past. It’s important to prioritize this along with any other obligations that may impact your credit score.
- Miscellaneous— This is a catch-all category that might include things such as clothing, entertainment, maintenance, etc.
This will be an easy exercise if you have a previously established family budget. If you don’t have a family budget, you should.
- Financial Abilities (“cash inflow”)—Family financial abilities can cover a wide array of sources, some of which are not likely to be available to most. Here is a list of some of the more common sources of cash inflow:
- Savings— bank accounts, investment accounts, life insurance cash value
- Credit— home equity line of credit (HELOC), 401(k) loan
- Family Assistance— gifts, loans
- Public Disability Programs— California State Disability (partial income replacement), Social Security Disability Insurance (needs to be permanent disability and could take a long period of time before a benefit is approved)
- Individual Disability Insurance Programs— Worker’s Compensation (if disability is work related), group disability insurance programs
Public Disability Insurance Programs:
These are governmental programs available at both the federal and state level, although only a few states actually have statutorily mandated State Disability Insurance programs (California, Hawaii, New Jersey, New York and Rhode Island):
- Social Security Disability Insurance (SSDI)— The US Social Security and Supplemental Security Income disability programs are the largest of several Federal programs that provide assistance to people with disabilities. Both are administered by the Social Security Administration and only individuals who have a disability and meet medical criteria may qualify for benefits under either program. Social Security Disability Insurance pays benefits to you and certain members of your family if you are “insured”, meaning that you worked long enough and that you paid Social Security taxes. Supplemental Security Income pays benefits based on financial need.
- State Disability Insurance (SDI)— Some states provide disability benefits to qualified residents. Residents of California have access to California State Disability Insurance (SDI), which is a partial wage-replacement insurance plan for California workers. This program is state-mandated and funded through employee payroll deductions. It provides affordable, short-term benefits to eligible workers and the benefit amount is determined by the resident’s level of income over the previous 12 months.
Individual Disability Insurance:
Whereas SSDI and SDI are considered public programs, Individual Disability Insurance is a private program and generally comes from two sources, through an employer or by purchasing a private policy from an insurance broker.
- Employer Plans— Most individuals have some sort of disability insurance through their employer, in the form of Worker’s Compensation (See “Am I covered by Workman’s Compensation?” in FAQ’s). Sometimes, an additional group policy might be available through the employer, union or other association.
- Private Plans— Private plans are offered by insurance companies and are available to most individuals through insurance brokers. There are two main types of disability insurance: Short-Term Disability Insurance and Long-Term Disability insurance. Within each type, options and choices are many and varied, enabling you to design a plan that satisfies your needs while remaining within your budget (See “Can Disability Insurance plans be designed for very specific needs?” in FAQ’s).
A few often-overlooked features of disability insurance are as follows: the insured will receive the “benefit” free from any income tax, and the proceeds can be used for any purpose. The cost for protection can be a bargain, allowing you to provide adequate coverage for your changing needs without breaking the bank.
Examples of Disability Insurance
Although many people believe themselves to be impervious to disabling accidents, extended illnesses or even unexpectedly extended surgical recovery periods, the fact remains that even the fittest of us can succumb to any of these, preventing us from performing our jobs, and resulting in loss of income. Disability Insurance can allay concern over loss of income by providing coverage for a portion of your income. Here are a few of the most common reasons given for purchasing disability insurance:
- Peace of mind— Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Sole wage earner in the household— The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Each of the examples in this section will present a unique family dynamic: single; married without children; married with children; empty nesters; retired, and will place each of the reasons for purchasing disability insurance (see above) into one of three categories:
- Reasons to purchase coverage now
- Reasons to consider coverage
- Not currently applicable to the scenario
The rationale for why Disability Insurance is or is not recommended in each scenario will be provided in the Overview section.
Although many people believe themselves to be impervious to disabling accidents, extended illnesses or even unexpectedly extended surgical recovery periods, the fact remains that even the fittest of us can succumb to any of these, preventing us from performing our jobs, and resulting in loss of income. Disability Insurance can allay concern over loss of income by providing coverage for a portion of your income. Here are a few of the most common reasons given for purchasing disability insurance:
- Peace of mind— Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Sole wage earner in the household— The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Each of the examples in this section will present a unique family dynamic: single; married without children; married with children; empty nesters; retired, and will place each of the reasons for purchasing disability insurance (see above) into one of three categories:
- Reasons to purchase coverage now
- Reasons to consider coverage
- Not currently applicable to the scenario
The rationale for why Disability Insurance is or is not recommended in each scenario will be provided in the Overview section.
Scenario:
- Single, age 23, earning $40,000 per year
- No dependents
- Monthly living expenses = $2,000
- Current savings = $4,000
- Renting an apartment with a roommate
Reasons For Coverage Now:
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Reasons To Consider Coverage:
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
Not Currently Applicable To The Scenario:
- Peace of mind— Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
- Sole wage earner in the household— The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
Overview: This individual should not be overly concerned about the potential financial consequences associated with an unexpected disability for the following reasons:
- At the current age of 23, a single person is highly unlikely to become disabled in the not- too-distant future.
- Current net worth is probably not much greater than the $4,000 savings. Because of this, the potential for loss given a worst case scenario is minimal.
Being aware of any group disability coverage offered by the employer would be beneficial, especially if such coverage is paid for by the employer, or offered to employees at a reduced cost through a group plan.
Scenario:
- Single parent, age 27, earning $84,000 per year
- 2 children, ages 3 & 6
- Monthly living expenses = $6,000
- Current savings = $20,000
- Homeowner:
- Appraised Value: $350,000
- Loan Balance: $315,000
Reasons For Coverage Now:
- Peace of mind—Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
- Limited savings—Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Sole wage earner in the household— The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Reasons To Consider Coverage:
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
Not Currently Applicable To The Scenario:
- All of the common reasons for having disability insurance are worthy of consideration.
Overview: Even though the likelihood of this young parent’s becoming disabled is not very great, the outcome could be devastating to the family if it did happen. The savings of $20,000 would not cover monthly expenses for long, particularly given that the family’s monthly living expenses would likely increase due to a number of factors, most notably additional child care costs. The family’s current living expenses of $6,000 per month could quickly increase to $8,000 or more. A reasonable emergency fund would be 6 months’ worth of monthly living expenses, or $48,000 in this case, $28,000 more than is currently available. Hopefully, this individual would have access to disability coverage through his/her employer. If that were the case, knowing the details of the coverage provided would help determine if any additional coverage was needed. While there is a bit of equity in the home, these funds would not likely be available for use in an emergency since the loan-to-value ratio (loan amount divided by market value) is 90%, generally considered too high for most lenders’ consideration.
Scenario:
- Married:
- Wife—age 25, college graduate, earning $75,000 per year
- Husband—age 26, college graduate, earning $60,000 per year
- No dependents currently, but planning to have 2 children by age 33
- Monthly living expenses = $5,000
- Current savings = $25,000
- Homeowners:
- Appraised Value: $350,000
- Loan Balance: $315,000
Reasons For Coverage Now:
- Peace of mind—Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Reasons To Consider Coverage: Same as Reasons for coverage indicated above, particularly in light of their intention of having two children by age 33.
Not Currently Applicable To The Scenario:
- Sole wage earner in the household— The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
Overview: The need for disability coverage for this young married couple is somewhat diminished by a variety of factors:
- Both husband and wife are gainfully employed, and one of their salaries could cover the vast majority of their monthly living expenses, thereby minimizing a potential cash flow problem.
- While their current savings are a bit short of an adequate emergency fund (minimum 6 months of ongoing monthly living expenses), they have demonstrated an ability and a willingness to save money. With their current salaries and savings habit, they could have an adequate emergency fund in short order.
Having children would impact this a bit since monthly expenses would increase substantially and income could be reduced by one of the parents becoming a stay home mom or dad. Of course, if a long-term disability occurred, the decision to have two children by age 33 could be put off or even taken off the table.
In any case, each should know what disability insurance benefits are available through their respective employers, if any. While they do have some equity in their home, these funds would not likely be available since the loan-to-value ratio (loan amount divided by market value) is 90%, generally considered too high for most lenders consideration.
Scenario:
- Married:
- Husband—age 35, earning $90,000 per year
- Wife—age 34, housewife
- Two children:
- Girl—age 3, in preschool
- Girl—age 6, in first grade
- Monthly living expenses = $7,000
- Current savings = $50,000
- Homeowners:
- Appraised Value: $550,00
- Loan Balance: $350,000
Reasons For Coverage Now:
- Peace of mind—Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Sole wage earner in the household—The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Reasons To Consider Coverage: All of the above—if not already covered
Not Currently Applicable To The Scenario: All of the common reasons for having disability insurance are worthy of consideration.
Overview: At first glance, this family’s finances seem to be in order enabling them to be less concerned about an immediate financial crisis resulting from the wage-earner’s unexpected disability. Their savings of $50,000 represents an emergency fund of over 7 months of expenses. Additionally, they have $200,000 of equity in their home, a good portion of which could be accessed through a Home Equity Line Of Credit (HELOC). It is not unusual for banks to offer HELOCs up to a combined loan-to-value ratio of 80% (sometimes even 90%). In this scenario, their home is worth $550,000, with a loan amount of $350,000. A combined loan-to-value ratio of 80% equates to $440,000, allowing for a HELOC of $90,000.
Irrespective of the apparent comfort from the above, he should know what disability insurance benefits are available through his employer, if any. If his employer does not provide any long term disability coverage, he may want to consider a long term disability insurance policy with a one year elimination period; usually the most inexpensive policy available.
Scenario:
- Married: No dependents—Their three children, ages 23, 27 & 30, are all married with plans to have at least two children by age 35
- Husband—age 55, earning $100,000 per year
- Wife—age 53, earning $125,000 per year
- Monthly living expenses = $6,000
- Current savings = $600,000
- Homeowner:
- Appraised Value: $750,000
- Loan Balance: $150,000
Reasons For Coverage Now:
- Peace of mind— Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
Reasons To Consider Coverage:
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
Not Currently Applicable To The Scenario:
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Sole wage earner in the household—The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Overview:This is a great example of a family who practiced fiscal responsibility during their lives together. There is very little reason to consider the purchase of disability insurance and if they carried disability insurance up to this point in their lives, it might be time to discontinue the coverage…..that is, unless their existing coverage adds to their peace of mind. Remember, most disabilitypolicies are discontinued at age 67, or to age 75 as long as you continue to work full-time and pay the increased premium. As an alternative, consider Long Term Care Insurance coverage as a potential replacement for disability coverage as you approach retirement.
Scenario:
- Married:No dependents
- Wife—age 62, retired
- Husband—age 65, earning $85,000 per year
- Monthly living expenses = $6,000
- Current savings = $750,000
- Homeowner:
- Appraised Value: $750,000
- Loan Balance: $100,000
Reasons For Coverage Now:
- Peace of mind— Knowing that your family will not have to suffer financially from a loss of income caused by a disability that prevents you from performing your job and losing your income.
Reasons To Consider Coverage:
- Peace of mind—knowing your family will not have to suffer financially from a loss of income caused by a disability preventing you from performing your job and losing you income.
Not Currently Applicable To The Scenario:
- Limited savings— Without significant savings, the family’s living expenses would not be covered for an extended period of time, causing hardship.
- Sole wage earner in the household—The non-disabled spouse might be able to seek employment, but it is likely to take some time before employment actually begins, and the salary might not be sufficient to cover the family’s living expenses.
- Income replacement— Proceeds from a disability insurance policy can replace all or a portion of the wage-earner’s income lost due to disability.
- Complement to existing disability benefit plans— There are various public and private disability plans for which you might qualify, but they may not be sufficient to cover your financial exposure due to a disability.
- Lock in a low premium and future insurability at a young age— Premiums for disability insurance will never be more affordable that they are today. Purchasing early guarantees that future events will not keep you from qualifying for coverage.
Overview: This is a great example of a family who practiced fiscal responsibility during their lives together. There is very little reason to consider the purchase of disability insurance and if they carried disability insurance up to this point in their lives, it might be time to discontinue the coverage…..that is, unless their existing coverage adds to their peace of mind. Remember, most disabilitypolicies are discontinued at age 67, or to age 75 as long as you continue to work full-time and pay the increased premium. This family would be hard pressed to justify any disability insurance coverage at their current ages, let alone any increased premium for the husband beyond age 67 if gainfully employed. At this point in their lives, a potential, albeit quite costly, alternative to Disability Insurance coverage could be Long Term Care insurance coverage.
Comparisons of Disability Insurance
There are fundamentally only three types of disability insurance available to satisfy your needs. They are: Accident Only, Short-Term Accident & Illness and Long-Term Accident & Illness. Similar in some respects but different in many others. The costs vary dramatically based on a number of factors. The most significant of which are: Monthly Benefit, Elimination Period and Benefit Period. In this section, you will be provided comparisons illustrating the relationships between coverage types and premiums, for men and women, young and old, healthy or not.
How Do Premiums Compare Between Accident Only and Accident & Illness Disability Insurance?
As you will see there is a substantial difference in premiums between Accident Only and Accident & Illness disability insurance. The difference is primarily the result of the cause of disability. As the name implies, an Accident Only policy provides protection to the insured from disabling-accidents if you are unable to work irrespective of how or where the accident occurred or who was at fault. The Accident & Illness policy has a more broad definition of disability which includes illness as well as an accidental cause.
Conclusion:
No surprise here, the differences are substantial. However, this is a comparison between two very different coverages both of which provide vital elements of disability insurance protection. Oftentimes, the decision is made on affordability.
Do Disability Insurance Premiums Vary Between Males And Females?
Yes they do and the differentials might surprise you. This is not a discrimination issue on the part of an insurance company. Essentially, insurance companies employee actuaries to analyze past accident and illness disability rates and correlate the findings to create “Morbidity Tables”. Insurance is prepared separately for men and women and take into account factors such as, age, occupation, recreational activities, social activities etc.
Conclusion:
It pays to be a Female. Not only are women expected to live 4.6 years longer than a man, they are less likely than a man to become disabled from an accident or illness.
Should You Purchase Disability Insurance Now or Wait Until Later?
Below you will see that the cost of disability insurance, irrespective of the type of policy chosen, will never be lower than it is today. However, that in and of itself is no reason to purchase a disability insurance policy. The reason to purchase should be based on a need. That need should either exist today or have a strong likelihood that it will exist in the not too distant foreseeable future.
Conclusion:
It is pretty evident that purchasing disability insurance sooner rather than later is beneficial. But again, without a need you would likely be wasting some money. However, there is another reason that is often overlooked for purchasing disability insurance sooner rather than later and that relates to insurability. As you age, there an increasing likelihood that you will suffer a medical issue or disability that will cause an insurance company to rate you as uninsurable….eliminating the ability to purchase a policy when you need it most.
Are There Benefits of Being Healthy When Purchasing Disability Insurance?
Of course there are benefits of being healthy anytime. But it certainly pays to be healthy when you are shopping for disability insurance. When you apply for disability insurance you are typically subjected to certain underwriting guidelines that seek to determine the risk of you becoming disabled. Essentially, the healthier you are perceived to be the less likely you are consider to become disabled. Conversely, an unhealthy person is more likely than a healthy person to become disabled. The insurance industry typically uses four risk categories when evaluating the risk characteristics of an applicant. They are: Preferred Risk, Standard Risk, Sub-standard Risk and Uninsurable Risk.
Conclusion:
Plain and simple, as evidenced by the comparisons above it pays nicely to be healthy when purchasing disability insurance.
Can I Afford Accident Only Disability Insurance?
An accident only insurance policy protects you against your inability to work as the result of a disabling accident. This type of policy is the most restrictive as to defining the disability. This feature is what makes an accident only disability policy one of the best values in the industry making it very affordable to most people.The charts below provide illustrations of varying premiums based on tailoring a policy by selecting the Monthly Benefit period, Elimination Period and/or Benefit Period.
Conclusion:
The cost of securing an Accident Only Disability Policy is within most people’s financial reach and as such should be a consideration in a family’s overall financial plan. However, Accident Only Disability policies only provide a monthly benefit if you are unable to work due to a disabling accident. If you become disabled as a result of illness you will not be covered and will have to look to income replacement from other sources.
Can I Afford Short-Term Accident & Illness Disability Insurance?
This policy offers features between what is offered by Accident Only and Long-Term Accident & Illness disability insurance. Since Accident Only is considered to be the least expensive and Long-Term Accident & Illness the most expensive, it is no surprise that Short-Term Accident & Illness is somewhere in between.
Conclusion:
The cost of securing a Short-Term Accident & Illness Disability Policy is within most people’s financial reach and as such it should be a consideration in a family’s overall financial plan. However, as the name implies, Short-Term Accident & Illness Disability policies only provide a monthly benefit for a maximum of 24 months. While this is satisfactory for many situations, it may not be for others. If your disability extends beyond your benefit period (3 months to 24 months), your coverage will cease and you will have to look to income replacement from other sources.