CHAPTER FIVE - DISABILITY INCOME INSURANCE

 

DEFINITION AND OVERVIEW

Disability Income Insurance is health insurance that provides income payments to the insured wage earner when income is interrupted or terminated because of illness, sickness, or accident.  Basically, there are two types – Long-term and Short-term, the difference being the length of time that income can be paid.  There are other differences also, as will be discussed in this text, but most Long-term policies are sold on a Group basis, whereas Short-term policies are sold on an individual or Association Group insurance.

Disability Income policies are difficult to discuss in general terms and to compare with similar products.  Disability Income policies are specifically designed to allow for maximum flexibility and to provide for the maximum coverage of the individual needs of the insureds.  This flexibility is provided through the availability of benefits and optional coverages.  The benefit provisions must be related closely to each other, otherwise there could be unexpected claims.  Actuaries involved in policy designs for life and health insurance products agree that there is probably no other type of insurance that relies so much upon the differences and distinctions in the benefits and in the language that is used to describe the benefits.

In today’s high-tech society, there are constant changes – some changes involving disability risks.  Remember carpal tunnel syndrome that was a result of computer terminal operators spending long hours at data entry?  The modern methods of medical treatment and diagnosis have changed the practical application of “disability” terminology and with the rapid development of treatment for many diseases and impairments, there is little doubt that benefits and provisions will continue to change.  Regardless, there are basic criteria that can be used for analyzing and evaluation of all health insurance policies.

Disability Income policies that are sold to individuals are issued either on a Guaranteed Renewable or Noncancellable basis, and in some cases, Conditionally Renewable. 

Conditionally Renewable

This category is used for Disability Income and medical expense insurance.  It gives the insured a limited right to renew the policy to age 65 (or some later age) by the process of simply paying the correct premium on time.  The insurance company may refuse to renew coverage but only for reasons that are stated in the policy.  If the insurer is not going to renew under these provisions, the insured must be notified 30 days in advance of the due date of the premium.  The insurer retains the right to change premiums and benefits for all insureds of the same class. 

The reasons for not renewing the policy are clearly stated in the policy and vary according to the type of insurance.  The insurer cannot refuse to provide coverage because of a change in the health of the insured once the policy has been issued.  The company may refuse to renew a specific class of insureds (such all those insured under the policy form residing in the state) or may decide to discontinue a policy series for all insureds in a single jurisdiction. 

On an individual basis, the insurance company may refuse to renew the policy when/if the insured changes to a more hazardous occupation.  They may refuse to renew if the economic need for the policy changes, such as the insured becoming incorporated.  In particular, with Disability Income insurance, if the insured becomes over-insured through purchasing other insurance that will provide benefits in excess of the expected loss, the insurer may decline to renew.  This prevents “stacking” of policies, which could lead to an anti-selection situation where the insured would make more money on disability than by working.

The Conditional Renewable provision is used mostly in specialized business disability income policies (other than overhead expense insurance).  In these specialized policies, the insurer retains the right not to renew on an individual basis when the covered business risk no longer exists, or when other specific and specified events occur.  In these policies, the insurer may retain the right to change benefits, but typically, it guarantees that the premium rates will not change.

This renewal provision is used traditionally in those noncancellable and guaranteed renewable Disability Income policies which provide continuous coverage from age 65 to age 75 while the insured continues to be employed full-time.  The premiums for this period are usually the renewal premiums for persons of the same attained age and risk classification (see later discussion of risk classifications).  During this period (called “Conditional Renewal period”) the monthly indemnity amounts are usually not reduced, however, the benefit period is usually limited to two years.

THE NEED FOR DISABILITY INCOME INSURANCE

The perception of the general public has been in the past and will probably continue in the future, that Disability Income insurance is not as useful or necessary to most individuals as Medical insurance or even, life insurance.  Most of the wage-earning population purchase, many times with the assistance of their employer, insurance that will provide medical coverage for themselves and their families.  Large proportions of the wage-earning population purchase group or individual life insurance.

A much smaller share of the wage-earning population has either individual or group Disability Income insurance.  In fact, only about one in four has any Disability Income insurance of any kind.  The attitude seems to be that there is little chance of one losing his income because of a disability, and anyway, if they do become disabled, they will recover completely in a short period of time. 

Most disabilities are of the Short-term variety, usually lasting less than one month.  However, the probability of sustaining a disability that lasts for 3-months or more is high during the wage earning years.  The probabilities of Disability for periods of 90 days or more and Probabilities of Death prior to Age 65 (based on 1980 CSO Mortality Table) can be best illustrated by the following graph.

Probability of Disability and Death at various ages

It should be noted that the probability of a Long-term disability (90 days or more) is considerably greater than the likelihood of death until age 60, when they are about the same.

Also, it should be noted that if a person is disabled for at least three months, the average duration of disability ranged between five to seven years, as shown in the graph below.

 

Years                              Age at inception of disability (1985 Commissioners Disability Table)

 

The need for Disability Income insurance has increased for the same reasons that the need for Long Term Care insurance coverage has increased, which is basically the fact that as society develops economically, support for family members that was formerly provided by other family members, declines.  Many medical advances have substituted disability for what would have previously been death.

From these basic statistics, it is obvious that the financial implications of disability can be a terrible burden for many people, and is even more financially difficult on the family than death.  A point missed by many in this discussion is that the expenses of a disabled person not only continues, but in most cases, increases.  With death, all expenses cease.  Medical expenses are generally covered by insurance, but only Disability Income insurance can cover the loss of the income stream.

DEFINITIONS

Definitions under the policy may be part of the benefit provisions, but usually they are separate.  The definitions are used to evaluate claims and control the benefit payments.  The most important definitions are those of injury, sickness, preexisting conditions and disability.

INJURY

Under a Disability Income policy, the word “injury” is defined as accidental bodily injury, occurring while the policy is in force.  Originally this definition used “accidental means,” but the latest wording uses “results” language.  This may seem like nit picking, but not all accidental bodily injuries result from accidental means.

Accidental Means vs. Results

When “accidental means” is used regarding a bodily injury, there are two requirements that must be met if the loss is to be covered: Both the cause of the injury and the result (the injury) must be unexpected and unforeseen.  In addition, the event must not be under the control of the insured that results in the bodily injury.  Most states prohibit the use of the accidental means clause in any health insurance contract. 

SICKNESS

The definition of “sickness” is not entirely uniform among companies and their products, but generally it is defined to means sickness or disease that first manifests itself during the time that the policy is in force.  Some insurers extend the “first manifest” language to mean a sickness or disease that is first diagnosed and treated during the time that the policy is in force.  There is little difference, actually, and the intention in either case is to cover only sickness that is first contracted during the time that the policy is in force.

If the Disability Income policy contains either a “first manifested” or “first diagnosed” sickness definition, the policy will contain a preexisting condition limitation.

PREEXISTING CONDITION

It usually applies to the first two policy years and is used to exclude benefits for any loss that results from a (medical) condition—sickness or disability—that had not been acknowledged or reported by the insured, and that occurred prior to the policy date.

Preexisting condition provisions are tightly regulated in most states and therefore there are some variances from state to state.  Typically the definition would be similar to the following:

 

“A pre-existing condition means a medical condition that exists on the Effective Date and during the past five years either (1) caused you to receive medical advice or treatment; or (2) caused symptoms for which an ordinarily prudent person would seek medical advice or treatment.”

DEFINITION OF DISABILITY

Unquestionably, the most important definition in a Disability Income insurance policy is the definition of “disability.”  Individual Disability Income policies have been called “loss of time” insurance because of the definitions of occupational disability.  A disabled person insured under a Disability Income policy must have suffered a loss of income because they cannot perform the duties of their job.  The definitions of total disability and of partial disability depend upon the inability of the insured to perform certain occupational tasks. 

Partial Disability vs. Residual Disability

(Permanent) partial disability is a disability in which a wage earner is forever prevented from working at full physical capability because of injury or illness.

Residual Disability is the inability to perform one or more important daily business duties or inability to perform the usual daily business duties for the time period usually required for the performance of such duties.

RESIDUAL DISABILITY INCOME INSURANCE

If Residual Disability Income coverage is provided, benefits are usually provided for the unused portion of the total disability benefit period, up to age 65.  If an individual is at least age 55 at the time of disablement, and total disability lasts less than a year, residual benefits are payable for the unused portion of the benefit period for up to 18 months, but not beyond age 65. 

If there is at least a 25% loss in current earnings, the residual benefits will equal the percentage of loss times the monthly benefit for total disability. 

In most policies, the Residual Disability concept has replaced the partial disability provision as a means of paying a portion of the benefits to an insured who works at reduced earnings as a result of sickness or injury.  It should be noted that the residual concept differs from the usual indemnity plans as it stresses the protection of the income, rather than the protection of “occupational performance.” 

TOTAL DISABILITY

There are two different definitions used by insurance companies to describe total disability.  The “any gainful occupation” definition, called “any occ” in the industry which is the most liberal coverage – and the most expensive.  The other is the “own occupation” definition, which is called “own occ” in the industry.

OWN OCCUPATION

The “own occupation” clause defines an insured as totally disabled if he cannot perform the major duties of his regular occupation.  Under this definition, an insured could be working in some other capacity and still be entitled to policy benefits if he cannot perform the important tasks of his own occupation in the usual way.  In most cases, the own occupation coverage is limited to clients in the highest occupational classes, such as professionals and business executives. 

 

This definition can vary by policy and company.  Frequently the own occupation definition defines one as being totally disabled if

(a) they cannot perform the major duties of their regular occupation, or

(b)  are not at work in any other occupation.

Under this variance, if the insured is disabled and cannot perform his regular job, disability benefits can be terminated if he voluntarily chooses to work at some other occupation.  However, if this provision is used, the insurer cannot require the insured to resume work in another suitable occupation.  This coverage is also known as regular occupation coverage.

The most comprehensive definition as included in a few policies, could read similar to:  “The inability to perform the major duties of your occupation; the insurance company will consider your occupation to be the occupation you are engaged in at the time you become disabled.”  They will pay the claim even if the insured is engaged in another occupation

The modern trend seems to be to include both definitions in the Disability Income insurance policy by using an “own occupation” definition for a specified period of time (usually two to ten years), and then thereafter, “any occupation” definition comes into play. 

Many insurers will offer own occupation coverage to age 65 for certain preferred classes of insureds, but this more liberal definition seems to be losing favor with insurers.

Physician Requirement

Nearly all Disability Income insurance policies require that an insured must be under the care of a physician to qualify for disability benefits.  It might be said that this requirement is “taken with a grain of salt” as obviously an insurer could not deny benefits if medical care is not essential to the recovery or well being of the insured.  Courts have frequently so stipulated also.  The insurance company simply cannot require that an insured maintain a doctor-patient relationship just for the purpose of certifying a disability.

PRESUMPTIVE DISABILITY

If a Disability Income policy provides benefits for total disability (as most do), it is quite common to also include a definition of presumptive disability.  Under this provision, an insured is presumed to be totally disabled (even if he is at work) if sickness/injury results in the loss of the sight of both eyes, the hearing from both ears, the power of speech, or the use of any two limbs.  Generally the insurer will waive the medical care requirement and will start paying benefits immediately upon the date of the loss.  The insured can work in any occupation and benefits will still be paid to the end of the policy benefit period, as long as the loss continues.  With the developments in new prosthetic devices, mechanical functions of the hands and legs can be restored so as in some cases, the individual can resume their regular occupation.

ANY GAINFUL OCCUPATION

If the policy definition were “any gainful occupation” (or "any occ”), the insured would be considered as totally disabled if he cannot perform the major duties of any gainful occupation for    which he is reasonably suited because of education, training, or experience.  Since the insured can work at other jobs, this is obviously a more restrictive definition of disability than the “own occ” definition.  Primarily, it limits the benefits.  Used primarily in Group Disability Income insurance, this provision may read: “Because of sickness or injury, you are unable to perform the material and substantial duties or your occupation, or any occupation for which you are deemed reasonably qualified by education, training and experience.”

INCOME REPLACEMENT APPROACH

The definitions of disability often revolve around the insured’s ability (or inability) to perform certain tasks.  Several companies now use an income replacement approach to defining disability wherein insureds are reimbursed when they lose a percentage of their earned income, usually 20 or 25%.  The earned income must be lost due to an injury or sickness that requires a doctor’s care.

POLICY PROVISIONS

BENEFITS

The Benefit provisions of a Disability Income insurance policy may be divided into three areas regarding the payment of benefits.  These areas of benefits form the base of a Disability Income insurance policy, and other provisions related to them are used to expand or limit benefits.  A policy may be judged as to its liberalism (generally making it more marketable) or its conservatism (generally making it less marketable) by the way that benefits relate to these areas of benefits.

ELIMINATION PERIOD

The elimination period is the number of days at the beginning of a disability during which no benefits are paid – often referred to as the “waiting period.”  For those who are familiar with other lines of health insurance, it is similar to a deductible in other types of policies.  The purpose of the elimination period is to exclude illnesses or injuries disabling the insured for only a few days and therefore, can be met by the insured from their own funds. 

The typical Disability Income insurance policy elimination period – or at least the most common – is 3 months or 90 days, however periods from 30 days to as long as 720 days are available.  It is important to remember that benefits are paid at the end of the elimination period, therefore, using a 90 day elimination period as an example, the insured would not receive the first benefit payment for 120 days after the sickness began or the injury was suffered, which disabled the insured.  Most Long-term Disability Income insurance policies have the same elimination periods for sickness or injury.  Conversely, most Short-term Disability Income insurance policies will have a longer elimination period for sickness but for accident the waiting period is either waived or for a relative short period of time, such as 7 days.

Voluntary Interruption of Elimination Period

Most of the major Disability Income insurers offer a provision that allows the insured to return to work for a brief period of time without penalty before the end of the elimination period.  The recovery period is usually limited to either 6 months, or if the recovery period is less than 6 months, to the length of the elimination period.  If the insured is then disabled because of the same or different cause after this interruption, the two periods of disability will be combined to satisfy the elimination period.

THE BENEFIT PERIOD

The Benefit Period is simply the maximum amount of time that the benefits will be paid under the Disability Income insurance policy.  In most policies, the Benefit Period will be the same for disabilities caused by sickness, or caused by injury.  The length of the period is usually offered for two years, five years or to age 65.  Benefits may be provided for “lifetime”, but the disability must be total, continuous and begin prior to age 55 (some policies go to age 60, or 65).

As discussed earlier, most disabilities are Short-term and statistics show that 98 percent of all disabled persons recover before one year has lapsed, and the majority recover within 6 months from the start of the disability.  Conversely, if the disability lasts longer than 12 months, the chances of the insured being able to return to work diminishes drastically.  The chance of returning to work is even lower at the older ages.  Therefore, a prudent choice would be for the insured to have as long a benefit period as is available, and of course, affordable. 

Recurrent Disability Provision

Most, if not all, Disability Income insurance policies include a provision that determines if a recurrent or consecutive disability or episodes of disability are to be considered as a new disability(s) or as a continuing claim.  This provision typically provides that recurrent disabilities from the same cause will be considered as one continuous period of disability, unless each period of disability is separated by recovery for a period of not less than six months. 

This provision is usually contained in Disability Income insurance policies that have a benefit period to age 65 (or longer).  The advantage of this provision to the insured is that a new elimination period is not required for disability that recurs between 6 months and one year after a brief recovery in a Long-term claim.  This provision eliminates the prospect of multiple elimination periods and the result would be that benefits for a recurring loss due to the same cause is payable to the insured immediately for the portion of the original benefit period that has not been used.

Conversely, if the disability results from a different cause after an earlier disability, or if the loss recurs due to the same cause after twelve months after recovery, then the insured would have a new benefit period and a new elimination period.

THE BENEFIT AMOUNT

For personal Disability Income insurance policies, the amount of the disability income is payable on a monthly indemnity basis for a fixed amount.  In essence, the disability income policy is an indemnity policy.  (For general reference, an indemnity agreement is designed to restore an insured to his or her original financial position after a loss.)  One of the fundamental principles of indemnity is that the insured should neither profit nor be put at a monetary disadvantage for incurring the loss.  Since the purpose of Disability Income insurance is to reimburse the insured for loss of income due to disability; therefore, in order to understand this product, these fundamentals should be kept in mind.

Taking this one step further, for total disability under the Disability Income insurance policy, the indemnity is usually written on a valued basis.  This means that the policy benefit as stated in the policy is assumed to equal the actual monetary loss suffered by the insured because of the disability.  This amount is stated on the policy and is not adjusted to the earnings of the insured, or for any other insurance payments, at time of claim for either total or partial disability.  If residual disability is involved, the benefit can be reduced in proportions to the loss of earnings of the insured. 

The benefit amount is extremely important in these policies because of the possibility of adverse selection as indicated previously.  Insurers limit the disability income that an individual may purchase to not more than (normally) 85% of the insured’s earned income.  The 85% is usually used for those in lower incomes as determined by company practices, and will be graded downwards to 65%—or in some cases, 50%—(or even less) for those in the highest income tax brackets. 

The benefit amount limits take into consideration any other income to the insured, such as from other type of sick-pay plans offered by the employer, Government (SSI) disability plans, and other types of personal &/or group insurance.  The limits may also be reduced if an insured has a significant amount of unearned income, or if they have a high net worth (such as $3-5 million). 

Limits may seem severe, but the purpose is to eliminate as much as possible the adverse selection and moral hazard of over insurance.  If the benefits of a Disability Income policy equals or exceeds the amount of income without the disability, there could be very little reason for an insured to return to work in case of a claim, with the result that recovery can be stretched out for a long period of time, or never be attained.  As with other insurance products, insurance laws weigh heavily in favor of the insureds and provide very little recourse for an insurer at time of claim, therefore the limits of benefits at time of underwriting is about the only control an insurer has to eliminate the over insurance hazard.  And when the insured is aware of undisclosed sources of income or knows how much he will need to maintain his present standard of living and is able to purchase benefits equal or nearly equal to that amount, the element of anti-selection rears its ugly head.

One thing to keep in mind where the employer pays the premiums:  The monthly benefit will usually be higher because the benefit is taxable to the employee so the net result will be approximately the same.  If the insured has unearned income, such as dividends, interest, etc., the monthly benefit may be offset by all or some portion of the unearned income.

Having said all this, the fact still remains that under limits regularly used by Disability Income insurance carriers for personal insurance, an insured in the most favorable risk classifications and with adequate income, may acquire up to as much as $20,000 indemnity a month for total disability.  It should be noted that this amount is usually separate from the limits of special business Disability Income insurance policies – for example, overhead expense insurance.

Participation Charts

Most companies use a “participation chart” which determines the maximum monthly benefit according to the applicant’s annual income.  Limits have grown over recent years, and whereas it used to be 50 or 60 percent of compensation with a monthly cap of $6,000 or so was normal, these limits are much higher in today’s market.

BASIC BENEFIT PROVISIONS

There are different benefit provisions for total disability and a benefit for waiver of premium, and they are used by all insurers in spite of any other coverages that may be included in the policy.  The benefit provision will define loss, the method of benefit payment, and determination as to termination of benefits.

Rehabilitation Benefit

This benefit is used as an inducement for a disabled insured to return to work.  It provides for payment of a specified amount (typically 12 times the total of the monthly indemnity and any other supplemental indemnities) to cover the costs, when not paid by other insurance or public funding, when the insured enrolls in a formal retraining program that will help the insured return to work.  However, the rehabilitation is not mandatory in the greatest majority of the policies.

Non-Disabling Injury Benefit

This benefit pays “up-to” a specified amount which helps to reimburse the insured for medical expenses incurred for treatment of an injury that did not result in total disability.  The amount generally is in the range of 25% of the monthly indemnity benefit.  The benefit of this provision to the insured is obvious – additional medical expenses paid – and for the insurer, the payment can possibly and logically eliminate a disability claim by making it possible for the insured to treat the injury before it becomes a disability. 

Transplant Benefit

A relatively new benefit, this benefit actually is two-fold.  If an insured becomes totally disabled because of the transplanting of an organ from his body to that of another, the insured will be considered as totally disabled because of sickness.  Further, this benefit provides that cosmetic surgery performed to correct appearance or a disfigurement would be considered as a total disability because of sickness. 

The wording of this benefit will vary by those companies offering it.  It immediately raises the question as to whether cosmetic surgery coverage would include such (frivolous to many) surgery as breast implementation.  One must remember that there is an elimination period involved, and since it would be treated as a “sickness,” the insured would be deemed to have been “cured” in most cases.  However, in the case of reconstruction augmentation surgery because of breast cancer, it fulfills an important personal and social function.

Principal Sum Benefit

As in many other types of life and health policies, this benefit pays a lump sum accidental death benefit amount if the insured is killed in an accident.  The death must be caused by injury, both directly and independently, and it must occur within (usually) 90 (or 180) days of the accident.

It also pays a dismemberment or loss of sight benefit in the form of a lump sum, typically 12 times the monthly indemnity plus any additional indemnities.  If sickness or injury results in the dismemberment or loss of sight, however, the insured must survive the loss for 30 days.  This payment is in addition to any other indemnity payable under the policy and will pay the benefit for two such losses during the lifetime of the insured.  However, it is generally limited to the irrecoverable loss of one eye, or the complete loss of a hand or foot because of severance above the wrist or ankle.

OPTIONAL BENEFITS

Most insurers offer optional or supplemental benefits and some insurers may include one or more of these benefits in their policy, but usually they are available for an additional premium.

RESIDUAL DISABILITY BENEFIT

This benefit provides a lower monthly indemnity in proportion to the insured’s loss of income, when the insured returns to work at lower earnings.  If the policy’s definition of total disability is “own occupation,” the residual benefit is paid only when the insured has returned to work in his “own occupation.”  It is interesting to note that about 35% of all Disability Income insurance claims either start or end in a residual claim.

In most Disability Income insurance policies, the insured may be either totally or residually disabled for purposes of the elimination period and waiver of premium.  In order to determine residual disability, most policies use test of time and duties, combining both occupational and income requirements. 

The “specialty” definition of total disability is often used during residual disability in those situations where the insured is considered as totally disabled for his professional specialty, but is at work earning a lower income in a general practice.  Usually, the specialty type of definition is used only for regular occupations to avoid equivocation when the definition of total disability is based upon the “own occupation” provision.

Typically, a prior period of total disability sustained is not required prior to claiming the residual benefits, therefore it is possible for a residual claim to commence on the date of the claim and the reduced indemnity is payable at the end of the waiting period and will continue for the length of the benefit period.  Until recently, there was a “qualification period” which was a period of time (30 to 90 days usually) that the insured must have been totally disabled.  Today, most policies allow the insured to combine periods of total and / or partial disability to satisfy any qualification period.  Practically, however, residual claims nearly always follows a period of total disability, but in any event, they make up a very small percentage of disability claims, either from incurrence date or following a period of total disability.

Residual disability payments are payable for the policy benefit period, or until the loss of income is less than 20% (or 25%) of the insured’s prior income.  Residual disability payments usually cease at age 65.

Practically speaking, of the two major types of residual claim – loss of income only, or loss of time and duties – most experts feel that the loss of income type of residual claim provision is better for the consumer, as under the loss of time and duties, benefits cease when the insured returns to work.  However, many people that return to work after disability, do not immediately start making the income that they did prior to the disability.  While in some occupations, such as technical and some professional jobs, a person is able to immediately start at the same income after a disability, but if, for example, the insured is in marketing or sales, it will take some time for him to return to his previous level of performance after a disability. 

PARTIAL DISABILITY BENEFIT

There is a distinct similarity between the Partial Disability Benefit and the Residual Benefit, and most policies have replaced the partial benefit with residual benefit provisions for professional and white-collar occupations.  However, many insurers maintain a partial disability provision for less-favorable occupations.

Typically, the Partial Disability Benefit provides 50% of the monthly benefit amount payable for total disability, and is paid for the lesser of (1) six months, or (2) the remainder of the policy benefit period, provided the insured has returned to work on a limited basis after a period of covered total disability.  Partial Disability is usually defined in terms of occupation, and refers to both time and duties.

SOCIAL INSURANCE SUPPLEMENT (SUBSTITUTE)

The Social Insurance Supplement (SIS) was created in response to problems in underwriting Disability Income insurance because of the disability benefits available through workers’ compensation insurance, or for disability and/or retirement under Social Security.  These benefits can be substantial and most insurers take these amounts into account in arriving at a benefit amount.  Most companies limit the amount of Disability Income insurance that will be available to those with incomes of less than $35,000 per year and in particular, those in less-favorable occupations.

These riders are usually issued in amounts of $600, $800, or $1,000 per month.  Keep in mind that this rider is designed to provide additional income if the client CAN NOT QUALIFY for Social Security benefits. 

Many times the insured will not qualify for the social insurance benefits because, for instance, a loss is covered by workers’ compensation insurance.  In addition, the requirements for total and permanent disability under Social Security are very restrictive.  This would mean that if the insurer had limited the benefit amount under a Disability Income insurance policy, the insured could be underinsured each month by several hundred dollars – or even more. 

The Social Insurance Supplement benefit meets this gap in coverage as it provides a monthly benefit amount that approximates the amount of Social Security Disability benefits for total disability.  Obviously, the SIS is paid when the insured is totally disabled according to the policy definition, but is not receiving benefits from any social service plan.  Benefits are paid at a fixed amount, but if at a later date, the insured starts receiving income from a social service plan, the insurer will either terminate the benefit payments, or terminate the benefits on a dollar-for-dollar basis with the social insurance plan.  If the latter method is used, there usually is a “floor” below which the SIS benefit will not be reduced while the insured is on total disability. 

In actual practice, purchasing this rider is more cost-effective than purchasing the same amount of base disability coverage.  Therefore, since the insured will probably never receive Social Security Disability Benefits, the insured can receive additional income at a lower premium.

As far as the insurance company is concerned, this rider can help protect the company against over-insurance.  An insured could (conceivably) receive 60 percent of income in benefits in addition to Social Security Benefits.  This would hardly provide an incentive for an insured to return to work.

Some insurers now offer Social Insurance Substitute Benefits that operate in the same fashion except they cover other federal, state or local benefits the insured receives, such as Civil Service or Workers’ Compensation, etc., benefits.

INFLATION PROTECTION

The Cost of Living Adjustment (COLA) benefit under a Disability Income insurance plan provides for benefits to be adjusted each year during a Long-term claim, to reflect the changes in the cost-of-living from the time that the claim started.  Various methods of determining the COLA are used, but the most typical are those using the U.S. Consumer Price Index.  Originally, using fixed percentage increases provided the inflation protection, but these plans could increase the benefit amount faster than the rate of inflation, leading to the over insurance moral hazard problem. 

The calculation itself can be rather complex, but simply put; the index for the current claim year is compared with the index for the year in which the claim began.  If the index increased or decreased since the claim period began, the benefits for the next 12 months are adjusted by whatever percentage change there was in the index.  This percentage change would be limited to a specified rate of inflation, generally ranging between 5 and 10 percent (compounded annually).

With these calculations depending upon an index that can rise or fall with the economy, the adjusted benefits of the policy can increase or decrease each year, however the policy provides that the benefits cannot be reduced beyond an amount stated and specified in the policy on the policy issue date.  Some policies are capped so as to limit the increase in benefits to a maximum of 2 or 3 times the original benefit amounts, but others have no limit on the amount that the benefits can increase before insured reaches age 65. 

Many professional Disability Income insurance agents will not recommend this rider if the insured is over age 45, as after that age, an individual is not as much at risk for inflation as at the younger ages, when a permanent disability would be tragic.

Some COLA riders are “capped,” usually at double or triple the monthly amount, but other COLA riders allow benefits to increase until the insured is age 65.

There can be a “buy-back” provision, i.e., if the insured returns to work after suffering a disability and receiving monthly benefits, which increases according to the COLA benefits.  If the client returns to work and then suffers another disability, the monthly benefit payment would return to the original amount (prior to COLA increases).  With the buy-back provision, the coverage for the new disability can be what he was receiving under the previous disability with the COLA advances, by paying an additional premium (depending upon his age).

SUPPLEMENTAL PROVISIONS FOR INCREASED FUTURE BENEFITS

Automatic Increase Benefit Provision

This benefit provides for increased benefits as provided by a specified table, in the monthly benefit payment.  Usually these increase in each of 5 consecutive years, at a published fixed rate (usually 5% or 6%).  There are increases in premiums also, with each increase in benefit being paid for at the attained age rate (for the portion of the benefit that was increased).  Usually the insured has the choice of accepting or rejecting each increase over the five-year period.  If he does so, he usually has the option of continuing the automatic increase over another five-year period.  This option is often provided with no extra charge on policy issue date but other companies may charge an additional premium for the rider. 

When (if) the insured recovers, the benefits usually revert to those benefits that were in-force on the date the policy was issued.  Some insurers allow the insured, after recovery, to continue permanently the adjusted benefits that he received during the last claim payment year, but the insured will have to pay the required premium for the age and amount.

Guaranteed Insurability Option

This option, also referred to as a “Future Increase Option,” is similar to that offered in life insurance, i.e., it allows the insured to purchase additional Disability Income insurance at future policy anniversary dates without evidence of insurability.  This type of option would be expected to have some anti-selection elements, as it would more often be purchased by those who expect to suffer claims and among those whose insurability is questionable.  The increase in benefits available under this rider varies greatly among insurers, but usually is limited to twice the monthly indemnity the insured has in force among all insurers on the original policy issue date.

The purchase options are available annually to the insured, on the policy anniversary date, usually until age 50 or 55.  The amount of the benefit is limited to the insurer’s limitations of disability income in relation to the earned income, and can also be limited by amount – such as $500.  Some policies allow the purchase of all or part of the total purchase option, on any policy anniversary date prior to the insured’s age 45 – annual increases thereafter are usually limited to a maximum of one-third of the original total.

If the insured is disabled on an option date, the insured can purchase the additional monthly indemnity but the additional amounts will not apply to the current claim.  If the insured is disabled on the date that they could exercise the increased benefit option, the future increase options are immediately payable.  Income requirements, in these situations, are based upon earned income at the start of the claim, and immediate benefit payments are subject to an elimination period, beginning on date of issue of the additional insurance coverage. 

 

TYPES OF GROUP DISABILITY PLANS

Disability Income insurance is one of the two medical plans available to employees or members of an organization that qualify for group insurance, the other being Medical insurance.  Group Disability Income insurance consists of two types: Short-term and Long-term.

SHORT TERM DISABILITY

As a general rule, Short-term Disability Income insurance is simpler in many respects than the Long-term plans.  Typically, the Short-term Disability Income plans places a maximum dollar amount on the benefits that will be paid in case of disability, regardless of the earnings of the insured.  Some Short-term plans and the majority of Long-term plans apply benefits as a percentage of the total earnings of the insured excluding bonuses and overtime. 

Short-term plans may provide a maximum dollar amount of benefits, regardless of how much the insured draws in income.  For instance the Short-term plan offered might provide a benefit equal to 75% of earnings, with a maximum of $250 per week.  It is common to provide Short-term benefits on a weekly basis.  If the group is large enough, or if the earnings vary greatly among the various levels of employees, the group policy may have a schedule of benefits that would so indicate the variances, and the maximum benefit would often be graded by occupational classes, rather than by strictly income. 

In the discussion of elimination periods, it was noted that in most Long-term plans, the waiting period for sickness and injury was the same.  There is no elimination period because of disability resulting directly from an accident, but there would be a waiting period for sicknesses (usually one to seven days).  The reasoning is that most sicknesses are of short duration and this would eliminate many “nuisance” claims – otherwise premiums would be higher because of the short waiting period for injuries caused by accident.  There are actually several other combinations of elimination periods offered by various companies.

The benefit period for both accident and sickness caused disabilities, are usually payable for up to a range of 13 to 52 weeks.  Twenty-six (6 months) weeks is the most common benefit period. 

NOTE:  Federal law requires that pregnancy be treated the same as sickness under all fringe benefit plans (which include disability income insurance) for employers with 15 or more employees.  Various states have even stricter laws in this respect, and the impact of these laws on the cost has been substantial. 

MARKETING OF GROUP SHORT-TERM DISABILITY PLANS

One of the most successful methods of marketing Group Short-term Disability Income insurance is by what is termed “Workplace Marketing.”  As the name connotes, the plans are sold at the employers place of business and usually also include other types of insurance, such as Cancer policies, life insurance, accident policies, etc., with the premiums being paid by the employer and/or by the employee through payroll deduction (which is usually the case). 

This type of marketing is not true “group” marketing, but would more precisely be called “Endorsement Group” or “Franchise Group.” The employer endorses the programs offered by the agent and/or company, who then makes individual presentations of the products at the workplace to each employee and it, is usually done during, before or after working hours.  Many times the enrollment of the employees in these Short-term Disability Income insurance and other plans coincides with the enrollment of the employees in an employer-sponsored group health plan, thereby providing minimum disruption of the employee’s time.

MARKETING OF GROUP LONG-TERM DISABILITY INCOME PLANS

With Group Long-term Disability Income Insurance, the benefits are provided to fulfill the need for income during a Long-term disability from either sickness or accident, and regardless if it is job connected.  Normally, in Group plans, the definition of disability is that of total disability, but a few companies will include a residual disability benefit clause in their policies, and some also offer a presumptive disability clause (as discussed earlier).

If the group policy has a residual benefit provision, the insured does not have to be totally disabled to qualify for benefits, e.g., if the insured suffers a disability that that reduces his income by (normally) at least 20% in the first two years of disability, then the policy will pay a proportionate benefit.  The purpose of this is to be consistent with insurers continuing to place emphasis on rehabilitation services as part of the overall plan benefits.  If the presumptive benefit provision is provided in the policy, the elimination period is waived, and the total loss of sight, speech, hearing, or two more of limbs (arms &/or legs) will qualify the insured for long term benefits de facto.

Typically, an elimination period of 7 days to 12 months is used.  The Long-term policy is actually designed to provide long-term disability income protection upon the expiration of the Short-term disability coverage.  Coverage will usually be provided to age 65, however other coverage periods – such as 2 years, 5 years, lifetime accident, etc., - are often used.

The size of the group is the most important factor in underwriting Long-term disability income policies, as a large group will allow much more flexibility in underwriting.  Another important factor in group underwriting for this coverage is the nature of the work that the group performs.  Some insurers refuse to write blue-collar groups, or at least underwrite them much more cautiously. 

TAXATION OF GROUP DISABILITY INCOME BENEFITS

Taxation of health insurance benefits are consistent among various types of health insurance whereas the premiums contributed by the employer for disability income insurance for employees, are tax-deductible (usually) for the employer and are not taxable income to the employee.

Employee contributions are not tax deductible by the employee.  Therefore, the payment of benefits under an insured plan (or a noninsured salary continuation plan) are treated as taxable income by the employee, but only to the extent that the benefits that are received are directly attributable to the employer’s contributions.

FLEXIBLE BENEFIT PREMIUM PLANS

Flexible Benefit Premium Plans are a result of Title 26. IRS Code Section 125, usually called “Cafeteria Plans.”  The entire program is beyond the scope of this text but it is used so frequently in the marketing of Short-term Disability Income insurance products that a brief description of the program is in order.

Flexible Benefit plans may offer group and/or individual policies, but usually the benefits offered in the Disability Income insurance area, are supplemental benefits – supplemental to group health (usually major medical plans), pension plans and life insurance, and not necessarily supplement to group Disability Income insurance, although they certain can be and are frequently offered.  Supplemental Disability Income insurance is usually written on an individual basis with payroll deduction, so even if the policies are individual policies, the payment of premiums to the insurer by the employer (payroll deduction to the employee) and the fact that marketing is performed at the worksite and during, before or after work, puts a “group face” on the product.

Section 125 was created by Congress in the Revenue Act of 1978 and added to the Internal Revenue Code because of the changes in the work force and the increasing cost of health benefits.  Basically, it allows employers to establish flexible benefit plans, or cafeteria plans, under which employees can choose between tax-free benefits and taxable benefits. 

Qualified benefits can include:

1. Accident and Health Insurance (Medical and Disability Income)
2. Group Term Life Insurance
3. Dependent Care Reimbursement Account
4. Medical Reimbursement Account
5. 401(k) plans
6. Vacation Days
7. Health Reimbursement Arrangements (HRAs)

 

ANNUAL CLAIM COSTS FOR DISABILITY INCOME POLICIES

The annual claim costs that are used in premium calculation for a disability income benefit varies considerably by occupation class.  The following table shows the annual claim costs for one type of Disability Income insurance policy.  As explained below, the costs vary according to age, sex, occupation class, elimination period and maximum duration.  It should be pointed out that if the elimination period and the maximum duration of benefits are different for sickness than for accident benefits, separate claim costs will have to be developed taking each into consideration.

The following statistics are derived from the Society of Actuaries publication, 1998, and are used for illustrative purposes only.  These annual claim costs are for $100 of monthly disability income benefit with a seven-day elimination period and reflect experience for years 1986-1991.  These statistics use basically two occupational classes, white-collar jobs and blue-collar jobs.

 

                             

 

MEASURING MORBIDITY

In determining a premium, the first step is to provide a measure of the expected net annual claim cost per policy in an established line of business.  In order to predict future claims costs, the best source of this information is from the insurer’s own files, if they have been in business for a while.  Otherwise, the Society of Actuaries publishes morbidity tables for this purpose as well as studies by other insurance industry organizations.  These studies analyze claim costs for various types of benefits.

There are only a few Disability Income insurance companies that are able to do their pricing based upon their own experience.  The NAIC publishes public disability morbidity tables, and the Society of Actuaries publishes annual updates on disability experience.  The final analysis, of course, must come from the actuary developing the product and their interpretation as to the value of the various sources of information available.

As in any technical determination in insurance, a formula is used to determine the annual claims cost.  This is based upon a “Unit Benefit Cost,” which is the frequency of claims multiplied by the amount of the amount of the average claim.  The net annual claims cost is the unit benefit cost by the benefit amount.  In Disability Income insurance, the unit of exposure would be $1 of monthly benefit amount. 

Continuance Tables

The expected claim frequency amount persons insured and the average claim value are important determinations that must be made by the actuaries.  However, since an elimination period is used in Disability Income insurance, there would be variance of claims costs based on the elimination period.  The actuary then develops a “Continuance Table” which is the probability of claims continuing for various durations or amounts.

The elimination period has a very dramatic effect on rates, as illustrated in the following table:

 

Probability of Continuation of Disability per 10,000 disabled lives or age 40, adult males

G Probability of Continuance                            Duration of Disability F

LOSS RATIO

Loss ratio is another term that is “thrown about,” particularly in health insurance.  If one has to explain why premiums are higher for one class of insured than for another class, or if there is a premium increase on the same policy form, the theory usually is that it is because the “loss ratio” is higher, or in case of an increase, higher than expected. 

Loss ratio is actually a method of establishing the level of morbidity costs based upon the ratio of claims incurred to premiums earned.  Really quite simple in concept.

Without getting two technical, there actually are two types of loss ratios, permissible loss ratio and incurred loss ratio: 

Permissible loss ratio is the portion of each premium dollar that is used to pay claims.  The remainder of the premiums is assumed to pay taxes, expenses and profits.  Another way to put it is that the permissible loss ratio is the expected loss ratio; and

Incurred loss ratio is the portion of each premium dollar that is actually used to pay claims.

Therefore, if the permissible loss ratio is compared to the incurred loss ratio, the result will be the percentage that is necessary to bring the pricing in line with the experience. 

GROSS PREMIUMS

The Gross Premiums can be simply explained as the premium that must provide for not only benefits to be paid (net level premium), but also for expenses, taxes, and funds held for contingency purposes in case claims and expenses are higher than expected.  They are usually computed on the assumption that they will be paid annually, although premiums can be paid on other basis.

Premium rates for Disability Income insurance benefits consist of morbidity, provider payment arrangements, expenses, taxes, persistency, interest and profit/contingency margins. 

Morbidity

For comparison purposes, in calculating premiums for life insurance the actuaries only have to consider the number of deaths during a year compared with the total number of persons exposed in the same class.  For Disability Income insurance, however, in measuring morbidity, the annual claim cost for a given age/sex/occupational class is, as described earlier, the annual frequency of the disability and the average claim when the disability occurs.

Generally, morbidity tables used in Disability Income insurance for benefits exclude the experience during the calendar year in which the policy was issued.  There is not the importance of a “select” period (the period of time that it takes a newly underwritten insured to reach the experience of all of the insureds), as there is in life insurance. 

Disability Income insurance has rather unique morbidity statistics.  For instance, there appears to be considerable adverse selection by those who apply for Disability Income policies with short elimination periods and long maximum-durations.  Applicants, who purchase insurance in the 20-30 age ranges, develop a higher level of morbidity after age 50, then those who become insured after age 50.  To further complicate it for the actuaries, experience varies considerably among various benefits.

Expenses

Expense assumptions used in premium calculation for Disability Income insurance include premium taxes, agents’ commissions, policy issue costs, underwriting costs, claim costs, and investigation/legal costs.  These expenses are much higher the first year (administration-underwriting-issue costs plus the higher first year commissions), and are relatively constant after the first year – except for inflation, of course.

Persistency Rate

Persistency is the length of time that a policy stays on the books (in force).  It is expressed as a ratio of the number of policies that continue coverage on the date of premium due, to the number of policies in force as of the previous policy due date.  Persistency improves with policy duration, and after, for instance, five years; the persistency rate is usually in the 90 percentile with many types of policies.

Interest

While low interest rates are good for many industries, it is a double-edged sword for insurance, as premiums are based upon assumed interest on the investments of the insurance company.  If interest is higher than assumed, benefits can be increased, better and less expensive policies can be introduced, and dividends are paid (if mutual company).  On the other hand, as in today’s economic climate, when interest rates are at a historic low, the insurers are not making the money on their products that they had assumed because of the difference in the assumed interest rate and the actual interest rate being collected.  With the present interest rates, many companies have had to divest themselves of investments in order to meet their profit objectives and pay claims. 

With Disability Income insurance, interest is very important to consider the interest in measuring the average claim cost and the value of the disability annuity can be significantly reduced because of the interest discount.

On occasion, when discussing Disability Income Insurance, the terms “disability annuity” or “claims annuity” are used—the “annuity” refers to the amount that must be paid out for a specified period of time.  In essence the insurer creates an annuity that pays out the monthly income payments at time of claim, using annuity statistics and cost of money, etc. 

Profits Contingency Assumptions

If the premium-rate calculations do not assume a profit and a reserve for contingency, then there will be no profits.  There are several methods of producing these assumptions, one of the simplest is to calculate the premium without the profit/contingency assumption, and then add a certain percentage of the premium to the premium for this purpose. 

MISCELLANEOUS PREMIUM VARIABLES

Changing, adjusting and monitoring costs are very important for Disability Income insurance because under a noncancellable policy, the insurer is in effect guaranteeing the premium for the life of the policy. 

If the policy is guaranteed or conditionally renewable Disability Income insurance policy, the insurer may raise or adjust the premium in certain circumstances.  If the experience of an entire block of policies experiences higher claims costs than assumed, the insurer can raise the premiums on the entire block of policies – but not separately for individual policies.

One of the difficulties in creating a premium that meets assumptions is that the inability to work because of the result of sickness or injury is subjective and involves an attitude in addition to a physical or mental impairment.  Therefore, many factors come into play at time of claim – such as the level of unemployment, individual’s work ethics, the attitude of the insured in respect to retirement, attitudes of physicians who certify the disability, and last but not least, the attitude of the insurance company. 

FINAL DETERMINATION

Even though the calculation of the premium may appear complex, there are several other factors that must be taken into consideration that are beyond the scope of this text.  However, one of the most important factors is simply that of actuarial judgment.  Actuaries may voice this factor in different ways, but simply put, after the premiums have been determined, they look at it and ask if it makes sense and will it do the job intended, and further, how does it stand up to competition. 

There have been more than a few instances where an actuarial department has slaved to develop a new product, and then when it is announced, discover that another company offers a similar or nearly-the-same product, but at lower rates and/or higher commissions.  This is called, “Back to the drawing board!”

While agents certainly are not required to understand the entire premium-making and/or product development process, it is important to note that new products are almost always a result of a request of the marketing department and agents’ requests.  Then once the product is introduced, it is the marketing department and agents who really determine whether the product performs as intended.  Insurance company files are full of policy forms and rates of products that the agents could not or would not sell.

BUSINESS OVERHEAD INSURANCE

A specialized but very important area of Disability Income insurance used for business purposes is that of business overhead expense insurance.  This provides for the needs of the business if the owner (or principal) becomes disabled and is therefore not able to perform their important role in the business or to generate most of the sales.

This type of coverage is of importance to self-employed professionals, and to business owners and entrepreneurs as they must continue to meet payroll each month, pay the rent, utilities, taxes, insurance premiums, etc., etc. even if they become disabled and are no longer able to actually contribute to the business. 

If such should happen, they may try to stretch out their payment of these obligations, even though it would eventually hurt their credit.  Of course, one of the first things that would come to mind is the expenditure of personal savings and other personal assets to keep the business afloat.  This could very easily put their family’s well being in jeopardy and possibly even lose their home.  A personal Disability Income policy usually covers only the personal costs of the disabled person, so any expenditure of those funds would again cause a cash crunch on the family.

The business owner could try to hire a replacement – usually very difficult to do, but even if successful, it would take considerable funds.  Therefore, they would likely start liquidating inventory at prices designed to move the product quickly, which is a good situation for consumers, but almost always a death knell for the company.  Employees will have to be let go and eventually the business owner will have to close the business.

Business overhead insurance is not attractive to large corporations as they usually have several sources of income and the loss of one Key Employee is not that crippling to the corporation.  But to a doctor or dentist or sole proprietor of a small business where the owner brings in most, if not all, of the firm’s revenue, what will happen if they become disabled?

These policies used to be issued to professional persons primarily, and were called “professional overhead policies.”  However, they now are issued to manufacturers, wholesalers and retailers, and the name “business overhead” now encompasses all policies of this type. 

The policy concept is rather simple.  When the business owner becomes disabled, the policy pays a monthly benefit.  The benefit is based upon the overhead of the business, and not on the insured’s personal earnings (gross) or anticipated profits.  However, the business owner can also insure (up to) 100% of the company’s tax-deductible expenses (as opposed to the limits of 60%-70% of an individual’s gross earnings). 

The “eligible” expenses are those that are necessary for the operation of the business, and can be considered “usual and customary” such as rent or mortgage payments, salaries of employees, office supplies, legal fees, etc.

Expenses that are usually not covered include the cost of goods or services used in the business, income taxes, cost of furniture, tools or equipment used in the business, any salaries or income paid to the insured owner or his family members if they were hired after the owner’s total disability started, profits forecast or anticipated, income taxes and any expenses that the owner was not responsible for prior to his disability

THE BUSINESS OVERHEAD POLICY

The policy form is rather simple and not at all complicated.  There are only a few basic policy provisions that need to be discussed.  With these policies, the definition of disability simply states that benefits are payable if the insured is unable to perform his duties in the business, which is basically the own-occupation type of definition. 

Elimination periods are typical 30, 60 or 90 days, with benefit periods of 12 to 24 months under the theory that if the insured is disabled for more than two years, it is more than likely that the business is no longer existing or is awaiting sale.

The amount of the benefit depends entirely on the expenses that the firm anticipates and the income flow from the business.  One should keep in mind that the more the revenue from the business is likely to decline due to disability of the owner/principal, the larger the benefit amount that is needed.

This policy has a provision that states that the maximum monthly overhead expense benefit is the maximum amount of benefit that will be paid to the insured during a given month of disability.  If the actual expenses of overhead are less than the policy maximum, the insurer will pay only the actual expenses up to the maximum amount (making this an indemnity policy – the insurer pays for the actual loss to the insured, but does not allow the insured to profit from a loss).  Therefore, the monthly benefit would depend on the overhead business expenses for that particular month.

Carryover of Monthly Benefits

This situation can be best explained by illustration.  Assume that the policy is a 12-month policy with benefits of $1,000 per month (for simplicity).  Further assume that when the insured is disabled, the overhead expenses actually only totals $800 per month.  The question is obviously, what happens to the other $200 per month.

An insurance company could just pay the $800 per month, and at the end of the year, $2,400 of benefits would be lost. 

The most logical approach and that offered by some insurers, is that in the above situation the policy may allow for a carryover whereby the benefit period is extended in order to “use up” the unused maximum monthly benefit that has accumulated.  In the above example, this would extend the benefits for an additional 3 months of coverage.

Accumulation Provision

Using another example, the actual expenses are $800 one month, $1,000 the next month, and $1,200 the next month.  With some policies, the benefits for the month when expenses exceeded the policy benefits would not be paid.  In other policies, there is an accumulation provision that, using the example above, the additional $200 of benefits not paid the first month, could be used to pay the $200 excess in the third month.  In other words, the months in which the total benefit is not used, it can accumulate and be used when the expenses exceed the policy benefits.  If there were still unused benefit “credits” at the end of the policy period, the policy would automatically be extended until all the benefits are used. 

Partial Disability

Partial disability in these policies varies from the typical definition of partial disability in individual policies because the insured is usually able to earn some income during the disability period – especially if the insured owns the business.  Partial disability is defined as a disability that follows a period of continuous total disability for which benefits are payable.  

Typically, the insured may receive 50% of the benefits that would be payable if the insured were totally disabled.  It is usually paid for a period not to exceed 6 months if the insured is working at his regular occupation and can perform a portion (but not all) of these duties.  They may also provide that benefits are paid if the insured can perform all of his duties for his “regular” occupation, but not for more than half of the time every day that was previously required to perform the functions.

TEMPORARY REPLACEMENT

Some overhead expense policies will pay for the salary of a temporary replacement that specifically is hired to perform the duties of the disabled person, after disability is incurred.  This is generally limited to others than members of the insured’s family, and the amount cannot exceed the maximum monthly benefit and overhead expense maximum.

There are also provisions for survivor’s benefits, conversion rights to an individual policy if the business is sold, in which case the insured has the option of increasing benefits (to keep up with inflation) in the maximum monthly benefit and in the overhead expense maximum.

Technically, premiums are paid by the business and the premiums are allowed as a business expense, therefore any benefits will be taxed.  However, since business overhead expenses are tax deductible, practically speaking, there are very little, if any, taxes due.

BUSINESS CONTINUATION

Business continuation insurance is primarily of interest to closely held companies as business continuation in case of disability (or death) of a principal and/or owner is of primary interest.  These problems arise because the owners of the business generally manage the company and work on a salary basis.  Most closely held corporations are owned by a few persons, usually less than 10, and because of this, their ownership interest is not traded on an exchange so there is no ready market for their interest.  Since others outside of the business are usually not interested in purchasing and running the business, those who would be interested are other owners.  Frequently competitors are also very interested in these businesses.

Not only is the survival of the business in case of disability (or death) of a principal of interest to other owners, it also is of critical interest to family members. 

PARTNERSHIP BUY-SELL AGREEMENT

For partnership businesses, disability income insurance is used in case of a Buy-Sell agreement which obligates the surviving partners to purchase the business in case of disability (or death) of the first partner to become disabled, at a stipulated price.  It also states the obligation of the other partners to purchase the interest of the disabled partner.  The value of the business may be determined by a mutually-acceptable method, such as a pre-determined amount, or by formula.

There are two types of these policies:

1. Indemnity Disability Income policies that pay an amount specified in the policy, regardless of the actual value of the business at time of claim and may be written for amounts as high as $350,000.
2. Reimbursement Disability Income policies, wherein the policy pays the lesser of the amount specified or the actual value of the business and may be written with a maximum of $1 million on any one individual.

 

There are several uses for Disability Income insurance to be used for buy-sell agreements for self-employed businesses, partnerships, or corporations.  The buy-sell and other business uses of this product is technical and can be quite complex, plus there are tax implications in nearly all agreements of this type.  Therefore, more detailed explanation of using Disability Income insurance for business purposes is outside the scope of this text.  If an agent or broker feels that such a plan might suit a particular business, it would be wise to involve an accountant and/or attorney.

 

STUDY QUESTIONS

1.  There are two types of Disability Income Insurance,

      A.  expensive and narrow.

      B.  short-term and long-term.

      C.  guaranteed issue and instance issue.

      D.  commissionable and non-commissionable

 

2.  When the insured has the right to renew the policy to some specified age by the process of the insured paying the premium, this is

      A.  Guaranteed Renewable.

      B.  Noncancellable.

      C.  Conditionally Renewable.

      D.  Limited Cancelable.

 

3.  When “Accidental Means” is used regarding a bodily injury, there are two requirements that must be met if the loss is to be covered:

      A.  accidental and intentional.

      B.  the cause and the result of the injury must be unexpected and unforeseen.

      C.  disabling and casual.

      D.  caused by a common carrier or private vehicle.

 

4.  A disability in which a wage earner is forever prevented from working at full physical capacity because or injury or illness, is

      A.  permanent partial disability.

      B.  total disability.

      C.  residual disability.

      D.  conditional disability.

 

5.  An “own occupation” clause defines an insured as totally disabled if

      A.  the insured cannot perform any work or occupation.

      B.  the insured cannot perform the major duties of his regular occupation.

      C.  the insured can perform the 75% of the major duties of his regular occupation.

      D.  the employer signs an affidavit to that effect.

 

6.  Before an insured can qualify for disability income benefits,

      A.  he must be under the care of a physician.

      B.  his disability must be attested to by two disinterested parties.

      C.  his employer must attest that he can no longer do his job satisfactorily.

      D.  he must leave his regular job and attempt to get employment elsewhere.

 

7.  The insured is considered as totally disabled if they cannot perform the major duties of any gainful occupation for which he is reasonably suited because of education, training or experience, this is defined as

      A.  presumptive disability.

      B.  “his occupation” disability.

      C.  “any occupation” disability.

      D.  qualified disability.

 

8.   If a Disability Income insured has continuing episodes of disability, the determination as to whether this will be treated as a continuing claim or a new claim will depend upon

      A.  whether the disabilities occurred in the same geographical area.

      B.  what the insured was doing when the disabilities occurred.

      C.  whether the policy was a group or individual policy.

      D.  whether disabilities from the same cause will be considered as one continuous period of

            disability, unless each period of disability is separated by at least a 6-month recovery pe-               riod.

 

9.  Because of the possibility of adverse selection, Disability Income policies limit the amount of insured that an insured may purchase

      A.  to an amount usually not more than 85%, graded downward for those with high income.

      B.  100% of the earned income only.

      C.  a composite of the average of the last three years of earned income.

      D.  an amount equal to earned and unearned income.

 

10.  Business overhead insurance

      A.  cannot use a disability income insurance policy.

      B.  provides for the needs of the business if the owner become disabled.

      C.  is not used by the self-employed.

      D.  the amount of the benefit depends on the business gross sales.

 

ANSWERS TO STUDY QUESTIONS

1B     2C     3B     4A     5B     6A     7C     8D     9A     10B