Disability insurance explained from A to Z

The results of a 2012 survey commissioned by the Consumer Federation of America indicated that many Americans working in the private sector have a serious lack of disability insurance. What makes this fact scary is that majority of the respondents say that if they miss work for three months because of an injury or illness, they and their families would find themselves in dire financial stress.

This is where disability insurance becomes important.

How disability insurance works

Disability insurance provides an individual protection against loss of his income because he is unable to continue working due to an illness or accident. The covered individual will get his disability checks, in many cases, three to six months from the date he is unable to continue working.

Sources of disability coverage

Consumers have three ways to get disability insurance:

  • From the Social Security Administration - this government-implemented program provides coverage to an estimated 153 million U.S. workers. How it defines disability is strict - for instance, disability has to last twelve months to be covered and the individual cannot be gainfully employed. Also, approval can take up to two years sometimes even longer.
  • Via Workers' Compensation insurance - state laws make it a requirement for employers to have this program. This insurance pays the individual an equivalent of two thirds of his salary prior to his disability. This, however, is limited to illnesses or injuries that are work-related.
  • State programs on disability insurance - a number of states offer coverage to workers who pay for them via salary deduction. States that provide this include New York, Rhode Island, New Jersey, Hawaii and California.
  • Employer-sponsored insurance - majority of disability insurance coverage in the U.S. is offered as an employer-sponsored benefit. This can be short-term (three months), or long-term (longer periods.)
  • Consumer-purchased policies - here the consumer buys coverage on his own from insurance providers. These policies have the benefit of being portable, meaning, coverage does not get lost when the individual changes jobs.

Pros and cons of disability insurance

Pros

  • Provides you with monthly income while you are unable to work. If you already have Social Security coverage, a disability insurance policy can add to what you are getting.
  • If you get a policy out of your own funds, your benefits are tax-free. This is crucial as policies typically provide about sixty percent of your regular income. Regular income after tax is about the same as the payout you get from a disability policy. This means that your finances after suffering from disability are almost at the same level as it was pre-disability.

Cons

  • Rules can be strict when the time comes to claim benefits and also, when trying to to get coverage for a longer period of time.
  • Disability policies also tend to have limits on the length of time that benefits are provided.
  • If you are denied coverage and you dispute the insurer's decision, you may have to undergo through arbitration. This can be lengthy as well as frustrating.

Types of disability insurance policies and important features

  • Short-term policy - with this coverage, the policyholder has to wait from zero to fourteen days before receiving the benefits. The longest period of time that benefits can be claimed is two years.
  • Long-term policy - here the policyholder has to wait between several weeks to a number of months before receiving the benefits. The length time that the policyholder receives the benefits can be for a few number of years to a lifetime.

Features of policies that should be noted include the following:

  • Non-cancelable - provides the policyholder the ability to have his policy renewed every year and not having to suffer from a hike in premium payments or see a reduction in his benefits.
  • Option to buy additional insurance.
  • Coordination of different benefits - how much you receive from the insurer depends on the other benefits you get from other sources, for example, Social Security.
  • Cost of living adjustment - this feature allow you to increase your benefits to cope with rising costs. To avail of this feature, you have to pay additional on your premium.
  • Partial disability - a rider that allows the insured to claim partial benefit if his disability is only partial, that is, he can still go back to his job.
  • Return of premium - allows for a refund of a portion of the total premium payments if there are no claims made during a specified time period.
  • Waiver of premium - a feature that allows the policyholder to stop making premium payments once his disability has reached ninety days.

How rates are determined

Insurance companies determine premium payments on the basis of an individual's age, gender, type of occupation, the income that could be lost because of a disability, riders and the benefit period. The general rule is that the greater chance of disability, the higher one has to pay for coverage.

When to consider disability insurance coverage

  • You have debts to pay - a home mortgage, student loan, auto loan. The most important for many people is the need to continue paying the home loan. A disability policy can prevent losing a home to foreclosure when one is unable to continue working because of injury or illness .
  • When there is a family involved - if you are the main income earner of your family, think about what will happen to them when that income stops coming in.
  • When there is no fund for emergency purposes - a short-term disability policy could be a necessity in this situation.
  • You have a high-risk job - where the likelihood of an injury is very high. In most of these jobs, employers provide disability coverage to their workers.
  • Your family has a disability history - if one or both your parents have become disabled because of arthritis, stroke or similar conditions, there could be a chance of the same happening to you.

Individual versus group policies (short-term and long-term)

Individual Policy

  • Require you to present proof you are in good health.
  • Allows portability of coverage. You can job or career and still have coverage.
  • Non-cancellable by the insurer, as long as you are updated on your payments.
  • Tax-free benefits if paid out of personal funds.

Short Term Group Policy

  • Offers benefits per week to employees who suffer from partial or total disability.
  • Can be costly if purchased individually, better to buy it through employer.

Long Term Group Policy

  • Generally provides up to sixty percent of pre-disability income to totally disabled individual.
  • Coverage is set up to a certain limit per month, for example $10,000.
  • Available for disabilities that are both short-term and long-term and, in many cases you need not present an proof that you are insurable.

For group policies, it is important to note the following:

  • total disability is a condition (in most group coverages),
  • taxability of benefits (if premiums are not paid by you but by your employer),
  • benefits are cancellable by employer,
  • non-portability of coverage,
  • limits on benefits

How to shop and save

  • Consider "own occupation" policy. This policy pays out if you cannot continue working on your present job. In contrast, an "any occupation" coverage means you can still do other jobs which could mean that the insurer will not pay you your benefits.
  • Consider a policy that covers you up until you are 65. By that time you will be reaping benefits from your retirement fund.
  • Determine how long your own emergency fund can last. If your emergency fund can cover six months or longer, you can get lower premium rates.
  • Determine the level of benefits you need. Think of your mortgage, and other debts that need to be considered when income is hampered by disability or illness.
  • Get a renewable policy. This would give you assurance that the insurance company will not change any of the policy's features with the exception of the premium amount when you renew your coverage.
  • Be aware of the two basic ways you can keep your premium rate down:
    • Choosing to wait for a longer period of time before you get to receive the benefits. Policies that offer benefits after thirty days of disability will cost more in premium payments compared to those that offer benefits after three months from the start of disability. If you opt to wait longer, be sure you have enough money to cover you during the waiting period.
    • Choosing a shorter period where you get the benefits. This may save you money in terms of premium payments, however, you could be exposing yourself and your family to greater risks once the benefit period lapses. Many experts recommend that coverage should be up 65 years old so that there is no gap in coverage. Therefore, financial experts advise for a longer waiting period but at the same time an emergency fund has to be set aside.
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