*Any other type of income that is not dependent on the insureds ability to work.

 

For the vast majority of people who are employed by a business and who earn a salary or an

 

 

122

hourly wage, determining earned income is easy. Earned income is shown on paycheck stubs and W-2 forms. More difficult to determine is the income earned by self-employed people and by either employed or self-employed people who receive commissions and performance bonuses or other income that is riot fixed.

 

Fluctuating Incomes

 

To deal with fluctuating incomes, insurers generally look at earnings not just for the current year, but also for the proceeding two or more years. When you take an application from an individual whose income varies, you can use financial information from prior years to estimate your client's average insurable income. However, your insurer's underwriting department probably requires a financial statement from the applicant in order to more accurately arrive at insurable income. In fact, for applicants at higher income levels, a financial statement is probably required whether income is relatively stable or not. You'll learn more about specific financial information requirements in the underwriting chapter. It is important for you to be aware of the circumstances under which an applicant must provide more data. This allows you to advise your customers in advance that more information will be needed and to caution them that the figures you are working with at the point of sale are estimates.

 

Special Needs of Self-Employeds

 

Particularly for people who are self-employed, it is important to differentiate between the income the business earns and the wages the self-employed person pays him or herself. An individual, personal disability income policy is designed to cover only the personal income, not the entire business earnings. For example, let's say a small business owner generates $12,000 monthly income in his business. He pays himself a salary of $8,000 per month. An individual DI policy that pays benefits at a level of 70% of income will replace 70% of $8,000 or $5,600 for this person. Of the $12,000 the business generates, only the $8,000 paid as salary is substantially replaced. Remember, however, that income generated by the business to pay ongoing business expenses can be protected with the business overhead expense policy discussed in Chapter Five. That's how this person could replace the $4,000 of income not accounted for under the individual DI policy.

 

Minimum and Maximum Income Levels

 

Insurance companies typically specify both minimum and maximum incomes that qualify for individual disability income policies. The annual minimum is usually from $20,000 to $30,000. As we have indicated elsewhere, people whose incomes are below these levels can generally be covered adequately during disability by social insurance programs such as workers compensation or Social Security. By setting minimums at this level, insurers effectively eliminate the problem of coordinating individual DI policy benefits with the benefits of those programs.

123

 

Insurers also may stipulate a maximum income level from $300,000 to $400,000 annually, or about $25,000 to $33,000 per month. Alternately, an insurance company might allow a DI policy to be written for people with higher incomes, but place a cap on the monthly benefit. For example, the insurer stipulates that the monthly benefit will be no more than $20,000, regardless of the individuals actual earned income. On the other hand, insurers catering to high-income professionals are likely to take a more liberal approach and will insure a higher monthly benefit.

 

Another consideration is the amount of an individual's unearned income. When sources other than the person's occupation provide a high level of unearned income, the insurance company takes a close look at the individual's net worth-the amount remaining when total liabilities are deducted from total assets. Insurers sometimes refuse to write personal DI coverage when net worth exceeds a certain level, perhaps $3 million or $4 million. The reasoning is that a person with a very high net worth probably has assets, other than earned income, that are adequate to support the person comfortably if disability occurs, so there is no need for insurance coverage.

 

The companies you represent will provide you with guidelines for your high-income prospects. However, even when you submit applications that seem to fit the guidelines, you should know that the underwriting process would include careful scrutiny of earned and unearned income and net worth. The dollar minimums and maximums included in this section are representative figures only. Actual figures differ from insurer to insurer and are subject to change.

 

The Replacement Percentage

 

You know that the purpose of disability income insurance is to help the insured manage financially during a disability, but to replace less than 100% of pre-disability earnings in order to keep the insured motivated to return to work. Therefore, DI policies stipulate a benefit equal to a percentage of monthly earnings.

 

Some insurers use gross earnings before taxes as the base and offer a benefit from 60% to 70% of gross monthly earnings, with 66b% being the most common. Other insurers work with net or after-tax earnings rather than gross. In this case, the replacement percentage is likely to range from 70% to 90%, with 75% or 80% most commonly used. The following examples show the differences in monthly benefits based on various means of figuring the benefits.

 

Percentage     Of Gross         Benefit            Of Net Benefit

   70%               x            $4,000   =     $2.800            $3,000     =      $2,100

66b%                x            $4,000   =    $2,668            $3,000     =       $2,000

   75%               x               N/A              N/A $3,000     =       $2,250

   80%               x               N/A               N/A            $3,000     =       $2,400

124

 

You'll also recall that lower percentages are typically used with higher income levels and higher percentages with lower income levels. The insurers you represent will provide the exact information for your use.

 

Integration with Other DI Benefits

 

Social Insurance Benefits

 

Earlier we mentioned the dilemma faced by both the insurer and the insured in regard to the potential for receiving disability income benefits from the Social Security program. In spite of the difficulty in qualifying for Social Security disability benefits, insurers must take this possibility into consideration to avoid overinsuring. Here is an example of what could happen if the potential Social Security benefit is ignored by the insurer and the insured ultimately receives benefits from both Social Security and an individual DI policy.

 

Suppose an individual earns $2,000 per month and qualifies under the insurer's guidelines for a monthly benefit of 66b% or $1,334. The insurer writes the individual DI policy for the full $1,334 monthly benefit, ignoring Social Security. If the individual is able to receive Social Security DI benefits, they will total $800 per month. Let's add up the benefits:

 

DI Policy                    $1,334

Social Security                800

Total               $2,134

 

You can see the problem. This individual, who was earning $2,000 per month on the job, now receives $134 more each month by virtue of being disabled. Although not a huge amount, an additional $134 of tax-free income could make it more difficult for this person to "recover" from the disability.

 

One way insurers handled this situation in the past was simply to deduct the potential Social Security benefit from the amount of DI insurance the person would otherwise qualify for and write the policy for the difference.

 

DI Policy                    $1,334

                        Minus Social Security               -800

Reduced DI Policy    $   534

 

Writing the policy without regard for whether the insured will actually qualify for Social Security benefits eliminates the overinsurance problem, but if the individual does not qualify for Social Security. the results can be devastating. The individual now receives only $534 per month compared to former earnings of $2,000-a 73% loss of income!  Said another way, the DI policy, which intends to replace from 60% to 70% of income, in this case replaces only 27%.

125

 

Using the Social Insurance Offset Rider

 

Situations such as that described above, you'll recall, were the inspiration for development of the Social Security offset rider and the subsequent social insurance offset rider. The latter addresses not just Social Security, but other types of social insurance as well, including workers compensation and state temporary DI benefits plus other government-sponsored disability programs. Let's review from Chapter Three how you can use the social insurance offset rider to coordinate all DI benefits. Three different applications are common.

 

Dollar-for-Dollar Offset

 

One method is a dollar-for-dollar offset, where the benefit dollars received from a social insurance program are deducted from the DI policy monthly benefit. In other words, the DI policy is written for the monthly benefit the insured otherwise qualifies for, but the policy actually pays only the difference between the specified monthly benefit and any other DI benefits paid from social programs. Here is an example based on the previous situation. The insured earns $2,000 per month and qualifies for a monthly DI benefit of $1,334. The DI policy is written for this amount and the social insurance rider is attached, providing a dollar-for-dollar offset. Here is the result:

 

Specified DI policy benefit   $1,334

Benefit insured receives from

a social insurance program     -500

 

DI policy pays                        $  834

 

The social insurance offset rider has solved both potential problems. The insured is neither overinsured nor underinsured. Instead, the insured receives 66b% of pre-disability income, which both adequately compensates him or her during disability and encourages returning to work.

 

Percentage Offset

 

The percentage offset method reduces the DI benefit by a specified percentage depending on the type and amount of social insurance benefits the insured receives. One of two different percentages applies, according to the circumstances.

 

The rider stipulates that the DI benefit will be reduced by a smaller percentage-let's say 30% if the insured receives the Social Security benefit known as the primary insurance amount (PIA). The PIA is determined by means of a formula applied to the individual's lifetime earnings and is also the amount a person receives from Social Security at retirement. This calculation is complex and we will not discuss it further here. If the insured receives either

 

126

the PIA or a DI benefit from any other social insurance program, the rider makes the 30% reduction (or other percentage the insurer stipulates). Here's an example.

 

Vince Venezia's DI policy pays a $2,000 monthly benefit, but he qualifies for the Social Security PIA, triggering the 30% social insurance offset rider reduction.

 

$2,000      x      .30      =      $600

 

                  $2,000

                - $   600

DI policy pays                  $1,400

 

The result is that Venezia receives $1,400 from the DI policy plus the PIA from Social Security. The same application would be made if he had received a DI benefit from some social insurance plan other than Social Security

 

But suppose Venezia receives the Social Security PIA plusa disability benefit from another social insurance program. In this case, the rider specifies that the DI policy's monthly benefit must be reduced by the larger percentage specified-let's say 90% for this particular rider:

 

$2,000      x      .90     =           $1,800

                                                 $2,000

-$1,800

 

DI policy pays              $  200

 

Now Venezia receives $200 from the DI policy plus the other two social insurance benefits. Some offset riders specify that, if the insured receives two or more social insurance DI benefits, no benefits are paid from the DI policy-in other words, a 100% reduction.

 

As you can see, under the percentage reduction method, the actual dollar amounts the insured receives from social insurance programs are not considered. The fact that the insured does receive other disability benefits triggers the reduction in the DI policy benefit.

 

Total Offset

 

The third method for applying the social insurance rider, total offset, also ignores the actual dollar amounts received from other sources. If the insured receives any social insurance disability benefit, the DI policy pays no benefits: it's that simple. If this method applied to Venezia's $2,000 monthly benefit DI policy and Venezia received $300 from any social insurance program, he would receive nothing from the DI policy. If Venezia received no social insurance benefits at all, the DI policy would pay the full $2,000.

 

127

Remember that these offsets can be critically important at the lower income levels where government benefits alone might be adequate to replace a significant portion of lost income. By contrast, social insurance benefits replace a much smaller proportion of higher incomes.

 

From the insureds point of view, the dollar-for-dollar offset is probably the most attractive. Knowing how your companies apply the rider will guide you in integrating policy benefits with social insurance benefits.

 

Social Security Supplement

 

Another method for coordinating benefits that you learned about in Chapter Three is a supplemental Social Security rider that increases the DI policy monthly benefit for the first year only. This rider takes into consideration the five-month waiting period for Social Security benefits plus additional time for approval before any Social Security benefits would be paid. The rider increases the DI policy benefit for that period.

 

As an example, suppose Mae North's income qualifies her for a $3,000 monthly benefit if no other benefits apply. Since she potentially qualifies for a $900 monthly Social Security DI benefit, the insurer reduces the DI policy benefit to $2,100 ($3,000- $900). Adding the Social Security supplement rider, however, gives back the $900 until the end of the first 12 months of disability. If North's policy has a 60-day (two-month) elimination period, she will receive $3,000 monthly for 10 months. If she is still disabled after that, the DI policy benefit drops down to $2,100 monthly, whether or not she actually receives the Social Security benefits.

 

Depending on which riders are offered by the Insurers you represent you maybe able to offer a combination of the Social Security supplement and the social insurance offset rider. Using either or both of these riders to integrate your policy's benefits with social insurance benefits allows you to offer the most advantageous monthly benefit without overinsuring.

 

Other Benefits

 

Any individual DI policy you sell must also take into consideration other sources of disability income, such as salary continuation plans, any other individual DI policies the applicant already owns, and group disability coverage.

 

Salary Continuation

 

Let's first see how you can coordinate benefits when you must consider a salary continuation plan and potential Social Security benefits. The applicant, Sarah Gordon, earns $4,000 per month and your insurer would insure this amount at 70% or $2,800 per month. If Gordon

 

 

128

qualifies, Social Security will pay her a DI benefit of $1,000 per month. Gordon's employer has a salary continuation plan that pays 100% of earnings for the first 30 days.

 

You can offer a DI policy with a 30-day elimination period so the policy's benefits start when the salary continuation plan ends. Gordon is assured of full income replacement from her employer for 30 days. Although the insurer's normal issue limits for Gordon's income are $2,800 monthly, you must consider the potential $1,000 from Social Security. You can use a social insurance offset rider to provide a dollar-for-dollar offset. The rider is for $1,000 and the DI policy benefit is $1,800. As long as Gordon does not receive anything from Social Security, the DI policy pays $2,800 monthly following the elimination period.

 

Let's suppose, however, that Gordon is approved for Social Security DI, but the $1,000 estimate was wrong and she receives only $800. Here are Gordon's total benefits from all sources:

 

DI Policy                    $1,800

Rider                               200    ($1,000 - 800 offset)

$2,000

Social Security Total Benefits               800

Total Benefits                        $2,800

 

If Gordon is also eligible for other social insurance benefits, such as workers compensation, the dollar-for-dollar offset would apply to those benefits as well. Remember, though, if the insurer you are working with uses another method to offset social insurance benefits, the figures will be different.

 

Another Individual DI Policy

 

Another possibility is that the applicant has another individual DI policy in place. This applicant, Sam Wong, earns $6,000 per month and would otherwise qualify for $4,000 monthly benefits under your policy. However, his existing policy provides a monthly benefit of $1,500 and an additional $1,100 might be available from Social Security.

 

Since $1,500 per month is already available to Wong, you must first subtract this amount from your insurer's issue limits.

 

Issue limits                  $4,000

Existing policy           -1,500

New limits                  $2,500

 

But you still need to consider the potential Social Security benefits of $1,100. Again, you can use the social insurance offset rider to provide the $1,100 representing potential Social

 

129

Security benefits and the balance of $1,400 as the monthly benefit from the new DI policy.

 

New issue limits         $2,500

Offset rider                -1,100 (potential 55 benefits)

New DI Policy            $1,400

 

As was the case with Gordon, if Wong qualifies for any other social insurance benefits, those, too, will be offset by the rider.

 

Group DI coverage

 

Insurers often use a different arrangement when an applicant already has group DI coverage by increasing the issue limits before reducing that amount by the group monthly benefit. For example, assume the applicant, Justin Hackley, has group insurance that would provide him a $2,000 monthly benefit if he became disabled currently. Under your DI policy, Hackley's issue limits would normally be $3,500. Taking into consideration the $2,000 group benefit normally leaves this result:

 

Issue limits                  $3,500

Less group benefit     -2,000

       New issue limits                     $1,500

 

However, since the other benefit comes from group insurance, the insurer might increase the original issue limits slightly, let's say by $500 in this case. Now, instead of purchasing a new policy with a benefit of only $1,500, Hackley may purchase a $2,000 benefit:

 

Increased issue limits $4,000

Less group benefit     -2,000

New issue limits         $2,000

 

There are two basic reasons insurers offer this increase when the other coverage is group DI:

 

1.    Group coverage might be canceled for the group or the covered individual might leave the group; in either case, the DI benefit terminates.

 

2.    If the employer pays all or part of the group premium, all or part of the benefit is taxable to the employee; the larger individual DI policy benefit can help pay taxes due on the group benefit.

 

Unearned Income and the Monthly Benefit

 

In some cases, determining the monthly benefit requires con­sideration of the applicant's

 

130

unearned income. When an applicant has significant unearned income, but not so much that he or she is ineligible for DI coverage, insurers typically use one of two methods to calculate a benefit that provides adequate protection while recognizing the potential impact of unearned income.

 

Under one method, the insurer specifies a dollar amount of unearned income that will essentially be ignored for purposes of determining the monthly DI benefit. This will be a relatively small amount, such as $2,000 per month. Then the insurer stipulates that, if the insureds unearned income exceeds that limit, the policy's monthly benefit will be reduced by a certain percentage of the excess. Let's look at how this works, using the $2,000 limit and a reduction equal to 50% of unearned income over $2,000.

 

Assume the insured, Willa Ellis, qualifies for a $4,000 monthly DI benefit based on her earned income. This must be reduced, however, because she has unearned income of $3,000 monthly-$l,000 more than the limit her insurer imposes.

 

Unearned income                  $3,000

Unearned income limit                      -2,000

           

Excess unearned income                   $1,000

 

$1,000      x      50      =          $    500

 

Monthly DI benefit               $4,000

Less reduction for excess

unearned income                   -    500

 

Monthly DI benefit payable             $3,500

 

How does Ellis fare in terms of income replacement? We know she'll receive $6,500 monthly-$3,000 of unearned income plus the $3,500 DI benefit. In order to qualify for the $4,000 issue limits originally, Ellis probably had earned income of about $6,700 per month, based on a replacement percentage of 60% of earned income:

 

$6,700      x      .60      =     $4,020 ($4,000 issue limits)

 

Ellis also has $3,000 unearned income, so her total monthly income is:

 

Earned                       $6,700

Unearned                     3,000

Total               $9,700

 

 

131

To determine what percentage of her income is replaced by the DI benefit and unearned income totaling $6,500, divide this figure by her former income:

 

$6,500      ¸      $9,700      =      67%

 

So, even by reducing the DI policy's monthly benefit in response to Ellis' unearned income, her income during disability is still two-thirds of pre-disability income, which is a common replacement ratio.