William, an entrepreneur making around $300,000 a year, suffered a debilitating injury that left him unable to stand — let alone work. For the next ten months, he was unable to do much of anything.
Lacking disability insurance, he was forced to take money from his company’s coffers to pay his bills and take care of his family’s financial needs. He also needed to come up with funds to pay for someone to come in and run his firm while he was flat on his back. In the end, he burned through his cash and very nearly went bankrupt.
If you don’t think this could be you someday, think again. Do you realize that you may be three times more likely to become disabled for an extended period than you are to die before age 65?
While death and taxes are life’s only two certainties, it seems disability may be close behind.
Here’s why that’s such a big deal. We’ve discovered that far too many business owners have not taken steps to protect themselves — and their incomes — from the financial carnage that can occur in the wake of suffering a disability.
It’s time to ask yourself a few questions:
- What would happen to me, my family and my company if I were to become unable to work?
- Do I have the protections in place that I need in order to ensure my personal and professional financial security if I become disabled?
A Shocking Lack of Protection
Despite the sizable threats that becoming disabled can present to financial security, few business owners actually have disability insurance protection in place.
Example: Less than one-fifth of entrepreneurs we studied have individual disability insurance — policies purchased by the business owners themselves that can offset the loss of income that would occur from their being unable to work (see Exhibit 2).
Even fewer entrepreneurs have bothered to buy business owners’ expense disability insurance — which covers business expenses if owners are disabled. These expenses can include rent and property taxes, utilities, leasing costs, accounting costs, business insurance premiums, employees’ salaries and benefits, and other key expenses that help keep the lights on.
Finally, a minuscule percentage of business owners have buy-sell disability insurance, which is designed to allow a partner to buy out another partner who has become disabled and is unlikely to continue in his or her role (see Exhibit 4).
Eight questions to ask before you buy disability insurance
Not surprisingly, disability insurance — like many other types of policies — can be a jumbled mess of terms that create more confusion than clarity. To break through the noise, start by considering these eight questions when evaluating disability insurance.
1. What’s the policy’s definition of disability? This is one of the most important features, if not the most important feature, of a disability insurance policy. When you buy disability income insurance coverage, you are essentially buying the insurance company’s definition of disability.
There are three basic definitions: “own occupation,” “any occupation,” and “partial” or “residual” disability.
- Own occupation. This refers to the occupation you were working in just prior to your disability. If your “own occupation” is protected, the policy will not require you to work in another occupation. This is also sometimes referred to as “regular occupation” or “your occupation.”
- Any occupation. Some policies will not pay benefits if you can perform “any” occupation you are suited to, based on your education, training and experience.
- Partial/residual. Residual disability insurance pays benefits even if you are not completely disabled (and can work part time). Benefits are based on the income you earn working part time, relative to your previous full-time earnings. Partial disability coverage is similar, but loss of income is not considered. Instead, the policy pays 50 percent (or less) of the benefit that you would get if you were totally disabled.
Advice: Look for a disability income insurance policy that considers you disabled if you cannot perform the substantial and material duties of your own regular occupation. Note, however, that this option is not always available.
Based on your occupation, you may be eligible for a less comprehensive definition of disability. Don’t dismiss that coverage. Having some sort of protection is better than having none. You can further enhance your policy with coverage that provides benefits in the event of a partial disability.
2. What is the amount of coverage? Most plans set a limit on the percentage of your income you can insure — usually 50 to 70 percent of your total gross earnings. We tend to suggest that business owners aim for policies on the high end of the spectrum, assuming such policies are financially feasible, so they can meet their responsibilities and take care of unexpected financial needs without eroding their lifestyles greatly.
3. How long is the waiting period? The waiting period (also known as the elimination period) is the length of time you must wait before disability income benefits begin to be paid if you are too sick or too hurt to work. The period can be as short as 14 days (short-term disability policy only) or as long as a year. As a rule, the shorter the waiting period, the more expensive a policy will be. Most people choose either a 90-day or 180-day waiting period. Note: Benefits are typically not paid until the end of the month following the waiting period. If you have a 180-day waiting period, you’d receive your first benefit check after at least 210 days.
4. How long will benefits last? The benefit period is the length of time benefits are paid. The shortest benefit period is usually two years. A five-year benefit period is fairly common. Most people purchase coverage that lasts until age 65, or longer if available. Pro tip: Buy the longest benefit period you can afford. If you remain in good health, most insurance companies will allow you to upgrade your coverage down the road.
5. Is the policy noncancelable and guaranteed renewable? If you’ve got a noncancelable and guaranteed renewable disability insurance policy, the insurance company can’t raise your premiums or cancel the policy as long as you pay the premiums — giving you considerable security. A policy that is only “guaranteed renewable” can increase premiums under certain circumstances.
6. Does the policy cover accidents and illness? About 90 percent of disabilities are the result of illnesses, according to the Council for Disability Awareness. However, accidents — such as a bad car wreck or a serious fall from a high ladder — also put you at risk. Be sure your policy addresses both sources of disabilities.
7. Does the policy come with a cost-of-living increase in benefits? A long-term disability deprives you of income. Unless you are careful, some policies can also put you at the mercy of inflation. To avoid the risk of inflation eroding the value of the disability payments, you can purchase a policy that automatically adjusts your payments to reflect an increased cost of living.
8. Are the benefits taxed? Benefits may be tax-free if you pay the premiums using after-tax dollars. That said, the key is to evaluate the tax implications of using pretax or after-tax dollars so you understand what you’re getting and so you can customize your policy to your needs if necessary.
Is it Time to Re-evaluate Your Income Protection?
By now, you may have realized that you’re among the vast majority of entrepreneurs who lack one or more types of disability insurance, and that you are putting your financial well-being at risk.
If so, what are you waiting for? The time has come to safeguard yourself, your family and your company from potential catastrophe.
Or you may be part of that select group of business owners who have insurance policies to protect their business and income in the event of a serious disability.
If so, it’s time to reassess your current level of coverage and the type of new options available to you. We find business owners often discover that the disability coverage they bought years ago and forgot about doesn’t meet their current needs in one or more of the eight categories outlined above. That’s especially true if your income has risen substantially.
The upshot: As your needs, level of success and health status change over time, your disability protection has to keep up — or else you needlessly put yourself at risk.
Contact a legal or financial professional who can evaluate your unique situation to determine your disability insurance needs, what types of policies could meet those needs and whether any existing policies you have are up to snuff.