Long-Term Disability Policies: Understanding the Features That Affect Income Replacement

Individuals with long-term disability coverage may not be fully aware of how policy features can affect income replacement. In additional insights from AAII’s interview with financial planner Carolyn McClanahan, M.D., CFP, she explains how provisions such as elimination and benefit periods can shape the income you receive. AAII also recently spoke with Thomas Farrell, founder and principal attorney at Farrell Disability Law, who shared valuable perspectives on what disability insurance claimants can expect when it comes to income replacement.

Cynthia McLaughlin: What percentage of income should people strive to replace with long-term disability coverage and why?

Carolyn McClanahan: Disability insurers won’t allow you to insure more than a certain percentage of your income. Group disability policies usually only cover about 60% of income. Some may go up to 75%. When you combine individual insurance with group coverage, you can usually get up to 75% of coverage.

Early on in your career when you have little in the way of savings, you want to have as much disability insurance as possible. However, the challenge with disability insurance is that you can only buy so much. Let’s say you start your career making $100,000 per year. You may only be able to get insurance for a benefit of $60,000 per year. But, if you’re making $250,000 per year 10 years down the road, it’s important to revisit your disability coverage, because the amount of coverage you have doesn’t automatically increase. You may have to buy additional disability policies in the future to cover your increase in income.

As you age, you may be able to pare back on your disability coverage if you’ve saved money. For example, if you’re in your 50s and your savings are on target to retire in your 60s, you may not need all of your disability coverage. You may be able to let go of policies as your savings increase.

Cynthia McLaughlin: How do benefit periods and elimination periods affect premiums and the actual protection you receive?

Carolyn McClanahan: The most common exclusion period is 90 days, meaning that you must be disabled for 90 days before you can start receiving benefits from long-term disability insurance. You can buy disability policies that have much longer exclusion periods—I’ve seen exclusion periods of up to one year—and those end up being a lot cheaper because many disabilities don’t last one year. For example, if you have back surgery with a six-month rehabilitation period, you’ll have recovered before the end of a one-year exclusion period and won’t be able to make a claim. A one-year exclusion period will cover major disabilities that prevent you from working long term, such as a stroke or advanced multiple sclerosis (MS). Those policies are cheaper, but you must realize that the benefit won’t start for a very long time.

Most disability policies stop paying benefits at either age 65 or age 67. Some will go on to age 70, but how long they’ll pay the benefit depends on when you become disabled. If you have an underlying condition, such as diabetes, when you purchase your policy, the insurer may limit the payout to five years. For example, if you get a disability policy when you’re in your 30s and you have Type 1 diabetes and go on claim at age 45, it would only pay benefits until age 50. This exclusion can apply to very common medical conditions.

This is why it’s important for people, especially young people, to get coverage—both disability insurance and life insurance—before they develop health problems. Once you develop medical issues such as diabetes or heart disease secondary to common conditions such as obesity, you likely can’t get good coverage.

Cynthia McLaughlin: Are there occupational factors or other factors besides medical history that influence insurance approval or denial and the cost of premiums?

Carolyn McClanahan: Yes. Disability insurance coverage is very dependent on what type of work you do. It’s very easy for people like accountants and financial planners to get disability insurance because of the low risk. They sit at a desk most of the time, and the chance that they will become disabled is low.

However, for someone in an occupation with a high rate of disability, such as a hairdresser or jobs with heavy physical labor, it’s almost impossible to get disability coverage. You can still get group coverage if your employer or professional membership societies offer it.

It’s also challenging if you are in an odd occupation. For example, my clients who are professional athletes can get disability coverage, but only for a short period of time. It’s also super expensive since professional athletes can become injured easily. I tell those clients to save their money so they don’t have to pay for this expensive disability coverage.

Charles Rotblut: Is long-term disability insurance meant for those who were employed prior to their disability and are trying to make up that income?

Thomas Farrell: Yes. But long-term disability insurance is not wage replacement, because it doesn’t pay your full wage. The other thing that a lot of people don’t realize until they get deep into the claims process is that these policies, especially the group policies, often have offsets. This means that policies will offset the benefits paid to you by any “other income benefits” that you receive.

The most common “other income benefit” is Social Security Disability Insurance, and many of these group policies also offset Social Security retirement benefits. A lot of them offset any retirement benefit you get from your former employer. They also offset personal injury settlements by prorating them. Workers’ compensation benefits are another common offset. Insurance companies want to get the Social Security Disability offset and will pursue the claim for the individual. It’s motivated by their desire to offset the benefits paid.

Charles Rotblut: Do insurance companies consider personal investments or savings—such as money from an individual retirement account (IRA) or savings account—part of the offset?

Thomas Farrell: No. Investment income and general personal savings don’t count. Offsets are often any income that you get from a third party.

Charles Rotblut: What percentage of one’s predisability income does long-term disability insurance typically pay in benefits?

Thomas Farrell: For group policies, 60% is usual. Individual, privately purchased policies vary and could be much different.

From a legal perspective, if you get into a dispute with the insurance company and have to file a lawsuit, a private disability policy lawsuit and a group policy lawsuit are completely different animals. Group policies are governed by the Employee Retirement Income Security Act (ERISA) and are hard cases to win, even when you have a “good case.” Private policies are not subject to ERISA because they aren’t sponsored by an employer, so those are plain-old breach of contract cases. There’s a lot of restrictions in ERISA that do not apply to a non-ERISA case.