Chapter Three

Provisions and Riders

Health Insurance Policy Provisions

Every individual health insurance policy, including disability income insurance policies, must include certain provisions. The governing law that orders these provisions to be included is the Uniform Individual Accident and Sickness Policy Provision Law. The provisions are often called the Uniform Policy Provisions. In addition to the mandatory provisions, another group of uniform provisions are optional and insurers may or may not include them. In both cases, the provisions are essentially standardized among health insurers and the states. Many of the same provisions also appear in some form in-groupdisability income insurance plans.

In addition to including these standardized provisions, insurers write health insurance policies with other provisions that clarify the coverage. Many insurers provide unique options to make their policies competitive and more attractive to customers. In this chapter, you’ll look at the Uniform Policy Provisions and a variety of other provisions. Some are used by many insurers, while others are found in only a small number of DI policies.

Uniform Policy Provisions

You have no doubt been exposed to the Uniform Policy Provisions in earlier study as you entered the health insurance field, so this section very briefly reviews each of the 12 mandatory and 11 optional provisions. If you need additional information, please consult a basic health insurance reference. Remember that the wording of both the mandatory and optional provisions need not be duplicated exactly in the insurance policy, but the wording an insurer uses must be no less beneficial to the insured than the wording of the standard provisions.

Mandatory Provisions

Entire Contract and Changes

This provision affirms that the entire contract between the insured and the insurance company is contained in the insurance policy, the application. and any riders attached to the policy. These documents make up the only enforceable contract. No change, may be made except in writing as agreed to by the Insurer and the insured, and attached to the policy.

Incontestability

The incontestability or time limit on certain defense provision, limits the insurer's ability to cancel or void the policy because of representations the insured made in the application. The time limit is stipulated in the policy and is usually two years. No time limit applies, however, if the insured has engaged in fraud.

Grace Period

All insurance policies must specify a grace period following the premium due date during which the insured may pay the premium without losing any contractual rights. The length of the grace period is typically 31 days, but this may be shortened to seven days when premiums are paid weekly or ten days for monthly premiums.

Reinstatement

If a policy lapses because the insured failed to pay the premium within the grace period, reinstatement may occur under certain conditions:

* The insurer accepts a late payment from the insured without requiring re-application.

* The insured applies for reinstatement and the insurer fails to respond within 45 days.

* The insured applies and the insurer accepts within 45 days.

In the last situation, the insurer may require ten days to pass before it will approve a claim for sickness, while an accident claim will be honored any time after reinstatement.

Notice of Claim

This provision requires insured to submit a notice of claim within a stipulated period-usually 20 days-after a covered event occurs, or within a "reasonable period." For disability claims, when benefits are paid for two or more years, the insured must notify the insurer every six months that the disability continues.

Claim Forms

Within 15 days after receiving a notice of claim, the insurer must send claim forms to the insured. Failing that, the insurance company must allow the insured to submit the claim in any manner as long as the pertinent information is included.

Proofs of Loss

Insureds must submit proofs of loss within 90 days after the covered event occurs, unless its not reasonably possible to do so, in which case a full year is permitted. The time limit is waived for people who do not have the legal capacity to meet this requirement.

Time Payment of Claims

The time payment of claims provision informs the insured when claims will be paid. For disability income policies, payments must be made at least monthly.

Physical Exam and Autopsy

This provision gives the insurer the right to request that the insured undergo a physical exam. For ongoing DI claims, the insurer may require periodic exams on a reasonable basis. If the insured dies, the insurer also may request an autopsy except where prohibited by state law. The insurer pays the cost of physical exams and autopsies performed under this provision.

Legal Actions

Insureds who want to take legal actions against the insurer must wait at least 60 days after they submit proofs of loss. There is also a time limit by which such actions must be instituted, generally three years, sometimes two years, as stipulated by state law.

Change of Beneficiary

A health policy that pays any type of death benefit includes a change of beneficiary provision, allowing the insured to select a different beneficiary as long as an irrevocable beneficiary designation has not been made. This is the final mandatory provision.

Optional Provisions

Remember that insurers may choose to use any, all, or none of the optional provisions presented in this section.

Change of Occupation

The change of occupation provision allows tile insurer to adjust premiums or benefits if the insured changes to an occupation that is more or less hazardous. This provision is often used in disability policies since the occupation Is a key element in the cost of the policy. We will discuss this topic at length in a later chapter.

Misstatement of Age

If the insurer discovers a misstatement of age on the insureds part, this provision allows a benefit adjustment to provide the actual benefits that would have been payable if the correct age had been known from the onset of the policy.

Other Insurance in This Insurer

The other insurance in this insurer clause, also called the duplicate coverage clause, describes two methods the insurer may use to assure it pays only once for the same claim even if the insured has another policy with the insurer. Under one method, the insurer specifies a maximum dollar amount for which the insurer is liable, agreeing to return any excess premiums paid by the insured. Under the other method, the insured may select which policy will pay benefits and the insurer then returns premiums paid for the other policy.

Insurance with Other Insurers

This is actually a two-part provision dealing with situations where the insured has insurance with other insurers. The insurance company may choose to use one or both parts (or not use it at all since it is an optional provision). The first portion deals with benefits paid for expense incurred services-such as those provided by a medical expense policy. Although this doesn't apply to a typical DI policy, you will learn about a certain type of policy for businesses that pays on this basis.

The second part of the provision deals with all other types of benefits, Including DI benefits. Under both parts, the provision states that each insurance company will share in the benefit payments in proportion to the benefit amounts each insurer provides under its own policy. If, as a result of this proportionate sharing, the insured has paid excess premiums, those are refunded.

Relation of Earnings to Insurance

The relation of earnings to insurance provision is especially pertinent to disability income policies, addressing situations where DI benefits are payable under more than one policy. This clause restricts total benefits paid from all policies to no more than either (1) the insureds monthly earnings at the time disability occurred or (2) the insureds average monthly earnings for the two years preceding disability. Further, each insurer pays only its proportionate share of benefits, with excess premiums refunded to the insured if necessary. Later in this text you'll learn how to avoid over insurance situations such as this by taking into account all potential sources of DI benefits while completing the application.

Unpaid Premiums

If unpaid premiums are outstanding when the insured makes a claim, this provision allows the insurer to deduct the amount of the premium from the amount payable to the insured.

Cancellation

Some states prohibit use of the cancellation provision, but where it is permitted, this clause

requires the insurer to notify the insured in writing at least five days in advance of canceling a policy. The insured, on the other hand, generally may cancel a policy at any time without notice. Cancellation requires the insurance company to return any unearned premium to the insured. However, some policies are written so cancellation may occur only at a renewal date, in which case all premium has been earned and no refund is due.

Conformity with State Statutes

The conformity with state statutes provision automatically amends any policy terms and conditions that conflict with state laws where the policy is issued. This prevents policies from becoming obsolete when state legislatures revise insurance laws, as well as eliminating the necessity for different policy forms in different states.

Illegal Occupation and Intoxicants or Narcotics

The illegal occupation and intoxicants or narcotics clauses are the final two optional provisions. In both cases, the provisions allow the insurer to exclude coverage for injury or sickness that occurs as the result of and while the insured was either:

* Engaging in an illegal occupation, or

* Under the influence of intoxicants or narcotics.

In the latter case, exception is made for drugs that were prescribed or administered by a physician, recognizing that people sometimes have unexpected reactions to legal drugs. This concludes your review of the Uniform PolicyProvisions. A basic health insurance text can provide more information if you need it. Be sure to study the policies you sell to determine which, if any, of the optional provisions are included.

Renewability Provisions

In the following paragraphs, we will again review provisions you should already be somewhat familiar with-those dealing with guarantees about a policy's renewability. DI insurance policies may be written with any of the provisions discussed here as permitted by law. You will want to be completely knowledgeable about the circumstances under which the policies you sell are and are not renewable. Renewability is extremely important from the insureds point of view since people are more likely to become uninsurable as they grow older.

Guaranteed Renewable

A policy that is guaranteed renewable allows renewals up to a specified age, usually 60 or 65. In some states, these policies must guarantee renewal for at least five years if the policy

is issued after the insured reaches age 54. The insurance company may cancel a guaranteed renewable policy only if the insured does not pay the premium. The premium may not be increased for any individual insured, but rates for an entire class of insureds, such as everyone working in a certain occupation, may be raised. Many disability income policies are guaranteed renewable.

Guaranteed Renewable by Class

Other policies are guaranteed renewable by class, which means the insurer will renew an individual policy as long it renews all policies in that particular class. Likewise, the insurer may choose not to renew a policy only if it refuses to renew all such policies. Other features are the same as a guaranteed renewable policy.

Noncancelable

The most liberal type of renewability provision is a policy that is noncancelable and guaranteed renewable to a certain age. Failure of the insured to pay premiums is the only reason an insurer may cancel a noncancelable policy. Furthermore, the premium may never be raised for any reason. noncancelable disability income policies are generally reserved for the very best occupational risks, such as professionals and highly compensated executives.

Optionally Renewable

Policies that are optionally renewable give the insurer the right to refuse renewal at a specified time, typically only at the end of a period for which the premium has already been paid. The insurer must give the insured advance notice that it will not renew the policy. The insurer may increase premiums only for classes of insureds, not for any one individual.

Conditionally Renewable

Under a conditionally renewable provision, the insured may continue to renew the policy as long as certain conditions exist. In a disability income policy these conditions generally relate to the insureds continuing to work in a gainful occupation. The insureds health may not be one of the conditions. If the conditions are not met, the insurer may no (cancel the policy, but may opt not to renew only at a policy anniversary date. Premiums may be raised only for classes of insureds.

Cancelable

Many states currently prohibit cancelable policies. Where they are permitted, the insurer may cancel coverage by notifying the insured in advance and returning any unearned premium. Some cancelable policies may be canceled at any time, others only at an anniversary date. Premiums for cancelable policies usually may be increased.

This concludes your review of policy renewability. If you need additional information, please consult our basic health insurance text. The table that follows provides a summary of the features just discussed.

Renewability Provisions

Premium

Increases

Type Renewal* Permitted

Guaranteed Renewable Guaranteed to age 60-65 By class only

Guaranteed Renewable Guaranteed as long as entire

by Class class is renewed By class only

Noncancelable Guaranteed to age 60-65 No

Optionally Renewable Insurer has option not to

renew at specified time By class only

Conditionally Renewable Insurer has option not to

renew if certain conditions

do not exist By class only

Cancelable** Not guaranteed Yes

* All policies may be canceled for nonpayment of premiums.

**Prohibited in some states.

Miscellaneous Provisions

In this section, we will discuss provisions commonly included in DI policies. Since not every policy includes every provision, as usual it is important for you to be familiar with the particular policies you sell.

Nonoccupational Clause

When a nonoccupational clause is included in a DI policy. it states that the policy will not pay any benefits if workers compensation or similar compulsory benefits for employed people are payable for a condition otherwise covered by the DI policy. For example, if the insured is injured on the job and disabled as a result, the employer's workers compensation policy will typically pay disability benefits.

An individual DI policy that has the nonoccupational clause will. in this case, pay nothing

to the insured, whether the workers comp benefits are adequate or not. Although you should watch for this provision, it is more common for contemporary DI policies to coordinate benefits with workers compensation payments to provide a reasonable amount of replacement income. Later in the text, you'll learn more about coordinating the benefit amount of a DI policy with other benefits.

Premium Waiver

Virtually every DI policy includes a premium waiver provision, under which the insured is relieved of paying further policy premiums after disability continues for a specific length of time. Generally, the insured must be disabled for 90 days to trigger the waiver, but some policies use the elimination period instead. The insurer usually refunds any premiums the insured paid during the 90-day period or the elimination period, if that is the trigger for waiver.

Most policies waive premiums until the insured reaches age 65 if disability continues that long. This corresponds with the age at which many policies would no longer be renewed. More liberal DI policies continue to waive the premium for 90 days after a recovered insured returns to work.

Rehabilitation Benefit

Insurance companies often pay a rehabilitation benefit, aimed at assisting a disabled insured to return to the workplace. This type of benefit may be available whether or not a specific policy provision addresses rehabilitation and would be offered by the insurer sometime after disability benefits have been paid.

Some companies pay only for medical rehabilitation, such as physical therapy services or to cover training in the use of a new prosthesis when the insured has suffered a limb amputation. Other companies might also pay benefits for vocational rehabilitation, which would involve training or education costs associated with preparing for employment in a different job.

Rehabilitation benefits might take two different forms. One is an additional income benefit to help defray the costs of rehabilitative services such as those mentioned in the previous paragraph. Another is payment for the full cost of those services. Sometimes insurers do not specify a maximum rehabilitation benefit that will be paid, allowing themselves the discretion to fund substantial rehabilitation services if they believe this course of action is most likely to return the insured to gainful employment. Many times, a one-time cash outlay for rehabilitation will provide significant cost savings over providing no rehabilitative help and continuing to pay monthly benefits instead.

Transplant Benefit

The transplant benefit is a truly humanitarian provision found in a few disability income policies. When an insured is temporarily disabled because he or she has donated an organ to be transplanted to another person, the insurer recognizes this disability as a sickness covered by the policy. The benefit amount payable during such a disability is the same as the total disability benefit that would be paid under any other covered circumstances.

Nondisabling Injury Benefit

Although typical disability income insurance does not pay benefits for medical expenses, some policies include a nondisabling injury benefit that does just that. Also known as medical reimbursement and treatment for injury, this provision allows payment of a benefit when the insured receives medical treatment for an injury that does not cause total disability.

The maximum benefit is generally a portion of the monthly disability income benefit, ranging from one-fourth to one-half the benefit. For example, if the monthly payment for total disability is $3,000 and the portion is one-third, the policy will pay up to $1,000 for medical expenses, but not more than the actual cost.

Offered in various ways, this benefit might be available as a rider to the policy, rather than incorporated. In some cases, the benefit is paid only when the insured was not hospitalized for the injury. Most policies pay this benefit only for accidental injury, not for sickness.

Transition Benefit

When a disabled insured who has been receiving benefits dies, some policies pay a transition benefit 10 survivors for a short time after death. Usually, the insured must have been receiving benefits for a certain period before dying, often 24 months. Tile transition benefit is the same as the monthly benefit the insured was receiving and continues for a stipulated period, usually three to six months after the insureds death, but no longer than any time remaining in the policy benefit period. If the maximum policy limits have been exhausted, no transition benefit is available.

Automatic Indexing/Increasing

One remedy insurers have developed to deal with the problem of inflation is automatic indexing, which is also called automatic increasing. This feature automatically increases the amount of the monthly disability benefit at certain times. The third, fifth and seventh policy renewal dates are common. the increase may be a percentage that is either stipulated in the policy or determined by the Consumer Price Index (CPI). Figure 3-1 (on page 41) shows you how automatic indexing works when the original monthly benefit is $4,000 and the index is a flat 4% applied at the third, fifth and seventh renewals.

At the first use of the automatic indexing feature, on the third renewal date, the 4% figure is applied to the original $4,000 monthly DI benefit: $4,000 x .04 $160. The monthly DI benefit then becomes $4,160 ($4,000 + 160).

On the fifth anniversary, the 4% index applies to the larger amount: $4,160 x .04 = $166. This $166 figure is added to $4,160 for a new monthly benefit of $4,326.

At the seventh renewal date, $173 is added to $4,326 for a monthly benefit of $4,499. You can see the advantage of the cumulative effect. After seven years, the monthly benefit has increased by nearly $500.

Automatic indexing causes a corresponding premium increase. Depending on the particular policy, the insured might or might not have an option about whether to implement the indexing and pay the additional premium. If you sell policies with automatic indexing, be sure you know whether this is a feature the insured may refuse. The provision may have a limited lifetime, expiring after a certain number of years. While the idea behind automatic indexing is similar to cost of living increases provided by a rider, the two features are different. Later in this chapter you'll learn about the cost of living rider.

Exclusions and Pre-Existing Conditions

Most disability income policies written today specify very few blanket exclusions. Older existing policies often list more situations that are not covered. The most common exclusions are for injury and sickness resulting from acts of war. Policies that pay lower benefits and are written for more hazardous occupations also might exclude disability caused by an injury suffered during attempted suicide.

Pre-Existing Conditions

Disability income policies exclude coverage for pre-existing conditions, but this exclusion disappears after a certain period has passed. When the period is over, the policy covers any future disability related to that condition. The exact period varies, but 12 to 24 months after the policy's effective date are common examples.

The definition of a pre-existing condition varies from policy to policy, but is always related to a specified period before the policy's effective date. For example, any sickness or injury for which the insured was treated during the two years immediately preceding the effective date is a pre-existing condition for some insurers. Instead of two years, the period might be six or nine months, one year, five years or essentially any other period the insurer wants to use. You'll want to be aware of the definition in your policies. Obviously, the farther back the policy looks for treatment of a condition, the less advantageous the provision is to clients.

Figure 3-1

Automatic Indexing

(4% on 3^rd, 5^th and 7^th Renewals Illustrated)

Let's say that the look-back period for one insurer is two years and the provision disappears after one year. The insured, Leo Perks, was treated for a knee injury six months before the policy went into effect. Although Perks has had no recent problems, nine months after the policy effective dates the knee problem recurs. Because Perks is a telephone lineman who must be able to climb, he is unable to work. Perks cannot receive DI benefits for this pre-existing condition because not enough time has passed. If, however, the recurrence had occurred after the policy was in effect for at least one year. Perks would be eligible for DI benefits.

More liberal DI policies, written for the least risky occupations, often take a different approach to pre-existing conditions. Under these policies, disability resulting from the pre-existing condition will be covered provided the insured person had fully disclosed the condition on the application. In other words, a pre-existing condition is not covered only if the insured tried to conceal it from the insurance company. Still another approach is to cover disability from a pre-existing condition for an increased premium, or on a more limited basis.

For example, the insurer might agree to pay the monthly benefit for a shorter period if

disability occurs because of a pre-existing condition. Thus, if perks above had this policy, the insurer might pay DI benefits for only six months instead of the five-year benefit period available for disability resulting from other causes. Or perhaps the insurer might extend the elimination period for pre-existing conditions, so whereas Perks' elimination period for other situations might be 90 days, the insurer requires 180 days before benefits are paid for the pre-existing condition. Once again, you can see the importance of knowing the details of the policies you sell.

Rider Options

In this section you will learn about options that are typically provided by means of a rider added to a DI policy. Some of the most popular riders are discussed here; companies you represent might offer others.

Guaranteed Insurability Rider

Agents who are familiar with the guaranteed insurability rider available for life insurance will be happy to know a similar rider is available for DI insurance policies. Also referred to as the future income option, this rider is probably even more valuable in the DI field since the greater chance of disability increases the odds of becoming uninsurable. Many DI experts believe agents should attempt to sell this rider with nearly every DI policy and, without fail, to younger people who have many working years ahead during which their incomes are likely to increase.

How It Works

The rider gives Insureds periodic opportunities to increase the monthly benefit without proving insurability. The only requirement is proof that income has increased, warranting a higher benefit. Specific details vary among insurers, but the policy typically must be in force for one or two years before the first option becomes available. Then, additional options to purchase more coverage occur every two or three years up to a stipulated age. The age at which the options expire varies widely. Some examples include: to age 45,49, 50, 55, 60 or older, but probably expiring before age 65.

The insurance company notifies the insured in advance of when the option is available. The insured may decline to take advantage of the increase, but usually the option must be exercised from time to time to remain available. Each rider will specify the exact conditions.

Disability on an Option Date

If the insured happens to be disabled and receiving DI benefits on an option date, some insurers allow the insured to increase the benefit-but the increase does not apply to the current disability. How the increase applies if the insureds disability is permanent is an

individual company decision. More liberal policies, on the other hand, do allow the increased benefit to apply to the current disability.

Increase Restrictions

The amount by which an insured may increase the current monthly benefit is limited, first of all, by the insureds earnings. For example, if earnings have increased by $500 per month, the insurer obviously is not going to allow the benefit to increase by $800 per month. The relation of earnings to insurance clause discussed earlier comes into play here in order to avoid over insurance.

In addition to considering the actual earnings, the insurance company also has an overall maximum of some type. Some insurers use a percentage of the current DI monthly benefit. For example, suppose the insured, Maria Cortez, has a policy that currently provides a $2,000 monthly benefit. The guaranteed insurability rider stipulates the maximum increase permitted is 10% of the current benefit, which would be $200 in this case. This means that even if her monthly income has increased to a level that would make her eligible under a new policy for a $2,500 benefit, Cortez will be limited to a new monthly benefit of $2,200.

Other riders specify a maximum flat amount that may be added to the current monthly benefit, qualified by an additional limit on the total increase and taking into consideration all DI insurance currently available to the insured. For example, a policy might permit a monthly increase of up to $500, as long as the monthly benefits from all DI policies in place provide no more than one and one-half times the current total benefits. And. of course, the actual increase in the insureds earnings is the starting point for determining the benefit increase.

The Cost Question

As you examine the details of the guaranteed insurability riders offered by your companies, you'll see that this rider can add up to 10% to the cost of the DI policy-an increase that, at first blush, can cause your clients to resist. Is it worth it? You can definitely make the case for it.

Let's say your client is 30-year-old attorney Kimbra Kelly, who is employed by a successful law firm at a base salary of $56,000 annually. You've sold Kelly on the idea of buying a DI policy that provides a monthly benefit of $3,200 per month for which she will pay $1,200 annually. We'll assume the cost of the guaranteed insurability rider from this insurer is 9% of the annual premium-an additional $108 annually. Your experience as an agent will tell you that even though your sales skills have persuaded Kelly to pay the $1,200 premium, she still may resist adding another $108 to that amount. But if she turns down the rider, consider what can happen.

Compared to the average 30-year-old worker, Kelly has quite a nice income that one can assume will continue to increase as Kelly pursues her career. But compared to average attorneys' incomes, $56,000 annually is fairly low and Kelly can expect it to increase significantly. Let's now look up the road to Kelly's age 40. Her annual income has now nearly tripled to $150,000, which breaks down to$12,500 per month But Kelly still has only this single DI policy you sold her ten years ago, providing $3,200 per month-$8,300 less than she is accustomed to earning. Because a person's standard of living generally rises in tandem with earnings, Kelly probably spends considerably more than the monthly DI benefits just for routine expenses. So let's suppose Kelly now wants to purchase additional coverage. She believes she could live on as little as one-half her current income if she were disabled, about $6,200 per month. Her existing policy provides $3,200 monthly and she wants to purchase another $3,000 of coverage. If she is in good health, let's say the additional coverage will cost $1,800 annually at her age 40. She'll now pay $3,000 annual premium-$1,800 for the new coverage and $1,200 for the existing policy assuming she is able to purchase the coverage at all.

The key question is whether or not Kelly is still insurable. If not, she won't be able to purchase DI coverage at any cost. If Kelly is insurable, but has developed a medical condition that makes her a less attractive risk, she might be able to purchase additional coverage, but the insurer may charge an additional 40% of the premium because of her risky health-increasing the annual premium on the new policy by $720. The new coverage premium is now $2,520: the existing premium is $1,200: so Kelly must now pay $3,720 annually to get the amount of DI insurance she wants.

By paying the additional $108 annually to purchase the guaranteed insurability rider, on the other hand, Kelly would have been guaranteed that:

1. She could purchase additional DI coverage, and

She could purchase the coverage at standard rates, rather than higher rates

based on her deteriorated health.

Over the ten year period, Kelly would have paid a total of $1,080 additional for the rider, guaranteeing that she could purchase coverage at standard rates instead of paying the additional $720 annually in our example above. She would have recouped her $1,080 investment in the rider in less than two years. Furthermore, if Kelly had purchased the rider originally, it's likely she would have exercised the option to purchase more coverage over the years as her income increased and today her monthly benefit would bear a much closer relationship to the earnings she'll lose while disabled.

Be sure to do your homework on this issue in order to demonstrate the risks insureds take by passing up the opportunity to purchase additional insurance when there's no question about insurability and especially when they are young with many earning years and potential income gains ahead. It's important for clients to actually see in writing, in real figures related

to their personal circumstances, the potential financial costs of failing to provide for future income replacement now, while they're insurable, particularly in view of the one in three odds of suffering at least a short-term disability before age 65. Living Adjustment (COLA)
Rider

Cost of Living Adjustment (COLA) Rider

Earlier you learned about the automatic indexing feature used in some DI policies to help combat inflation. Another inflation control is the cost of living adjustment (COLA) rider, which operates differently from automatic indexing. The COLA rider also adjusts the benefit in response to inflation, but only when the insured becomes disabled and remains disabled for at least a year. That is, the benefit is not increased during the first year of disability.

The COLA Percentage

Determining the figure by which the increase will occur can be fairly complex. In most cases the increase is based on the Consumer Price Index (CPI). By comparing the CPI for the first year of disability with the CPI for the current year, the insurer determines the percentage by which to increase the benefit, Some insurers use a guaranteed percentage instead of making the CPI calculation, or if the CPI is the base, the insurer might guarantee 4% or 5% in the event the CPI is less.

How It Works

As long as the insured remains disabled, the COLA adjustment is made each year after the first, applying the applicable percentage to what is then the existing monthly benefit being paid. For example, if the original benefit of $3,000 per month has been increased to $3,100 by virtue of the COLA rider, the next adjustment is made to $3,100 rather than to the original $3,000. This method continues throughout the insureds disability. While most of us think of the CPI as ever rising, in fact, it could fall. If, during the period of disability the insureds benefit had been increased by the COLA rider, the benefit amount could actually be reduced instead of increased. In no event, however, would the benefit ever be less than the basic amount contracted for in the DI policy.

Insurers specify a maximum increase. This might be a maximum increase the insured is permitted to receive during a one-year period, a maximum total increase for the entire benefit period, or both. For example, a policy that provides a $3,000 monthly benefit or a total of

$36,000 annually might stipulate that the annual increase is limited to 10%, $3,600 in this case, and no more than $15,000 total over the entire benefit period. Check the details of the policies you sell to determine the exact limitations.

The following is important to understand: When the insured recovers and returns to work, the monthly benefit is notfrozen at whatever benefits the COLA rider is currently producing. Instead, the benefit available drops back to the amount for which the policy was originally

written (assuming there has been no automatic indexing. use of the guaranteed insurability option or any other change in the policy benefit).

Refer to Figure 3-2, which illustrates how the COLA rider works. In this example, the original monthly benefit is $4,000. During the first year of the insureds disability, no COLA adjustment is made, so the insured receives $4,000 each month. At the beginning of the second year, the insurer determines the CPI adjustment. 3.8% in our example, and applies this figure to $4,000 for a total monthly increase of $152. The insured then receives $4,152 during the second year of disability.

At the beginning of the third year, the CPI is 4.2%, which is applied to the current benefit of $4,152. The result is an increase of $174 and a new monthly benefit of $4,326 ($4,152 + $174).

In the fourth year of disability, a CPI of 4.9% applies to $4,326 for a $212 increase. The monthly benefit becomes $4,538. The insured recovers and returns to work at the beginning of the fifth year after the disability began, at which point the monthly benefit drops back to the original $4,000.

Figure 3-2

COLA Based on CPI Applied to $4,000 Benefit

Buy-Back Option

While the general rule is that the benefit returns to the original amount when the insured recovers, some insurers offer another option. The insured might be permitted to purchase an additional benefit equal to the amount of the increase existing when the insured returns to work. This is called a buy-back option. In this case, if the insured again becomes disabled

at a later date, the monthly benefit is equal to the benefit the insured was receiving at the time of the prior recovery and will serve as the basis for COLA Increases if the insured is again disabled longer than one year.

COLA and Residual Benefits

When the COLA rider is attached to a policy that pays residual disability benefits, the adjustment also applies to the amount of the residual benefit. Here's how it works.

First, let's briefly review how the residual benefit works. The key factors follow with a dollar amount assigned to each for illustration purposes.

* Monthly earnings before disability $10,000

* Monthly benefit for total disability $6,500

* Monthly earnings after disability $5,000

The insured has a 50% income loss after returning to work, so:

Residual benefit = 50% of $6,500 or $3,250

This is the monthly residual benefit the insured receives for the first year after returning to work. With the COLA rider attached, the adjustment to the residual benefit is first made at the beginning of the second year, just as was the case when the total DI benefit was adjusted. But the application for a residual benefit is even better. The adjustment applies not just to the monthly benefit, but also to the pre-disability earnings. This double indexing means the pre-disability income that the post-disability earnings are compared to increases so the insured does not suffer a loss by virtue of increases in the post-disability income

Look at the following example, which continues the situation previously described. For simplicity, we'll use a flat 60/0 increase instead of the CPI. We're also assuming the insureds post-disability earnings have increased during the year, to $5,250 monthly.

Pre-disability monthly earnings increased by 6% COLA:

$10,000 x 1,06 = $10,600

Post-disability monthly earnings = $5,250

Determine the percentage of income lost:

$5,250 + $10,600 = 49.5%

Now, you might expect that this 49.5% loss would be applied to the original monthly benefit of $6,500 to determine the residual benefit, but that's not the case when the COLA rider is attached. Instead, the original $6,500 is first increased by 6%:

$6,500 x 1.06 = $6,890

This adjusted monthly benefit figure, then, is the amount that the 49.5% loss applies to for determining the residual benefit:

$6,890 x 495 = $3,410

This $160 increase in the residual monthly benefit over the previous year's benefit stays in place for the full year, after which the calculation is made all over again. In the second year, following the method you learned for calculating second-year total DI benefits under the COLA, the 6% applies to the adjusted pre-disability monthly earnings of $10,600 and the adjusted total DI benefit of $6,890. These adjustments continue as long as the residual benefit is payable.

While this is a typical example of COLA rider applications. insurers develop a variety of creative ways to provide the most adequate inflation protection for insureds. Be sure to study the COLA riders offered by companies you represent to be certain how the increases apply. This feature is a very attractive selling point.

And Now, the Cost

That's the good news. The (comparatively) bad news is the high cost of the COLA rider, which may be 25% to 30% of the policy's annual premium. The benefits of this rider In the event of a long-term disability, however, are so significant that you'll want to carefully illustrate the effects of not including it.

Let's return to 30-year-old Kimbra Kelly from an ea4ier example. Her basic DI policy costs $1,200 annually and provides a monthly benefit of $3,200. Adding the COLA rider will increase her premium by $360 to $1,560 annually. Let's say she pays premiums for ten years, then is disabled. With and without the rider, Kelly will have paid:

With COLA rider $15,600 premiums paid

Without COLA rider $12,000 premiums paid

DIFFERENCE $ 3,600

Kelly is disabled for a total of five years. We're not going to show all of the calculations here, but we'll assume the policy with the COLA rider provides a flat 5% annual increase, which goes into effect at the be-ginning of the second year of disability. Here's the comparison of the total benefits Kelly will receive:

With COLA rider $212,172 benefits paid

Without COLA rider $192,000 benefits paid

DIFFERENCE $ 20,172

The figures show clearly that for a five-year disability, the benefits far outweigh the cost. Naturally, in any given case the figures will change with the situation. Imagine, for example, an insured who pays premiums for only two years-in Kelly's case, a cash outlay of only $3,120, for which she would receive over $200,000 In benefits. On the other hand, an Insured might pay premiums for many more years. If Kelly paid $l,560 for 20 years, for example, her premium outlay would be $31,200 versus $24,000 without the rider, a $7,200 difference. The benefits are still obvious. If you find the exercise valuable, you can make a number of comparisons, extending and reducing both the premium payment and disability periods, and keep these figures handy to illustrate the situations to your customers, using actual figures for the policies and riders you sell.

Customers (and you) may well wonder, "Why does it cost so much and since most disabilities last less than a year-the trigger point for the COLA-why would I want it?" The dollar illustrations you've just seen should answer the first part of the question, but to elaborate, the insurer takes a significant risk by providing the rider. Remember, an insured could pay only a few premiums in return for hundreds of thousands of dollars in benefits: and even when the insured has paid $30,000 or more in premiums, the insurer's obligations can quickly exceed the average risk assumed when the insurer agreed to write the policy. The average risk, of course, is what makes insurance possible and it would not require many long-term COLA-adjusted claims to put an Insurance company at the brink of severe financial problems.

As for the second part of the question, it's a matter of the risk an insured is willing to take. Save the additional premium and gamble that no long-term disability will occur or pay the premium as a hedge against the lower but genuine odds that long-term disability will occur? There's no easy answer. As an agent, you can attempt to sell the benefits of this rider every time you believe the prospect can afford to pay for it, but the decision is likely to be based as much on the individual's risk-taking nature as on the solid facts and figures you present.

Accidental Death & Dismemberment (AD&D) Rider

Another rider sometimes offered with DI policies pays a lump-sum benefit if the insured suffers accidental death or dismemberment. This rider is often abbreviated to AD&D. No benefit is available under this rider for death or dismemberment resulting from sickness. Some policies pay a lump sum that is a multiple of the monthly disability benefit, while others stipulate a flat dollar amount. Still other policies offer the benefit in more than one way, allowing the insured to choose the amount within the limits established by the insurer.

Most policies define dismemberment as loss of limbs and loss of eyesight, but others might include loss of hearing or speech, so be sure to check your own policies. Often, a half benefit is paid for lesser dismemberment’s, such as loss of one foot, and the full benefit is paid if the insured loses both feet.

Hospital Confinement Rider

At least two different types of hospital confinement riders are available with DI policies, each type paying a benefit only when the insured has been hospitalized as the result of accident or sickness covered by the policy.

One version of this rider either completely waives the disability income elimination period or pays a reduced benefit during the elimination period when the insured is in the hospital. When the elimination period is waived, benefits are payable from the first day the individual is disabled and hospitalized. If a reduced benefit is paid, it is often one-third the total disability benefit and it, too, is paid from the first day the insured is disabled and hospitalized. The benefit stops when the insured leaves the hospital or when the elimination period expires, whichever occurs earlier. If the insured leaves the hospital before the elimination period expires, for example, the benefit stops and the remainder of the elimination period must be completed before the regular DI benefit is paid. On the other hand, if the insured is still in the hospital when the elimination period is over, the rider's benefit stops and the policy's monthly DI benefit begins.

The other type of rider pays a stipulated dollar indemnity for every day the insured is confined in a hospital up to a specified number of days. The actual number varies from policy to policy, but the maximum is usually 180 days. As long as the insured is hospitalized (up to the maximum), even during the elimination period, the daily indemnity is paid. If the insured is still hospitalized when the elimination period ends, the hospital confinement benefit continues in addition to the monthly DI benefit. Assume an insureds policy, which will pay a monthly DI benefit of $2,000, has a 60-day elimination period and the hospital confinement rider pays $50 per day. On day 61, the insured is still hospitalized and remains so for 10 more days. The insured will receive a benefit totaling $2,500 for this period, reverting to $2,000 the next month since the insured is no longer hospitalized

Social Insurance Offset Rider

Various riders available in many forms from different insurers are known as social insurance offset riders or Social Security Offset riders. The original breed of these riders was intended primarily to offset benefits paid under a commercial DI policy against Social Security benefits, specifically. More commonly today, a single rider is used to offset any type of social insurance disability benefits, including not only Social Security, but also workers compensation and a myriad of other federal, state and local government disability benefits. You may still find some such riders that apply specifically to Social Security alone. Other

terms used to describe the broader riders are social insurance supplements and social insurance substitutes.

The purpose of these riders is to provide adequate DI coverage for individuals without causing the problems of over insurance that can result when an individual is also eligible for government-sponsored DI benefits. The riders do this by stipulating that the policy benefits will be offset by any social DI benefits the individual actually receives.

Why It's Needed

In the past, particularly when Social Security DI benefits were more generously paid, insurers began reducing the monthly benefit for which a DI policy would be written by the amount of Social Security DI benefit an individual had the potentta1 to receive. For example, if the person could otherwise qualify for a $3,000 benefit for a particular insurer and had the potential to qualify for an $800 Social Security benefit, the insurer would write the policy for no more than $2,200. The problem with this solution is that very few people actually qualify for Social Security disability benefits. This dilemma left the Insured with considerably less in the way of income replacement than would have been available if Social Security were not an issue at all. For the insurer, the problem was further compounded by the fact that the amount of Social Security benefits changes from time to time. The solution: first the Social Security offset rider and now the social insurance offset rider to accommodate the many other government benefits that could be available. These riders stipulate that benefits under the DI policy will be coordinated with other benefits or substitute for those benefits when the government denies them.

How It Works

A social insurance rider is generally designed in one of three different ways.

1. A dollar-for-dollar offset, under which the DI policy's monthly benefit is reduced one dollar for every dollar paid by any form of social insurance. For example, the monthly benefit is $2,000. The insured actually receives $500 monthly in some form of social DI benefits. The policy will pay only $1,500 monthly.

2. A percentage offset, under which the DI benefit is reduced by a certain percentage depending on what type and amount of social benefit the insured receives. For example, the policy might pay 30% less than the normal benefit if the insured receives Social Security benefits or 90% less if the insured receives both Social Security and another social insurance disability benefit. For a DI policy paying $2,000, then the benefits would be reduced to $1,400 in the first case and to only $200 in the second.

Total offset, under which the DI policy pays no benefit at all if the insured receives anysocial insurance DI benefits, without regard to the amount. If an insured receives, for example, a $600 DI benefit from workers compensation, the $2,000 policy pays nothing.

In a later chapter we'll say more about coordinating the monthly benefit you sell with social insurance and all other types of DI benefits for which an insured might be eligible.

Supplemental Social Security Rider

One of the problems with Social Security DI benefits is that, even if an individual qualifies to receive them, up to a year may pass before the Social Security Administration (SSA) makes that decision. Individuals must first be disabled for five months, after which six or more months may pass before any benefit is paid. While Social Security DI benefit payments are retroactive to the sixth month, an individual's living expenses continue with or without income.

Insurance companies devised the supplemental Social Security rider to address this situation. When attached to a disability income policy, this rider pays greater monthly benefits during the Social Security "waiting period," for up to one year after the insured first becomes disabled. When Social Security benefits begin, the DI policy benefit drops to the lower benefit stipulated in the policy.

Here's an example, assume an insured qualifies for a policy benefit of $2,600 monthly, taking into account the possibility of receiving $800 per month from Social Security. The supplemental Social Security rider permits payment of $2,600 + $800 or $3,400 for the first year of disability when the Insured is unlikely to have ally response from the SSA. The policy's elimination period must be completed before benefits begin. For example, with a 60-day elimination period, no benefits are paid for the first 60 days (two months), then the larger $3,400 benefit is paid for 10 months, completing the year. At the end of that period, the benefit drops to the lower $2,600 monthly benefit for the duration of disability, whether or not the insured actually receives any Social Security DI benefits.

That same policy, however, could have been written not only with the supplemental Social Security rider, but also with the social insurance offset rider. Now, at the end of the year, if the insureds Social Security benefits are denied, the offset rider takes over and continues to provide the $800 that Social Security would have paid if the insureds claim had been approved.

Cutting Edge Benefits

This final section of Chapter Three discusses three relatively new benefits that demonstrate how insurers respond to changing consumer needs and desires in the disability income

insurance field. These are just a few examples of innovations insurers may undertake to provide a responsive product.

Cash Value/Return of Premium Benefit

One of the greatest objections consumers have to disability income insurance is the high dollar investment in a policy most people believe they will benefit from only minimally, if at all. The inability to conceive of oneself as being disabled is a major stumbling block for many people. To answer this objection, some insurers have introduced a cash value type of benefit that allows insureds to recover part of their premium outlay when their DI policies have paid minimal or no benefits. Depending on how the particular feature operates, it may be referred to as a cash value or a return of premium benefit. Another term associated with this feature is the money back benefit. Some newer policies include this feature as a built-in policy provision, while others offer the benefit as a rider.

The Cash Value Approach

The cash value approach is comparable to cash value life insurance. The insured pays a larger premium in order to both accumulate cash values and pay for the insurance coverage. The portion of the premium set aside for cash values earns interest. If the insured terminates the policy in the early years, the policy typically pays no return. However, as the policy ages, an increasing percentage of the premiums paid will be returned if the insured terminates the policy.

Here's an example of how the insured might benefit, assuming the yearly premium is $1,800 and the insured has never been disabled during the life of the policy. The figures show the differences between leaving the policy in force for five, 10 and 20 years.

15 Years 10 Years 20 Years

Percent Returned 10% 30% 82%

Premiums Paid $9,000 $18,000 $36,000

Value Returned $ 900 $ 5.400 $29,520

In all cases, by the time the insured reaches age 65 with the policy still in force and no benefits paid, the return is 100%.

Suppose, on the other hand, the insured has been disabled and has received DI benefits sometime during the life of the policy. In that case, rather than receiving a return of all premiums paid, the total amount of DI benefits paid to the insured is deducted before the cash value is returned. Using the 20-year figure above, assume the insured, which is age 50.

Terminates the policy at this point, having received $8,400 in DI benefits during the policy period. The $29,520 figure is reduced by $8,400 and the insurer returns $21,120 to the insured.

The Return of Premium Approach

As an alternative, the return of premium approach operates in a similar manner, but the return is available much sooner. While the example above indicated nearly 20 years must pass before 80% of the premiums paid are available to the insured, some insurers use this approach to guarantee that an 80% refund will be paid in just 10 years. If the policy continues, another 80% refund occurs when 10 more years have passed. Other insurers return a smaller percentage in 10 years (or five, or any other number the insurer stipulates), ranging from 50% up, but still returning faster than under the cash value approach. Another way to write these policies is to guarantee a certain percentage return at specific ages, when the insured reaches age 55 or 62, for example. Insurers write the terms of this type of provision in various ways.

The quicker return naturally costs more. For example, the insured might pay an additional 30% of the premium annually under the cash value approach, but 50% or 60% additional under this approach. Interest is paid on the accumulating values in both cases.

The insured may use the return to pay up future insurance premiums if desired, or receive the refund in cash. As is true with the cash value approach, the amount of any DI benefits paid to the insured is deducted.

Objections to the Cost

Using one of these riders adds significantly to the cost of the policy, but the built-in savings are often enough to overcome objections. For example, let's say an Insured buys a policy at age 40, paying $1,800 in premium. Of this premium, $1,200 is the cost of the base policy and $600 buys the money back benefit. This is a 50% increase in premium. At age 50, 10 years later, the insured has paid $18,000 in premiums of which $6,000 pays for the rider. However, the insured is now entitled under this particular policy to receive a premium return equal to 80% of premiums paid or $14,400, assuming no DI benefits have been paid during this period. By deducting the extra $6,000 paid for the rider, we see the insureds gain:

$ 14,400

-6,000

$ 8,400

Currently, these benefits are treated as a return of excess premium and, therefore, not taxable income, just as is the case with dividends paid on participating life insurance policies.

A final word about prospects for the cash value/return of premium benefit: This feature is generally available only to the highest quality occupations that pose the lowest risk to insurers-primarily white collar professionals. These people have the greatest financial ability to pay the extra premium and also the greatest chances of receiving a 100% return since they, as a group, are among the least likely to collect DI policy benefits.

HIV Benefit

The risk of exposure to HIV Infection that medical professional’s face has inspired another insurer innovation, the HIV benefit. Originally developed as a separate policy that did not sell well, the HIV benefit has now been incorporated into certain policies written for high-income professionals. Coverage might also be provided as a rider. At this time availability is extremely limited, but insurers that do offer this benefit believed it is appropriate for policies offering high monthly DI benefits of $20,000 or more.

One of the unique features of this benefit is that a portion of the policy's maximum dollar limits may be paid in a lump sum for the insured to use in whatever way he or she chooses, while the remainder is paid in monthly benefits. For example, if the policy maximum is $1,000,000, perhaps 50% or $500,000 will be paid to the insured as soon as the insurer has confirmation of the diagnosis. The remaining $500,000 would be retained by the insurer for payment of the monthly income. Although essentially no "strings" are attached to the insureds use of the lump-sum benefit, insurers encourage using the money for experimental treatments that are not covered by traditional medical expense insurance.

Assault Benefit

Another benefit that responds to changing circumstances is the fairly new assault benefit. This provision adds to the DI policy a lump sum that is paid in addition to monthly DI benefits when the disability results from certain assault situations described in the policy. Typically, the disability must result from circumstances such as battery, car jacking, civil riots or similar events during which the insured suffers a disabling assault.

The assault benefit, a relatively small, flat amount of $2,000 to $4,000, is not deducted from the maximum DI policy benefits. The insured may use the benefit for any purpose. In order to collect the benefit, the insured must have a police report of the incident and proof that the assault caused the insured to be unable to work for at least five days. Like the HIV benefit, the assault benefit is generally available only for DI policies that provide high monthly income payments-those written for the best class of risks.

Future Benefits?

Insurers who remain active in the disability income insurance marketplace will no doubt maintain their competitive edge by continuing to offer new features and options not currently

available. In addition, they will amend existing provisions-as permitted by law-to make DI insurance products more attractive and responsive to consumers.

As an agent working the DI field, you have a responsibility both to yourself and to your clients to know what changes are occurring among insurers you represent. Staying abreast of the latest developments helps you serve your customers competently while enhancing your own career.

Please take a few minutes to complete the review that follows before going on to the next chapter.

Chapter 3 Review Questions

1. Of the optional standard health policy provisions, which of the following is likely to be included in disability income policies because it is pertinent to the type of coverage provided?

a. Relation of earnings to insurance provision.

b. Time of payment of claims provision.

c. Unpaid premiums provision.

d. Conformity with state statutes provisions.

2. From an insureds point of view, the most beneficial policy type is one that is (guaranteed renewable / noncancelable / optionally renewable).

3. Some DI insurance policies provide for payment of a benefit to help the disabled insured retrain for a new job when performing the former occupation is impossible because of his disability. This is called the (residual/rehabilitation/nondisabiling injury) benefit.

4. A benefit that continues DI payments to a disabled insureds survivors after the insureds death is the (residual/transition/AD&D) benefit.

5. A certain disability income policy includes automatic indexing. You know that when this feature is exercised, the insureds premium cost (increases/decreases/remains the same).

6. Which of the following correctly describes the typical pre-existing condition provision in DI policies?

a. Benefits will never be paid when disability is caused by a pre-existing condition as defined in the policy.

When disability is caused by a pre-existing condition as defined in the policy,

no benefits will be paid until the policy has been in force for a stipulated period.

7. What rider allows an insured to purchase additional DI insurance without providing medical insurability? (cash value rider/guaranteed insurability rider/cost of living rider)

8. A disabled insured receives the contracted DI benefit of $3,000 per month. She is still

disabled after 12 months, at which time her benefit is increased to $3,150 by her COLA rider. Seven months later, the insured returns to work and eight months after that she is again disabled. Assuming no other changes have been made to her policy, the DI benefit she receives now is ($3,000/$3,150/$3,150 plus the COLA increase).

9. What DI policy rider allows payment of a larger benefit during the insureds first year of disability only? (social insurance offset rider/supplemental Social Security rider/no

rider does this)

10. The type of “money back" rider or provision that allows for a fast build-up of premiums, a large portion of which will be returned to the insured after 10 years when no DI benefits are paid is called the (cash value benefit/return of premium benefit/social insurance benefit).

Answers

a is correct
noncancelable
rehabilitation
transition
increases
b is correct
guaranteed insurability rider
$3,000 – the amount reverts to the original benefit unless changed contractually
supplemental Social Security rider – to assist the insured during the period when the SSA is determining eligibility for Social Security DI benefits
return of premium benefit