Understanding Disability Insurance-Basics on Disability Insurance and Occupation Definitions

We have covered Life Insurance and Critical Illness Insurance in our insurance series so far. However, I have not touched much on Disability Insurance because it’s one of the most difficult policies to understand.  It is also the most expensive one and one where decline rates are highest. I received several questions about Disability insurance, so thought I should cover it. This post covers the basics of disability insurance (DI), if you need specific answer regarding your policy I suggest you contact your Insurance representative.

Two Types of Disability Insurance

There are two main types of disability insurance policies, Short Term Disability (STD) and Long Term Disability (LTD). As you can tell from the names Short Term Disability covers short term disabilities and Long Term Disability covers longer disabilities.

Short Term Disability
disability insuranceSome of the following points will vary across different policies, however these are the most common characteristics of short term disability.

  • Covers short disabilities (duh!)
  • has waiting period (usually 2 weeks)
  • benefit periods are usually between 13-26 weeks
  • depending on employer up to 100% of salary replacement

For short term disability premiums are usually paid by the employer and benefits are taxable at employee’s hand.

Long Term Disability

Long term disability is more complicated and varies much more from policy to policy, a few general characteristics are:

  • Has longer waiting periods 30-180 days most common is 90 days
  • longer pay out periods most common 5 years, but you can have up to age 65
  • generally pays up to 70% of your pre-tax income, benefits are tax free (if premiums paid by you)
  • Premiums paid by employee (otherwise benefits will be taxable)

There are three types of definitions for long term disability plans: Own Occupation Definition, Regular Occupation and Any Occupation each of these define the type of disability that will qualify you to receive disability payments.

Own Occupation Definition

Own Occupation definition is the least restrictive definition, it defines disability as follows:

The inability to perform the material and substantial duties of your regular 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 you are working in some other capacity.

So if you are unable to perform your current occupation you will qualify for disability payment even if you have a different job. For example if a dentist has an accident and losses a finger which will prevent him completing his duties as a dentist he will qualify for disability payments even if he becomes a professor at a University.

As one can imagine this is the most expensive type of disability policies and is usually only purchased by professionals, certain jobs do not qualify for this type of coverage.

Regular Occupation Definition

This type of coverage is more restrictive than the own occupation coverage

The “Regular Occupation” definition considers a person disabled if they are:

unable to perform the essential duties of their “regular occupation”, that is the occupation in which they were engaged at the time of disability, under the care of a physician and not otherwise gainfully employed.

This means that you cannot be forced to take up another occupation.  If you can not perform your occupation you will be paid total disability benefits and can choose not to take up another occupation. If you choose to work in another occupation, a loss of income will normally result in a partial disability benefit being paid.
This is usually the most common type of definition when purchasing disability insurance.

Any Occupation Definition

This is the most restrictive definition, an “any occupation” policy defines disability as:

the inability to perform the duties of any occupation.

This definition of disability is strict. To receive benefits according to this definition, you have to be unable to work in any occupation, not just your own. So if you are capable of performing any job you will not be entitled to disability benefits, usually it will take into account education and past work experience.

Most disability plans are set up as Regular Occupation Definition for the first five years and then become Any Occupation Definition.

Group Disability Plans vs. Individual Disability Plans

Because of the high claim rates on disability plans they are the most expensive insurance products to purchase. Fortunately for most part disability plans are offered by employers; however there are some differences between group and individual plans.

Group Plans:

  • Cheaper
  • No Medical Examinations
  • Company is the policy owner

Individual Plans:

  • More Flexibility
  • You are Owner
  • Can make changes as you wish
  • More expensive

Owning an individual plan comes with some benefits, but often the cost difference is so big that it’s not worth it.

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Comments

  1. says

    Great overview Ray.

    Something to point out is the difference in tax treatment of disability plans (at least in the US). Group insurance plan premiums are generally deducted from taxes, which makes the benefits taxable. However, most individual plans are paid with after-tax money, making the benefit from the insurance plan income tax-free.

    This is especially worth considering if you are in a higher tax bracket or would need to replace a larger amount of your income in the event of being sick or hurt. For those folks, they should generally still take the insurance plan from their employer, but also consider adding on a supplementary individual policy to make up the difference paid out to the tax man.

  2. Ray says

    I was not aware of that in US, in Canada almost all group plans are paid with after tax dollars…..but thx for pointing that out

  3. Jimmy says

    If I have a group LTD plan, do I need to get a personal one? I’m worried about changing company in the future and I might not get this benefit in the new company.

  4. says

    @ Jimmy Long term disability plans are very expensive and that is why I recommend individuals stick with their group plans……there can also be complications in terms of payments when more than one policy is in force and this usually comes down to the contract and wording of the contracts. I would suggest you look at your current group policy and than speak with an adviser to determine what the best option maybe for you.

  5. says

    @Ray

    While group plans tend to be a bit more affordable they’re not really yours to keep. In this economy many are seeing their benefits being reduced or cut altogether by their employers as they tighten their belts – not to mention those who have lost their benefits altogether because of layoffs. Considering that you can’t get disability insurance if you don’t have good health and that many develop disqualifying conditions the older they get, it really is risky to have a disability policy that is at your employer’s mercy.

Trackbacks

  1. [...] Disability insurance is another insurance you can not do without. Take a minute and think about what is the most important asset you have? It is your ability to generate income, if you are making say $40,000/year and you are 30 years old, you will be making over $1.4 Million over the next 35 years not including any raises. If you owned something that was worth $1.4 Million would you insure it? [...]

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