Disability Insurance Basics
What is "disability insurance"?
Disability insurance is like life insurance policy. It's a contract between you and a big life insurance company, except that the risk is not life insurance. It's disability. Disability insurance is probably the most important insurance, after health insurance, that you can consider. Your most important asset is your ability to earn an income. Now for most people, if they can't work, if they have an injury or an illness, and that prevents them from working, their potential of paying their mortgage payment goes down. So the ability to pay kids' school payments, the ability to pay car payment, your whole lifestyle can go down the drain if you don't have income coming in. What people don't realize is that even if income is fifty thousand dollars, seventy-five thousand dollars, or a million dollars a year, over a twenty or thirty year working period even the average person will be looking at millions of dollars of potential income. When your house burns down, and your house is worth a million dollars, and you have a seven hundred thousand dollar mortgage, you are really only losing three hundred thousand dollars. Most people will say that their most important asset, or their most valuable asset, is their house. But it's not really their most important asset. Three hundred thousand dollar equity is nothing compared to a doctor's income over a forty or fifty year period. So when I talk to people who need disability insurance I'm talking to people on a very gut level, and I talk to them and I say: "Look, if you became disabled tomorrow and couldn't work, would your lifestyle be affected?" Most of the time they say: "Yes it would. I would be in real hot trouble."
Do I need disability insurance?
Now, some people don't need disability insurance. A person, for example, who has a lot of money in the bank, or a person who has several apartment buildings with a positive cash flow; a person who has a huge stock portfolio, somebody who has a major inheritance coming any day now, that person really doesn't need disability insurance because they know that they can draw upon income from those sources to live a normal, good-quality life. Not too many people though, unfortunately, in America, have a huge cash flow from all these passive investments, so the day that they stop working, because they're unable to work due to an injury or an illness, their whole lifestyle goes down. I'm very passionate about disability insurance because a lot of people don't have it, and they should have it. It's more important than life insurance, because when a husband and wife marry, and they have life insurance, if one person dies, usually the other person will get along with their life. They'll find a new job, they'll find a new spouse, they'll make things happen and they'll get it together. When you're disabled though, you're still around, and you're causing a major negative cash flow on the household. What happens typically is your income goes down, your expenses go up, and you end up in tremendous debt. It ruins relationships between husbands and wives, because when money is not coming into the family, you start losing things. Your assets are so important to you, and when assets are lost, it causes aggravation and disruption in the family. Disability insurance is something that everybody should have, if they aren't lucky enough, or successful enough, to have developed a major net worth. In fact, that's what everybody is looking for--net worth. Having a lot of money in assets, and real estate; being able to use those in case you don't want to work, or can't work.
When should I consider buying disability insurance?
You're healthy when you are young, and this is the time to buy disability insurance. As your income grows, you should add on to the insurance program. A disability insurance is not a one time purchase. Sometimes, a person will buy eight to ten individual disability policies, and the total sum of those policies might pay out fifteen thousand dollars a month. The individual might have been a young attorney earning thirty-five thousand dollars a year out of law school, but five years down the road, that attorney is earning two hundred thousand dollars, and ten years after that might be making five hundred thousand dollars a year. Over the years, my clients will purchase several policies so that they can ultimately cover the loss of their income due to disability.
How do I determine how much disability insurance I need?
What are the basic types of disability insurance?
There are three types of disability insurance policies. One type of insurance policy just pays you a monthly income if you become disabled due to an accident or an illness. It's usually in a monthly benefit ($2,000 $3,000 or $4000 a month)- whatever amount you buy, and whatever amount the insurance company approves you for. The second type of disability insurance policy is this: Should you have a business and you become disabled, you're still going to want to pay the rent for your office. You're still going to pay the electricity, your malpractice insurance, or your regular insurance premiums. You may have leases of equipment, you have key employees that you've had for many years. Your rent is obviously the largest expense for most businesses. All that stuff continues even if you become disabled. Your landlord of the building where your business is doesn't just say because you're disabled you don't have to pay him or her rent. So, this type of policy pays you a monthly income to pay for the overhead in your office. The other type of disability insurance is called disability buyout insurance. This is if a partner becomes disabled. That partner's stake in the business is paid off because the insurance comes in with a large check and pays off the person from the proceeds of the policy.
What is a "residual claim"?
A residual claim is a provision in a disability policy which states that: if you decide you want to come back to work on a part-time basis, the insurance company doesn't abandon you and stop payments; they don't say "now you're not totally disabled, you don't qualify". You're still eligible for partial benefits. They look at your loss of income, they figure out the percentage of loss and they pay you a percentage of your monthly benefit on your policy.
What does "renewability" mean, and how does it affect me?
When you buy a disability policy, the last thing you'd want is for the insurance company to say: "Now that we know your health has changed, or now that you've put in a claim, we're going to raise the premiums, we're going to cancel the insurance.". Most disability policies that people purchase are what they call guaranteed renewal and noncancelable. You can cancel it as the insurer, just don't pay your premiums. However, the insurance company can't unilaterally cancel the policy on you. They can't even change the premium on you unless, of course, you decided to improve the benefits of the policy. So, once you buy a disability policy, you can keep it for as long as you want, usually to age 65. If you're still working after 65, they even let you keep it to 75.
What is "presumptive disability insurance"?
Presumptive disability is another claim inside of a disability policy. It presumes that should you have a loss of an eye and a hand, or a hand and a foot, or the irrevocable loss of your eyes, or the irrevocable loss of you hearing, even if you were able to work full time and still make good money, they'll still pay you full benefits. They consider those things so horrible, they'll pay you the full benefits even if you're not disabled.
What is a "cost-of-living rider"?
A cost of living rider is a very important feature in a disability policy. Today, you buy a $4,000 or $5,000 a month benefit. Let's say that you're disabled for the next 25 years. In today's world $5,000 a month might be just fine, but over a 20 year period, inflation is going to erode the value of that $5,000. In 20 years, the value of $5,000 may only have a purchasing power of $2,000. If you purchase a disability policy with a cost of living rider, the insurance company, automatically, every year, once you become disabled, will update and increase the benefits of your policy based on the CPI index. It's one of the most important things to have in a disability policy, especially if you're buying benefits with a long benefit period where they could potentially have to pay you a lifetime of benefits.
What is the "CPI" or "Consumer Price Index"?
The Consumer Price Index is published by the government. It basically tells whether we're having inflation or not. If you buy an egg for fifty cents today, but next year the cost of that egg is fifty-three cents, they might tell you there's a slight increase in the CPI. What we want to do with disability insurance planning is to make sure that if there is erosion of your money by inflation, that your benefits to your policy will increase over a long period of time.
What is a "benefit period"?
A "benefit period" on a disability policy, is the length of time that an insurance company is at risk in paying you a claim. If you buy a disability policy with a two year benefit period, the insurance company only will pay you for twenty-four months of disability after the waiting period. If you buy a policy that pays benefits all the way through age 65 they're on the hook for several years. So as example, if you're thirty years old and you are disabled all the way through 65, the insurance company is going to pay you a monthly benefit on your policy. From thirty to 65, which is 35 years times twelve months. That's a lot of money.
What is an "elimination" or "waiting period"?
A waiting period is like a deductible in a health insurance policy. It's the amount of time you have to wait before the first check comes in. The typical waiting period on a disability policy is about ninety days. So, as an example, if you have a ninety days waiting period or sometimes called elimination period, the first ninety days of your disability you don't get anything from the insurance company. After that, the insurance company starts paying you on the claim. The reason why they have a waiting period of thirty, sixty or ninety days is a way to keep the cost down. If you had a zero day wait everytime you had a cold you could put in a claim to an insurance company that would make the cost of the policy astronomical. A ninety day wait is typical for most people. The purpose of disability is the long-term payment of a claim, not if you are out for thirty days or sixty days or even ninety days.
