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Disability Insurance Basics

Originally published: 05.01.08 by Mike Coyne


Offering disability insurance helps companies attract and retain good workers.

Why disability insurance? For some employers, the answer is that some form of disability insurance is required by state law. For many employers, the answer may be a need to provide a competitive benefits package to attract and retain good employees. For other employers, disability insurance is viewed as a key component of the social contract between the employer and employee. Whether you are required to provide disability benefits or simply want to consider such benefits for your employees, you will need to have a basic understanding of how these policies work and what sort of benefits they can provide.

Government-Mandated Disability Benefits

Smart employers realize that they are already paying into one or two disability programs for their employees. Part of the Social Security tax paid by employers and employees is for disability benefits. Additionally, virtually every state requires employers to participate in a state-sponsored workers’ compensation program, or alternatively purchase private workers’ compensation insurance. While these programs provide disability income, they have some serious limitations.

Take, for example, Social Security disability benefits. These benefits generally do not start until you have been disabled for at least five months and are only payable if you have completed at least 40 quarters of employment under the Social Security system. The benefits that are provided are typically offset by workers’ compensation benefits. More importantly, the Social Security definition of disability is somewhat severe.

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To be considered disabled for Social Security purposes, you must be unable to engage in any substantial gainful activity because of physical or mental impairment. This means that you must not only be unable to do your previous work, but also any other type of work considering your age, education, and work experience. Additionally, it must be expected that your disability will either result in death or last for at least 12 months in a row. As you might expect, it can be somewhat difficult to qualify for Social Security disability benefits.

Workers’ compensation benefits and the requirements to receive those benefits vary from state to state and policy to policy. What is generally true, however, is that such benefits are only payable for work-related injuries and illnesses. If you are injured while commuting to and from work or at home, these benefits will not be available.

Commercial Insurance

Commercially available disability insurance offers far broader coverage than Social Security or workers’ compensation. For example, some policies will consider you disabled if you can no longer engage in “your own occupation,” even if you are able to do other types of work. Additionally, the purchaser of the policy can typically select the length of the waiting period before benefits commence. More importantly, benefits become payable if you are disabled, regardless of whether the disability or illness is work-related.

This last point is particularly important, since many disabilities are not caused by job-related injuries but rather by illnesses. According to Unum Group, one of the country’s largest disability insurance carriers, 26% of long-term disability claims were related to cancer. Cardiovascular illnesses and illnesses arising in connection with pregnancy also are leading causes of disability claims.

When you consider the incidence of cancer, you won’t be surprised that the American Council of Life Insurance predicts that nearly one-third of all Americans will suffer a serious disability sometime between the ages of 35 and 65.

Types Of Disability Insurance

There are two basic types of disability insurance: short term and long term. Short-term disability policies are designed to take care of temporary disabilities. Benefits typically start one to 14 days after you become disabled and continue for a period of one to six months. The benefit that will be payable will be a percentage of your normal wages, usually in the range of 50% to 66.67%. In almost all cases, the benefit will be subject to some dollar “cap” or maximum.

Long-term disability policies pay benefits for a much longer period of time, either a specified number of years, to age 65, or perhaps even for life. Benefits usually start three to six months after a disability occurs. Like short-term benefits, the maximum benefit will be the lesser of a percentage of wages (usually no greater than 66.67%) and a maximum dollar benefit.

Disability policies also are characterized as either group or individual. Group insurance is simply a plan under which individual employees or members are covered under a “master policy.” By covering a number of insureds at once, the insurer lowers its administrative cost and can therefore provide benefits less expensively. Frequently, these policies are “guaranteed issue,” meaning that all employees are covered regardless of individual health status. However, these policies also are cancelable by the insurer.

Individual disability policies cover specific individuals. These policies do require specific underwriting, based upon the individual’s health status. However, once issued, these policies cannot be canceled by the insurance company so long as the premium is paid.

Understanding Differences In Policies

Whether you’re shopping for a group policy or an individual policy, the key to understanding the policy will be found in certain key definitions. We have already mentioned one key definition, the definition of “disability.” As noted earlier, a definition similar to the Social Security definition of disability means that only very severe injuries or illnesses will be considered disabilities eligible for benefits. On the other hand, an “own occupation” definition may pay an employee disability benefits even if that employee is able to engage in other gainful activity. Many group policies include an “own occupation” definition for the first two years of disability and thereafter shift to a more general definition of disability.

The “waiting period” or “elimination period” is another key term. As you might expect, the longer the waiting period is for benefits to commence, the less expensive the policy. If you are considering purchasing both short-term disability and long-term disability, you might want to match the length of time that benefits are paid under the shortterm policy with the waiting period under the long-term policy. For example, if the short-term policy pays benefits for six months, you would want a long-term policy with a six-month waiting or elimination period.

Most policies provide benefits in the case of certain “presumptive disabilities.” Policies that provide benefits in the event a presumptive disability might pay benefits in the event of loss of sight, speech, hearing, or use of limbs, even if you are still able to work.

One very attractive feature of some disability policies is a “residual” or “partial” disability benefit. Residual disability benefits generally help make up the difference in your income if you are able to work but limited in your responsibilities or length of the workday due to your disability. Most residual benefits are triggered when an employee’s income is reduced 20% or more as a result of disability. Generally, residual disability benefits are only paid following a period of total disability for the same illness or injury.

In addition to these key definitions, insurers offer a variety of “add-on” benefits called “riders.” For an additional premium, policies can be purchased that will provide for automatic increases in coverage to adjust for inflation. Similarly, a rider can frequently be purchased to provide for automatic increases in benefits to adjust for inflation. Most recently, insurers have been offering policies that provide for a refund of premiums if you hold a policy a specified number of years without filing a disability claim.

Paying For Coverage

All disability benefits, whether short term or long term, may be structured as an employer-provided benefit, a benefit paid for solely the by employee, or a benefit where the cost is shared. In structuring the payment arrangement, there is an important tax consideration. If the employer pays for coverage for the employee or employee pays for coverage with pre-tax dollars, then any benefits paid under the policy will be considered taxable income to the disabled employee. However, if the employee pays for coverage with after-tax dollars, then benefits payable under the policy will be tax-free. If benefits are partially paid by the employer and partially paid by the employee with after-tax dollars, then a portion of the benefits will be taxable and a portion will be tax-free.

An argument can be made that the employer should pay for short-term benefits, since the taxability of those benefits is not a significant consideration. With long-term benefits, payment by employees with after-tax dollars of all or part of the premium so that the benefits will be tax-free significantly enhances the value of those benefits.

Final Thoughts

Because of the variations of disability policies and the variety of options that are sold with such policies, the best way to purchase this type of insurance is with the advice of a competent and trusted agent. There are some agents that specialize in this type of insurance. If you do not have an adviser with whom you are comfortable, ask your lawyer or accountant if they can recommend an agent with expertise in this area.

Michael P. Coyne is a founding partner of the law firm, Waldheger Coyne, located in Cleveland, Ohio. For more information on the firm, visit www.healthlaw.com, or call 440-835-0600. >> To pose a question to Mike, go to www. hvacrbusiness.com/forums.


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