Risk Management via Insurance - Disability Insurance
This is a guest post series by Brian Poncelet who is an independent certified financial planner (CFP) working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning. The first post was about reducing risk with life insurance.
From The Wealthy Barber: “Disability insurance is the most neglected of all forms of insurance, yet for many people, it’s the most critical insurance need…. A thirty year old has a one in four chance of becoming disabled for one year or more at some point in his or her life…When people are disabled, they don’t just cease to be an asset to their families…they become a liability.”
When I review benefit hand books, many of my clients are surprised to learn the details of the actual coverage that they carry. Most disability benefits only cover 60% of the employee’s salary and exclude bonuses. Many plans will only cover the first five years of disability and most plans are not indexed to inflation. Many clients are unaware that their disability benefits are not portable and a move to a new company results in a different benefit plan.
As the working population ages and companies are more cognizant of expenses, there is a growing trend for employers to offer “flex dollars” benefits. With this plan the employee is given an allotted sum of dollars from which he must choose from a shopping list of benefits (health, dental, life, short term disability, long term disability, critical illness insurance). While the employee can top up each element of coverage, in general, as the employee gets older, the same dollar allotment buys fewer benefits.
Who needs to buy individual disability insurance privately?
- Individuals on Flex Plans: Since disability insurance is one of the more expensive items on the flex dollar shopping list, many people will choose an inadequate amount of coverage or none at all, resulting in the individual being underinsured.
- Individuals who make frequent employer changes such as is seen in the IT industry. You can’t take your coverage with you and there is no guarantee that the next company will offer comparable coverage.
- All self employed individuals need to put disability insurance in place for replacement of income and business overhead expenses. A challenge that I frequently observe is the individual who shows minimal personal income to CRA as a tax planning strategy. This can place the individual at a disadvantage when attempting to show a realistic personal income stream to the insurance company.
The Disability Contract
When you pay for the premium out of pocket there is no tax-deduction, but you receive the benefits tax free. This compares to a company paid policy where you are taxed on the benefits.
A personally owned non-cancelable disability insurance policy is a contract between the individual and the insurance company. As long as the premiums are paid, the policy cannot be cancelled or altered in any way without the individual’s consent.
There are three common clauses used to determine the criteria and length of time for which an insurance company is obliged to pay a claim if you become disabled. This determines whether you can be forced to work, even in some other field at a reduced level of income. These clauses are known as:
- “Any occupation” requires that you must be unable to work in any occupation, regardless of the change in duties or income.
- “Regular Occupation” clause states you must be unable to perform the important duties of your own occupation and not working in any other gainful occupation.
- “Own Occupation” clause permits you to receive full benefits if you are totally disabled not working in your field but choose to work in another field.
Ask yourself “How likely is it that I could be totally disabled out of my specialty and still be able to work in another?”
Additional contract terms to know:
Elimination Period (waiting period)
This is the length of time that must elapse after the onset of the accident or sickness before the insured becomes eligible to receive disability benefits. The typical elimination period for private coverage is 90 days.
Non-Cancelable Contract
Under the provisions of this contract, as long as the premiums are paid, the insurance carrier cannot:
- cancel the policy
- change any provisions or add restrictions
- increase the premiums or add any changes to the existing policies
Features of Disability Insurance
Waiver of Premium
It is important to continue premium payments even after you become disabled especially since you may not receive benefits for 90 days. Many insurers take over paying future premiums while the insured is receiving a disability benefit and some will refund the premiums that were paid during the elimination period.
Future Increase Option
This benefit allows one to increase the benefit by a certain amount at specified intervals without providing evidence of health. You only need to prove earnings. This may be of interest to those who want a robust policy now but to keep premiums low, they take the lowest coverage and enhance the coverage at later time. A chartered accountant, who buys disability insurance and later becomes a roofer, would be an extreme example.
Cost-of-Living Benefit
This benefit ensures that while on claim, the purchasing power of your benefit dollar is increased at specific periods (every 6 or 12 months). There are two formulas which can generally be utilized when applying for coverage:
- CPI index (with or without minimums and maximums)
- Simple interest
Portability
As a general rule, you want the plan to remain as unrestrictive as possible so that future changes in your status or location can be accommodated. An example would be an oil engineer who moves to Saudi Arabia but owns disability insurance purchased 10 years before. Only private plans offer this feature without restriction.
Like all insurance, disability insurance is not well understood by most people. The old adage is true “you get what you pay for”, so do your research.
In the next, and final, edition of the risk management series, Brian Poncelet will discuss Critical Illness Insurance, how it works and how it compares to disability insurance. In case you missed it, read the first part of this series on reducing risk via life insurance.
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