When I was studying for the Certified Financial Planner exam, we were taught that the probability of disability at most ages before retirement is greater than the probability of death. In fact, 25% of today’s 20-year-olds may be out of work for at least a year because of a disability before they retire.1 Yet the percentage of Americans with disability insurance coverage declined from a high of 31% in 2012 to a low of 14% in 2021.2 People think they may not need disability insurance or that it is too expensive. Despite the statistics cited above, one study finds that workers believe their own risk of becoming disabled is just 10% or less.3 Other reasons for not buying disability insurance include a lack of knowledge and indecision.4
What is Disability Insurance?
As its name suggests, disability insurance is a type of insurance product that provides income in the event that a policyholder is prevented from working and earning an income due to a disability.
For example, if a worker earned $50,000 per year prior to becoming disabled, and if their disability prevents them from continuing to work, their disability insurance would compensate them for a portion of their lost income provided that they qualify.
How May Workers Obtain Disability Insurance?
In the United States, individuals may obtain disability insurance coverage from those employers that may offer it, or they may purchase it through private insurers, or finally, if their disability qualifies, they may secure it through the Social Security system or workers’ compensation programs.
Workers’ compensation may provide coverage for some disabilities, namely those that arise out of injuries in the workplace “in the course and scope of their job.” As such, benefits are offered through very specific circumstances. The coverage is mandated by each state and benefits may vary by state.
Social Security may provide disability insurance for medical conditions that prevent workers from engaging in “substantial gainful activity” that are “expected to last for at least twelve months or result in death.”5 This is a fairly strict definition of disability, and as a result, about 60% of initial applications for Social Security disability are denied.6 Even if you qualify for Social Security benefits, these benefits may replace only about half of your earnings.7
Group and Individual Disability Income Insurance
Some employers offer their full-time employees group disability coverage as a benefit at a reduced cost or no cost. You may also be able to purchase an individual disability income policy directly from an insurance company to either supplement a group plan or provide coverage if a group plan is unavailable.
There are many differences between group and individual coverage. Group disability coverage is tied to your employment. If you change or lose your job, the coverage may not be portable. The cost of group coverage may also change year to year. Individual disability policies may have higher premiums, but may offer better benefits.
Both types of disability insurance, group and individual, may be subdivided into long-term polices or short-term policies. Short term disability insurance is intended to cover you for a short period of time following an illness or injury that keeps you out of work. While policies vary, short term disability insurance typically may cover you for a term between 3-6 months. On the other hand, long term disability is intended to provide benefits for a longer period, and benefit periods for long term disability insurance may be stated in years: 5, 10, 20 or even until you reach retirement age, depending on your plan.
While short term disability insurance may begin paying benefits within a couple weeks following a qualifying illness or injury, long term disability insurance often requires a longer waiting period, called an “elimination period”, before a policyholder begins receiving benefits. The length of the elimination period varies by policy but is often around 90 days.
Some Factors to Consider When Purchasing a Disability Insurance Policy
- How much of your income would you need to replace to maintain your lifestyle if you became disabled and couldn't work?
There may be limits on the percentage of your income that you can replace and the existence of other sources of income may impact the amount of disability insurance you can purchase.
- How much do you have in cash reserves to pay for expenses if you become disabled?
This may be a factor in whether you need a short-term disability policy, and if so, how long.
- How long could you wait before the disability benefits kicked in?
This may determine the "elimination period" — the number of months you would wait after becoming disabled for the policy to pay out. The longer the elimination period, the lower the insurance price.
- How long would you want the benefits to last?
This may determine whether you need a short-term policy, a longer-term policy or both.
- How broadly would you define "disability"? Note this might be the most important factor about disability insurance and is often a major difference between employer group policies and individual policies.
Highly skilled people who have invested a lot of money in training may want a policy that pays out if they can't work in their specialty but will still allow them to work as a neurosurgeon who loses the ability to operate might still be able to teach or work as a general practitioner. Another consideration: Do you want a policy that pays out a portion of the benefits if you are partially disabled, meaning you can work only part time? People who suffer a disability often need to cut back on their hours, either on the front end as their condition deteriorates from an illness or on the back end as they recover from an injury or illness.
- How much of your budget are you able to allocate to disability insurance?
According to the Council of Disability Awareness, disability insurance policies generally range from 1%-3% of your annual income, although actual costs may vary significantly depending upon the extent of the policy.8
Disability Insurance Can Be Complex
Disability claims can be more complicated and frequently take more time to resolve than life insurance.9 Over the years, insurers have sometimes misjudged the pricing of these polices. As a result, disability policies may have a great deal of "fine print" that individuals must navigate and understand.10 One issue is the definition of disability. Some policies define disability as being unable perform duties of "your own occupation." Other policies define disability as the inability to perform "any occupation.” Some policies may have limitations relating to pre-existing conditions and mental or emotional issues. Some policies offer residual coverage that pays benefits for a partial-but-not-total disability. Others may not. Those that offer residual coverage may not provide enough income for workers to maintain their current lifestyles. These are just a few of numerous complexities that should be investigated before considering purchase.
Given the complexities of disability policies, it often pays to work with a qualified professional who is thoroughly familiar with the issues and the products available.
Conclusion
So--do you really need disability insurance? If you would be unable to meet expenses, or if your lifestyle and your family’s lifestyle would be significantly compromised if you were to become disabled, the answer is “yes.”
This is a very brief overview of a complex subject. If you would like to know more about disability insurance, or if you would like to discuss your personal situation with us, please feel free to contact us. We are here to help.
Doug Lemons, CFP®
CRN-6166209-121523
1https://www.simplyinsurance.com/disability-statistics/ and https://www.limra.com/siteassets/newsroom/fact-tank/fact-sheets/diam-2021-final.pdf
2https://www.limra.com/siteassets/newsroom/fact-tank/fact-sheets/diam-2021-final.pdf
4Ibid.
5https://www.ssa.gov/redbook/eng/definedisability.htm?tl=0
8https://www.nerdwallet.com/article/insurance/disability-insurance-explained
10https://www.kitces.com/blog/weekend-reading-for-financial-planners-sep-28-29/