What Makes Up A Disability Policy?

What are the Building Blocks that Make Up a Disability Policy? 

Disability Insurance may be thought of as financial security for your most precious asset: your ability to work and make a living. Your residence is covered by homeowner’s insurance. Car insurance safeguards the vehicle you drive. Your health and well-being are covered by health insurance. So, what type of insurance protects your ability to make a liking?

Not to worry – disability insurance covers your paycheck. This post delves into what you need to know about disability insurance.

Disability insurance is an arrangement between insurance providers and policyholders to cover income in case of illness or injury that may prevent an individual’s ability to work.  The insurance provider offers to pay you a monthly sum in exchange for monthly premiums paid by the policyholder. Disability insurance is meant to cover part of the income lost because of a failure to work. If you have disability insurance, you can buy food, pay bills, and cover living costs while you are unable to work. 

A disability insurance policy defines:

Premium Payment. This is the payment an individual would make each month to keep the policy active, much like any other form of insurance. 

Disability Definition. Some conditions prevent an individual from working in their regular occupation but still allow for different types of work. If there is a reduction in income, certain coverage plans will pay a monthly benefit to make up the difference. However, some plans do not pay benefits if the individual is capable to work in a different job that produces an income. 

Benefit Amount. Your benefit amount will almost always be a percentage of your salary. Usually, plans pay 60-80% of your pre-disability earnings. 

Benefit Period. The benefit period may be a fixed number of months or years. It could also last until you reach a certain age. 

Coverage Amount

So, how much coverage should you get? The most direct response to the question would be enough to replace your income. When it comes to disability insurance though, that answer isn’t valid. It is very unlikely you’d find that kind of policy. Almost all plans are intended to replace a portion of your salary, with amounts ranging between 40-80%. This number is based on a variety of factors. Here’s how to find out what you will need. 

Actual Current Expenses. If you want to maintain your current lifestyle, you can start by assessing all the expenses that go into it. Evaluate your monthly take-home pay to see how much money you have left over at the end of the month. If your monthly take-home is $5,000, yet you donate $300 and save $700, your actual monthly expenses are closer to $4,000. 

Changes to Spending Habits. Most financial analysts agree that 60-70% income replacement is the sweet spot as most individuals don’t truly spend as much while unemployed. What is the reason for this?

  • You don’t have to pay for transportation.
  • You save money on lunches and coffee breaks. 
  • You save money on clothes. 
  • You’ll also pay less in taxes.

You may also be able to dramatically reduce your housing costs. Since their careers are in prosperous urban areas, many professionals prefer to move to these parts. If they no longer need proximity to a particular job, they may opt to migrate to a less expensive location better suited to their new lifestyle. 

Spousal Income. If you remain at home, you would be able to do more of the things that your spouse does now. This may encourage your spouse to work more hours and make up at least some of the income gap. 

Taxable Benefit. Individual long-term disability policies are normally purchased with after-tax dollars, so the benefit is usually tax-free. If you have employer-provided benefits though, the premium is paid in pre-tax dollars and the profit is taxable. In this scenario, a benefit equaling 50% of your take-home income might be 35-40%. To make up for the deficit, many individuals with occupational disability insurance buy a supplementary disability policy. 

Additional Assets, Income, and Savings. If you have been setting money away for something other than retirement, you might use it to cover living expenses. Also, your work might not be your only source of income – i.e., rental properties. Similarly, if you work in legal or medicine, you may own your offices and can rent these spaces. 

How to Factor Benefit Amount. Try to assign a numerical value to all the above-mentioned factors and enter then into the following formula:

Your actual monthly expenditures in total

Fewer (reduced monthly spending)

Fewer (income from outside sources)

Equals: minimum disability payout per month

Bear in mind that long-term disability insurance is intended to last longer, with monthly payouts that could last years, even decades. This level of security comes at a price. If you are healthy and employed, the lower the monthly benefit you can live with, the easier it will be to pay your premiums. 

Deductible or Waiting Period

A waiting period – also known as an elimination period or qualifying period – must be served before eligible to collect benefits. This is the amount of time between the onset of a disability and compensation payments. 

If you have a disability insurance policy, you should be aware of the duration of the elimination period. The elimination period is the time that must pass before a disability insurance policy’s benefit can begin. Many disability insurances plans do not pay out right away. You must wait for the elimination period to pass before collecting benefits. If you fulfill the policy’s definition of partial or total disability, you can continue collecting compensation after the elimination period has expired. 

Waiting periods for short-term disability are measured in days. Waiting periods for long-term disability may last months. Typically, the length of time will be defined in your disability insurance policy. To prevent a lapse in coverage, the short-term disability policy should cover the length of your long-term disability waiting period. 

Elimination times can vary depending on the policy. A short-term disability policy will have shorter elimination periods between 0-90 days. Long-term disability policies may not begin benefit disbursement until two years following the start time of the disability. 

The most common elimination period is 90 days. For this form of insurance, the elimination period basically acts as the premium. The lower the insurance premiums, the longer the duration, and vice versa. Another stipulation is that you must be disabled for every day of the elimination period to be eligible for the compensation amount. 

Benefit Period

The amount of time you are eligible for benefits is referred to as a benefits period. The length of time you receive benefits is determined based on which insurance company you are covered. If you have private disability insurance, the benefit period also depends on whether you have a short- vs long-term disability insurance policy. The most important distinction between short-term and long-term disability insurance is the amount of time you’ll be eligible to collect payments when disabled – benefit period. 

Short-term disability insurance, as the name suggests, is a form of private insurance that is intended to cover temporary disabilities. This coverage is designed to protect you for a limited period after an injury or illness that prevents you from working. The length of benefits varies – anywhere from 3 months to 5 years. The average time for short-term disability insurance coverage is in the middle – approximately 1 to 2 years – depending on the insurer and policy. 

Long-term disability insurance is intended to cover conditions that are either permanent or expected to last awhile. This coverage is designed to pay benefits for an extended period. Payout periods for this type of policy are represented in years. Coverage will last as little as 2 years or reach up to 5, 10, or 20 years. Some policies provide coverage up until planned retirement age. Of course, the length of the disability benefit period depends on the insurance policy. 

Occupation or Own Occupation

Short-term disability insurance is always classified under ‘own occupation’ disability insurance. Short-term disability plans are written to include financial compensation if your disability prohibits you from performing the basic functions of your work. To put it plainly, if you are unable to fulfill your daily job duties as opposed to just any task. When it comes to filing for long-term disability insurance after the short-term benefits have run out, the distinctions between “own occupation” and “any occupation” is important. 

The secret to assessing your eligibility for compensation is the concept of complete disability. This is at the heart of every disability policy. While the term defines what constitutes complete disability, each carrier’s definition may be different. Own-occupation disability is described different by each carrier as well. Double-check your understanding of all aspects regarding disability insurance policies. 

True Own-Occupation Disability Insurance. Own-occupation disability insurance is just what it sounds like. This type of disability insurance allows you to continue collecting disability insurance when fully disabled. This applies even when you are working in a different profession or capacity – with no change in benefits. True Own-Occupation does not prohibit you from seeking another occupation when totally disabled in your current one.

Two-year True Own-Occupation Disability Insurance. This type of disability insurance allows for a two-year period of True Own-Occupation. If you’re still disabled following the two-year period, your coverage shifts to a Changed Own-Occupation term for the duration of your insurance period. When you are unable to perform the duties of your own profession due to a disability or illness and not gainfully employed, you are in a Changed Own-Occupation. 

Two-Year Modified Own-Occupation. For the first two years, another choice is to use a Modified Own-Occupation term. If you are still disabled after two years, the policy converts to an Any-Occupation plan. This means you are unable to work – solely due to determined disability – in any occupation for which you are, or have become, qualified through schooling, training, or experience. 

Policy Exclusions

If you qualify for disability insurance coverage with an exclusion, the insurance provider will still insure you. However, the insurer will include language in your policy stating that certain body parts, conditions, or disabilities resulting from certain activities will not be covered. 

All applicants are subject to a variety of exclusions. Disability insurers, for example, are reluctant to pay claims for accident or disease caused by self-inflicted acts, criminal activities, operating machinery while intoxicated, acts of war, and/or civil disobedience. You may also be subject to additional underwriting exclusions that limit coverage. Claims resulting from or linked to preexisting medical conditions or hazardous activity involvement that increases one’s risk of disability are susceptible to exclusions. 

Preexisting Condition Exclusion. Medical underwriting is required for most disability insurance plans. Most insurers have a two-year exclusion period during which they will not pay coverage if the patient has a preexisting condition that they did not report on their policy application. 

This effectively protects them from fraudulent clients. These individuals are unable to function due to a preexisting condition but lie about it on their policy and then attempt to file a claim as soon as possible. The result is that disability insurance remains affordable for everyone. 

If you have some sort of documented or preexisting disability, you will not be able to purchase a short-term disability policy with no waiting period. If you have a preexisting condition, most short-term plans have a one-year elimination period. 

Although certain exclusions are permanent in your disability insurance policy, others can be reviewed after a certain period. If you can prove to your insurer that you are managing a defined disability, that exclusion could potentially be removed. 

It’s also worth mentioning that an omission doesn’t necessarily mean a lack of benefits. For instance, let’s say you have a preexisting spine condition and experience a debilitating injury as a result of a serious car accident. Your insurer can conclude that the accident caused your inability to function – not the preexisting condition. You may also be eligible for compensation if you have two disabling conditions – one of which is exempt from coverage. If you become disabled, you can still file a claim, even if you have an exclusion. 

Each insurance company has its own underwriting system. A pre-existing condition or activity may be excluded by one insurer, while another may provide complete coverage regardless of those factors. There are even a few insurance companies that do not set limitations on coverage for mental-health related disabilities.  

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