Many people are not aware of the sobering statistics on the likelihood of becoming disabled. According to the Social Security Administration, more than one in four of today’s 20 year-olds will become disabled before reaching retirement age.1 And the 2010 Census found that 21.4 million people aged 16 to 64 in the U.S. have a severe disability that limits or prevents them from working.2
This article provides an overview of income protection insurance, including the distinctions between short-term and long-term coverages.
Income protection insurance
Income protection insurance, also known as disability income insurance, provides covered individuals with a replacement income should the insured become disabled and unable to work. Coverage amounts are designed to provide reasonable income replacement while maintaining an incentive to return to work. According to the National Association of Insurance Commissioners (NAIC), a typical disability policy benefit is approximately 60 percent of earned income pre-disability.3 Both premiums and benefits of disability income protection insurance vary depending on risk factors such as age, gender, health history and physical condition, income and occupation/job duties.
Sources of disability income protection vary considerably in both benefit levels and definitions of coverage. Five factors affect benefit levels and coverage: elimination period, total disability, benefit period, monthly indemnity and other income sources.
1. Elimination Period. The elimination period on disability income insurance can be compared to the deductible on an automobile or major medical expense insurance policy. It is an initial period of time during which the disabled insured is not eligible to receive benefits even though a sickness or injury prevents the individual from working.
2. Total Disability. Two definitions are normally used to describe total disability: “Own Occupation” and “Any Occupation.”
- The Own Occupation definition pertains to a person who is unable to perform each duty of their own occupation on a full-time basis. For example, if the person is a painter and their disability limits their accessibility to a ladder, then the individual would be able to collect benefits under the policy.
- The Any Occupation definition, which is stricter, indicates that benefits will only be paid if the individual is unable to perform each of the material duties of any gainful operation for which a person is reasonably qualified. If the painter had a disability policy that defined disability as Any Occupation, then the painter would be expected to find other gainful work, such as working in a retail paint store. Many employer-provided or individual-income protection insurance policies define disability under the Own Occupation definition for the first two years of disability. After that, the definition changes to Any Occupation.
3. Benefit Period. The benefit period is the maximum period of time during which benefits will be paid for a single period of disability. The benefit period can be as short as 13 weeks or as long as retirement age. The longer the benefit period, the higher the cost of coverage will be because the potential liability to the insurer increases. Keep in mind, however, that if you are close to retirement, you may only need a one- or two-year benefit plan. Therefore, having options for a one- or two-year plan may be important to help protect against short-term risks in your financial plan.
- Short-Term Disability.Many short-term disability policies, including employer-provided group policies, cover injuries during the first two years of disability. Pregnancy is defined as a sickness and thus is usually covered as part of a short-term disability plan.
- Long-Term Disability. A long-term disability policy will provide benefits up to age 65 in most cases. If an individual is working beyond age 65 benefit durations will reduce. As indicated above, the Any Occupation definition would apply to these longer disability benefit periods.
4. Monthly Indemnity. During periods of disability, the benefit paid to you is called the monthly indemnity. It represents a set dollar amount per month that will be paid as long as the insured is totally disabled under the policy definition and the benefit period has not been exhausted. The amount of the monthly indemnity, commonly 60 percent of the insurer’s earned income, is set at the date of policy issued and usually based on the insured’s earned income.
5. Other Income Benefits. While disabled, an insured may be eligible for benefits from other sources. Benefits payable under the disability plan may be offset (reduced) by other sources of disability income such as Social Security or disability benefits received from other employer-sponsored plans.
Pay attention to scheduled or limited benefits based on specific types of disability. For example, some low-cost policies only offer benefits if your disability is due to certain kinds of accidents. Since disability is caused by sickness, too, make sure your policy covers both accidents and sickness. Some policies may only pay a benefit if you undergo an operation related to an accident.
How much income protection do you need?
The amount of income protection needed depends on your monthly expenses covered by the income product. Consider such things as mortgage or rent payments, insurance premiums, car payments, credit cards, loans, food, clothing, utilities, day care costs and health care expenses not covered by insurance. Then consider how long the current resources, like employer-provided sick leave and sick leave bank, state retirement system benefits, Workers’ Compensation, Social Security and non-salary income from investments, would last.
1 Council for Disability Awareness: Disability Statistics July 2013.
2 US Census Bureau: Americans With Disabilities: 2010. July 2012
3 NAIC Consumer Alert: Protecting Your Financial Future with Disability Insurance. November 2011