Many people are not aware of the sobering statistics on the likelihood of becoming disabled. According to the U.S. Census Bureau, individuals have a one-in-five chance of becoming disabled. The 2000 Census found that 21.3 million people age 16 to 64 had a condition that affected their ability to work (11.9% of the 178.7 million people this age).

This article provides an overview of income protection insurance, including the distinctions between short-term and long-term coverages.

Income Protection Insurance

Income protection insurance, also known as disability income insurance, provides covered individuals with a replacement income should the insured become sick or injured and unable to work. Coverage amounts are designed to provide reasonable income replacement while maintaining an incentive to return to work. According to the Health Insurance Association of America, income protection plans generally do not replace more than 80% of predisability earnings. Both premiums and benefits of disability income protection insurance vary depending on risk factors such as age, gender, health history and physical condition, income and occupation/job duties.

Sources of disability income protection vary considerably in both benefit levels and definitions of coverage. Five factors affect benefit levels and coverage: elimination period, total disability, benefit period, monthly indemnity and other income sources.

• Elimination Period. The elimination period on disability income insurance can be compared to the deductible on an automobile or major medical expense insurance policy. It is an initial period of time during which the disabled insured is not eligible to receive benefits even though a sickness or injury prevents the individual from working.
• Total Disability. Two definitions are normally used to describe total disability: “Own Occupation” and “Any Occupation.”
  • The Own Occupation definition pertains to a person who is unable to perform each duty of their own occupation on a full-time basis. For example, if the person is a painter and their disability limits their accessibility to a ladder, then the individual would be able to collect benefits under the policy.
  • The Any Occupation definition, which is stricter, indicates that benefits will only be paid if the individual is unable to perform each of the material duties of any gainful operation for which a person is reasonably qualified. If the painter had a disability policy that defined disability as Any Occupation, then the painter would be expected to find other gainful work, such as working in a retail paint store.

Most employer-provided or individual-income protection insurance policies define disability under the Own Occupation definition for the first two years of disability. After that, the definition changes to Any Occupation. To be considered disabled by Social Security, the Any Occupation definition applies on the first day of disability.

• Benefit Period. The benefit period is the maximum period of time during which benefits will be paid for a single period of disability. The benefit period can be as short as 13 weeks or as long as retirement age. The longer the benefit period, the higher the cost of coverage will be because the potential liability to the insurer increases. Keep in mind, however, that if you are close to retirement, you may only need a one- or two-year benefit plan. Therefore, having options for a one- or two-year plan may be important to protect against short-term risks in your financial plan.
  • Short-Term Disability. Most short-term disability policies, including employer-provided group policies, cover injuries during the first two years of disability. In legal terms, maternity is defined as a sickness and thus is usually covered as part of a short-term disability plan. Most women of childbearing age new to any job should purchase a short-term disability plan, if available, because they may not have enough sick/vacation leave saved.
  • Long-Term Disability. A long-term disability policy will normally pick up after a short-term disability policy ends. The long-term policy’s elimination period is usually the length of the short-term policy, or in most cases, two years. As indicated above, the Any Occupation definition would apply to these longer disability benefit periods.
• Monthly Indemnity. During periods of disability, the benefit paid to you is called the monthly indemnity. It represents a set dollar amount per month that will be paid as long as the insured is totally disabled under the policy definition and the benefit period has not been exhausted. The amount of the monthly indemnity is set at the date of policy issue and usually based on the insured’s earned income. The benefit commonly ranges from 30%-80% of that income.
• Other Income Benefits. While disabled, an insured may be eligible for benefits from other sources. Benefits payable under the disability plan may be offset (reduced) by other sources of disability income such as Social Security, Workers’ Compensation, or disability benefits received from other employer-sponsored plans.

Benefit Limitations

Be wary of scheduled or limited benefits based on specific types of disability. For example, some low-cost policies only offer benefits if your disability is due to certain kinds of accidents. Since the overwhelming cause of disability is sickness, make sure your policy covers both accidents and sicknesses. Some policies may only pay a benefit if you undergo an operation related to an accident.

How the insurer defines pre-existing conditions and what benefits, if any, are payable for such conditions are additional ways for the insurer to limit benefits. If a policy defines a pre-existing condition as one for which you have ever had treatment, then that would be a policy to avoid. Most likely, a pre-existing condition is one for which you took prescriptions or sought treatment or medical advice within six months of the policy effective date. Some policies define a condition as pre-existing if it manifested itself prior to the effective date or by a certain number of months prior to the effective date. In such a case, it would be prudent to have the insurance company put in writing a definition of “manifested” to avoid limiting your right to benefits. Some policies may extend the meaning of “pre-existing” to other conditions exacerbated by the original pre-existing condition.

How Much Income Protection Do You Need?

The amount of income protection needed depends on your monthly expenses covered by the income produced. Consider such things as mortgage or rent payments, insurance premiums, car payments, credit cards, loans, food, clothing, utilities, day care costs and health care expenses not covered by insurance. Then consider how long the current resources, like employer-provided sick leave and sick leave bank, state retirement system benefits, Workers’ Compensation, Social Security and nonsalary income from investments, would last.