What to Look For in a Disability Insurance Policy

What to look for in a disability insurance policy

Photo courtesy of Joan Campderrós-i-Canas

Last week we talked about the importance of disability insurance and why it’s such an important part of building a secure financial base for our families.

As a quick reminder, disability insurance will pay you monthly income in the case that you become disabled and are unable to work. In other words, it’s insurance against the loss of income due to poor health.

And as we said in last week’s post, if there’s anyone that relies on your income, including you, then there’s a need to insure the ability to earn that income.

There are a lot of variables to consider when looking at disability insurance, and with all of the different terms it can quickly get confusing. Today I’d like to explain some of the most common and important characteristics of a disability insurance policy so that you can make a more informed decision when evaluating your options.

Definition of disability

They way the policy defines disability is incredibly important, as it determines the circumstances under which you’ll be able to collect benefits. At the highest level, there are basically three ways to define it:

  • Own occupation: You are unable to do the work of your current job.
  • Modified own occupation: You are unable to do the work of any job for which you are reasonably suited based on experience, education and training. (Yes, this is very vague.)
  • Any occupation: You are unable to do any kind of work. (This is Social Security’s definition.)

The “own occupation” definition is the most beneficial to the person buying the insurance, since it covers them under the most situations. It’s also the most expensive. But remember that this is one of the building blocks of our financial security, so while price should matter it shouldn’t be the primary factor.

Also keep in mind that even within these broad definitions, the language will vary from policy to policy and the specific language is very important. Make sure to get some help understanding the specific language of the policy you’re looking at before making any final decisions.

Personally, I decided to purchase a policy with an “own occupation” definition for myself because I didn’t want to have to fight the insurance company on the very vague language of the “modified own occupation” definition, and I definitely didn’t want to only qualify if I was completely unable to work.

Exclusions

Some policies will exclude certain conditions from coverage, either because of a pre-existing condition or because it’s something they just don’t cover. Mental health conditions like depression and anxiety are common examples of things that many policies simply won’t cover.

If you have a pre-existing condition, it will probably be difficult to find coverage for it. Though I’m not an expert on that area so it may be worth looking around to see if there are any reasonable options.

But it is worth your while to compare different companies against each other for more general exclusions. There’s no need to go with a company that excludes certain conditions if there’s another option that includes them.

Policy guarantee

At the very least, your policy should be what’s called “guaranteed renewable”. This simply means that as long as you continue to pay the premium on time, your policy cannot be cancelled by the insurance company. However, the insurance company CAN raise the premiums, but only if they do so across ALL policies for people with a similar type of occupation. In other words, they can’t simply decide to increase your individual premiums. It has to be a company-wide decision across a broad population of similar people.

One step up from that is a policy that is additionally “non-cancelable”. This simply means that all the same terms as above apply, but in addition your premiums are guaranteed for as long as the policy is in force. This will come at an additional cost.

Benefit

The benefit is the monthly amount you would receive in the event of disability. This may be expressed as a percentage of your income if you have a group policy (through your employer) or it may be a specific amount if you have an individual policy.

In either case, you likely won’t be able to have more than 60-70% of your income covered. The reason for this is that the insurance company wants to make sure you have an incentive to return to work.

I’ll talk about this more next week when I compare group policies to individual policies, but it’s important to understand whether your benefits will be taxed. If you have a group policy, the benefits you receive would likely be taxed, which means the money you actually get in your pocket will be less than the benefit amount. With an individual policy the benefits will likely be tax-free. This distinction can make a big difference in determining whether you have enough protection.

Benefit period

This is the maximum length of time that benefits will pay out. A typical policy will pay either only pay out for a set number of years or will pay until age 65, no matter when your disability starts.

My recommendation would be to make sure the benefits will last for as long as you currently plan on working. After all, the insurance is meant to protect you from lost income, so the protection should last as long as you expect to earn income. For most people this will probably mean that a policy that pays until age 65 is the best option.

Elimination period

Also called the “waiting period”, this is the amount of time from the start of disability before you would start receiving benefits. You will have some choice here, but typically the most cost-effective option is 90 days, meaning that benefits wouldn’t start paying out until you had been disabled for 90 days.

This is a very similar concept to a deductible with other types of insurance. It’s a cost-effective tool for you because it lets you insure the big loss (long-term disability) while handling the smaller losses on your own. This is one place where a good emergency fund can be incredibly helpful. If you have the cash available to handle the first few months, you can save a lot of money on premiums.

Residual benefit

Some policies may offer what’s called a “residual benefit” which will pay you partial benefits if you return to work at a lower salary than you previously had. This can be a valuable benefit and you should understand the terms under which this does or does not apply in your policy.

Cost-of-living adjustment (COLA)

The cost-of-living adjustment (COLA) will allow your benefit to increase over time by some specific percentage so that it can (hopefully) keep up with inflation. This feature will likely come at a small extra cost.

Future purchase option

You can also choose to have the option to purchase additional benefits later on without any review of your medical condition. This can be a valuable benefit if you expect your income to increase over time and therefore think you may need more insurance in the future. It basically allows you to lock in your current medical condition, removing the risk of developing an issue that would make it either more expensive or impossible to get more coverage in the future.

Keep in mind that this only locks in your current health, not your current age. So if you want to purchase more later the premium might be higher simply because your older.

Strength of the insurer

Finally, you should understand the the financial strength of the insurer. The best coverage in the world won’t help you if the insurer is bankrupt when you need it. The easiest way to check this from my own experience is to simply go to the insurer’s website and they’ll either have their financial ratings on the front page or you’ll be able to find it somewhere in their menus.

Summary

There’s a lot to consider here, and it certainly doesn’t make for an easy decision. If you’re looking for an individual policy (outside of anything offered by your employer), it probably makes sense to work with a broker who can pull quotes from multiple companies and help you understand the differences.

In next week’s follow-up, we’ll talk about the difference between an individual policy and a group policy, and why you might want an individual policy even if you already have coverage through your job.

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29 Comments... Read them below or add one of your own
  • Color Me Frugal December 2, 2013

    Great info Matt! The hubs and I both have own occ policies and it provides an enormous sense of security knowing that we are protected in this way should anything happen.

  • Holly Johnson December 2, 2013

    When Greg was training to sell investments and insurance, he learned a lot about disability insurance…including the fact that it was pretty expensive. I think that’s why most people don’t have a policy….it can cost a lot on a monthly basis.

    • Matt @ momanddadmoney December 2, 2013

      It’s definitely expensive. Though it’s a lot less expensive than trying to create the same kind of income protection on your own.

  • Laurie @thefrugalfarmer December 2, 2013

    Matt, I’m always impressed by how much you know about this stuff. I didn’t know about the “guaranteed renewable” thing, so thanks for that info. We are lucky to have an awesome policy through Rick’s work, but we probably should look into some type of independent policy.

    • Matt @ momanddadmoney December 2, 2013

      Thanks Laurie! I’ll actually have a post on the difference between group and individual policies next week, so stay tuned!

  • Debt and the Girl December 2, 2013

    We have def. looked into disability insurance especially for the bf since he works in home repair. I have done some research on the subject but thanks for added info.

  • Andrew December 2, 2013

    Thanks for the detailed explanation. I think disability insurance is something most people overlook. I might have to get a quote and check out the prices.

    • Matt @ momanddadmoney December 2, 2013

      Definitely worth looking into, though I would think a government job might already provide good benefits. But in any case, having that protection is key.

  • John S @ Frugal Rules December 2, 2013

    Great rundown Matt! I did some writing for a company here in town in regards to Disability Insurance and glad to see I was right on it. 🙂 That said, this is something we definitely need to look into purchasing even if I shudder at the cost. 😉

    • Matt @ momanddadmoney December 2, 2013

      Yep it’s definitely expensive. But like I said to Holly, it’s less expensive than trying to create the protection on your own.

  • Done by Forty December 2, 2013

    Okay, I am calling into my HR department to see how my policy fits under these definitions. Thanks so much, Matt. This coverage is one of those sneaky gaps in most of our lives, I’m sure. Thanks for making the scope of that gap clearer.

  • Done by Forty December 2, 2013

    Okay, I am calling into my HR department to see how my policy fits under these definitions. Thanks so much, Matt. This coverage is one of those sneaky gaps in most of our lives, I’m sure. Thanks for making the scope of that gap clearer.

  • MyMoneyDesign December 2, 2013

    Don’t forget to check if your work already covers you on this, and by how much. I read about disability insurance years ago and was all set to get some quotes and place an order. Then I was relieved to find out that I already had a plan through work.

    • Matt @ momanddadmoney December 3, 2013

      I actually have a post coming next week on the difference between group and individual insurance. Work policies can be good, but they can also have a lot of gaps. Still, as you say, best to understand what’s available to you.

  • DC @ Young Adult Money December 2, 2013

    Thankfully my employer has a disability insurance offering. If they didn’t I’m not sure I would get around to purchasing disability insurance. It’s unfortunate but I think most people don’t think about this topic until it’s too late. I’m glad someone is talking/writing about it!

    • Matt @ momanddadmoney December 3, 2013

      I would definitely still evaluate your employer’s offering against these criteria so you know exactly what you have. Depending on its specific features, you still may or may not be properly covered.

  • Kim@Eyesonthedollar December 3, 2013

    Disability insurance is one of those things people don’t buy because they think it won’t happen to them or they buy the cheapest policy, when it might not help them that much if it doesn’t cover their occupation. It wouldn’t do me much good if my policy didn’t cover me as an optometrist.

    • Matt @ momanddadmoney December 3, 2013

      Right, and I think it can definitely depend on your occupation. People like yourself have put a lot time and training into becoming highly specialized, so having an “own occupation” definition is even more important. I think there are some jobs where it might not be as critical.

  • Shannon Ryan December 3, 2013

    Great information, Matt. Disability insurance is something most people overlook but really is something most people need to consider. Most of us wouldn’t be able provide for our families if we were unable to work – even if it was temporary disability. It may not be super cheap but it’s worth it to protect my family in case my husband or I are unable to work, whether permanent or temporary.

    • Matt @ momanddadmoney December 3, 2013

      Thanks Shannon. I 100% agree with you on spending a little more now to make sure we’re truly protected. It can be frustrating, but in my view well worth it.

  • Elroy December 4, 2013

    Great article and I would add a few other things you may want to consider – mutual company? retirement benefit rider? unemployment waiver of premium? Occupation rehab?

    I’ve got a Guardian policy and at the end of the day, my policy is $$$$$$$$$$$$$$. Thanks for sharing!

    • Matt @ momanddadmoney December 4, 2013

      Good input! Each of those things would be useful to consider. What features did you end up going with on your policy? FYI mine is with Guardian as well.

  • Suburban Finance December 8, 2013

    I actually don’t have a disability insurance policy, outside of my work. My work tries to accommodate people who have disabilities (regardless of how they came about them) in their jobs, but I’ve never considered what would happen if for some reason I just couldn’t work at all.

    • Matt @ momanddadmoney December 12, 2013

      At least you have a policy through work! I think it’s pretty common for people to not have thought much about disability insurance. I’d be interested to see how you feel about your work policy if you take a look at the details.

  • Elisabeth Page March 11, 2014

    Hello there. Do you have any advice on how to shop for disability insurance or where to find quotes?

I’d love to hear from you, please leave a comment