CHAPTER SIX - 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, or 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.  However, 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 purchases, 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. 

It is true that 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.

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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.

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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 mean 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

Similar to preexisting condition clauses in other types of health insurance, 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:

 

FA 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 on 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 unusual 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 they cannot perform the major duties of their regular occupation, which is further defined as the occupation that the insured was performing when the disability began.  Under this definition, an insured could be working in some other capacity and still be entitled to policy benefits if they cannot perform the important tasks of their own occupations 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, would read:  “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 that disable 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.

F   The longer the elimination period, the lower the policy premium.

 

F  Some Disability Income insurance policies require that the elimination period be satisfied with total disability only, or with consecutive days of disability.  Most experts feel that an elimination period must be satisfied with either a residual or a total disability. 

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, is to be considered as a new disability 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

Generally, 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 overinsurance.  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 overinsurance 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

As briefly discussed earlier in this text, 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 had to 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 overinsurance.  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 overinsurance 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 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 that were in force on the policy issue date.  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 which is beyond the scope of this text.  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 place 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.  With the typical Short-term plan, however, there is no elimination period of disabilities that results 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 is actually several other combination of elimination periods available.

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” or better, "Payroll Deduction."  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). For further discussion, see "Cafeteria Plan" and "Flexible Benefit Premium Plans" in the following chapter.

This type of marketing is not true “group” marketing, but could 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, which provides 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.  If the disability continues, 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 underwrite them much more cautiously. 

TAXATION OF EMPLOYER-PROVIDED DISABILITY INCOME

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 one or more employees, are tax-deductible (usually) for the employer as a business expense and are not taxable income to the employee.

Premiums are deductible by the employer whether the coverage is provided under a group policy or individual policies, however, the deduction is allowed only if the benefits are payable to employees or their beneficiaries—benefits may not be payable to the employer.151

By court ruling, the deduction of premiums paid for a disability income policy that insured an employee-shareholder was prohibited when the corporation was the premium payor, owner and beneficiary of the plan.

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.  The benefits are fully includable in gross income.

If benefits are received under the plan to which the employee has contributed, the portion of the disability income attributable to the employee's contributions is tax-free.  Under an individual policy, the employee's contribution for the current policy year was taken into consideration.  Under a group policy, the employee's contributions for the last three years, if known, are considered.152 

An employer may allow employees to elect on an annual basis, whether to have the premiums for a group disability income policy included in their income for that year.  An employee who elects to have premiums included in his income will not be taxed on benefits received during a period of disability beginning in that tax year.  An employee's election will be effective for each tax year without regard to employer and employee contributions for prior years.153

Premiums that are paid by a former employee under an earlier long-term disability plan, were not considered paid toward a later plan from which the employee received benefit payments.  Therefore, the disability benefits were includable in income.  If the employer merely withholds employee contributions and makes none himself, the payments are excludable.154

 

STUDY QUESTIONS

 

1.  The principal reason that it is difficult to compare disability policies is

      A.  because the cost of the plans vary widely, even within the same insurance company.

      B.  that some are underwritten, some are not, and most are somewhere in between.

      C.  that they are designed to provide flexibility, which leads to a wide availability of

            benefits and optional coverages.

      D.  that all such policies are copyrighted and so they have to vary widely.

 

2.  In respect to renewing coverage, disability income and medical expense insurance are (uniquely)

      A.  guaranteed renewable.

      B.  conditionally renewable

      C.  provisionary renewable.

      D.  non-cancelable.

 

3.  Most disabilities

      A.  are of the long-term variety.

      B.  are of the short-term variety.

      C.  occur after the wage earning years.

      D.  are covered by private or corporate disability insurance.

 

4.  Under a disability income policy, the word "injury" is defined as

      A.  accidental body injury caused by accidental means.

      B.  accidental bodily injury occurring while the policy is in force.

      C.  injury occurring by accidental means, whether intentional or accidental.

      D.  an impairment requiring loss of income for a period of not less than 30 days.

 

5.  With a disability income policy, in order for the insured to be considered as "disabled,"

      A.  he must have suffered a loss of income because he cannot perform the duties of his job.

      B.  he must have received medical attention from a licensed medical professional causing

            mental or physical distress.

      C.  an insured must be classified as permanently disabled.

      D.  he must be under the care of a licensed medical professional 24 hours a day.

 

6.  Insurance companies use two different definitions to describe total disability:

      A.  unable to perform any gainful occupation or avocation.

      B.  unable to perform any part-time or seasonal work.

      C.  immobile or mobile.

      D.  any gainful occupation (any occ) or own occupation (own occ).

 

7.  If an individual is insured under a disability income policy, the policy may consider the insured to be totally disabled even while he is at a work if

      A.  he is making at least 50% of the compensation he was receiving prior to the disability.

      B.  he is a key man" or highly-compensated.

      C.  he can still perform the majority of the duties he performed prior to disability.

      D.  he lost the sight of both eyes, hearing from both ears, power of speech, or use of any

            two limbs.

 

8.  Some disability income policies require that the elimination period

      A.  be satisfied with total disability only.

      B.  be satisfied with total disability or with consecutive days of disability.

      C.  include consecutive days of disability.

      D.  be waived in case of sickness but at least 30 days in case of disability because of

            an accident.

 

9.  In determining whether a recurrent or consecutive disability or episodes of disability is to be considered as a new disability or as a continuing claim, recurrent disabilities will be considered as one continuous period of disability

      A.  unless each period is separated by recovery for a period of not less than 6 months.

      B.  unless each period is separated by recovery for a period of not less than 30 days.

      C.  in any event.

      D.  unless each disability period was caused by dissimilar incidents, medical conditions, or

            accidents within 1 year of the original disability commencement.

 

10.  It about 35% of all disability claims either start or end

      A.  because of an accident.

      B.  because of cancer, heart attacks or AIDs.

      C.  in a residual claim.

      D.  during the first year of coverage.

 

ANSWERS TO STUDY QUESTIONS

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