Disability Insurance

A severe illness or injury can harm more than your health - impacting your ability to work and meet your living expenses. And while many individuals have life insurance, fewer have disability insurance - even though, for many working-age adults, the likelihood of a disability lasting six months or longer is often cited as higher than the likelihood of dying before retirement. Of course, risk varies by age, occupation, and health, and estimates differ by source.

Long-term disability income insurance helps you pay living expenses while you cannot work. Disability income insurance may reduce how much of your savings you need to use if an illness or injury keeps you from working. How much it helps depends on the benefit amount, the waiting period before payments begin, and how the policy defines disability.

Understanding Policies

Before purchasing an individual long-term disability income insurance policy, evaluate the benefits you may already be eligible to receive from your employer and the government. Other programs that may provide a source of disability income include state workers' compensation, veterans' programs, and automobile insurance benefits for a disability resulting from an auto accident.

Not all individual disability income insurance policies are alike. Some policies pay benefits if you cannot perform the duties of any occupation for which you are reasonably qualified by training, experience, and education. Other policies pay benefits if you cannot fulfill the significant responsibilities of your occupation. Many policies combine these features, providing "own occupation" coverage for an initial period, such as one or two years, and "any occupation" coverage after that.

The amount of income you would receive when disabled varies by policy. However, benefits from all sources are usually limited to 70-80 percent of your monthly salary. Policies that pay 50-60 percent of wages are most common.

Policies have either level premiums (intended to stay constant over the policy's life) or premiums that increase as you age. A level premium policy may be appropriate if you plan to keep your policy in force long-term. If you're still determining whether or not you'll need insurance, a policy with premiums that increase with age may be the better choice.

The length of time that benefits can be received varies by policy. Some individual policies pay benefits for a specified period, such as two or five years, while others pay benefits until age 65 or your retirement age under Social Security.

Some policies require total disability before payment begins, while others cover partial disability. Some policies pay "residual" benefits. These benefits help make up for lost income when you can still work, but your disability keeps you from handling all of your regular responsibilities.

Most individual policies are either non-cancellable or guaranteed renewable. With a non-cancellable policy, the insurer generally cannot raise your premium or change your coverage as long as you keep paying premiums on time. The exact guarantees depend on the policy contract. Under a guaranteed renewable policy, premiums cannot be raised based on an individual's circumstances. Still, they can be increased for an entire class of policyholders.

Most insurance companies review an individual's medical and financial history and consider any other disability coverage that person has before issuing a policy. Based on this information, an insurer may offer limited or modified coverage.

Disability Insurance Policy Costs

Several factors determine the cost of an individual disability income policy, including:

• Age - Generally, the younger you are when you purchase your policy, the lower your premiums will be. This is because younger individuals are less likely to file a disability claim. For some people, purchasing a policy earlier in their career may help lock in lower rates - though the right timing depends on your overall financial situation and whether coverage is already available through an employer.

• Benefit Amount - Policies that replace more of an individual's salary are more expensive. A policy that replaces 80 percent of your salary costs more than one that replaces only 60 percent. When choosing the benefit amount, consider your essential expenses and how much you would need to maintain your standard of living if you could not work.

• Benefit Period - The shorter the benefit period, the less expensive the policy. Short-term benefits, such as those paid for two years, are less costly than policies that extend payments until retirement age. Think about how long your savings or other resources could cover your expenses if you stopped receiving income - that can help you decide how long your benefit period needs to be.

• Current Health - Insurers consider your current health when determining premiums. Individuals in good health may qualify for the insurer's standard rates, while those with pre-existing conditions or higher health risks may face increased rates or exclusions. Rate classes are set by each insurer's underwriting guidelines.

• Definition of Disability - A policy that pays benefits if you cannot perform the duties of your current occupation is more expensive than a policy that pays benefits if you cannot perform the duties of any job for which you are reasonably qualified.

• Extent of Disability - A policy that pays benefits only if the policyholder is totally and permanently disabled costs less than a policy that also pays benefits for a partial or temporary disability.

• Type of Job - Expect to pay more for a policy covering a high-risk occupation than a low-risk line of work. For example, a policy for a construction worker may be more expensive than a policy for an office worker who earns an identical wage.

To illustrate how these factors interact: Alex, a 30-year-old software developer, and Jamie, a 45-year-old construction worker, would likely see different premium quotes for similar coverage - reflecting differences in occupational risk and age. The actual difference would depend on each person's full underwriting profile, including health history and the specific policy terms selected.

Furthermore, if Jamie opts for a policy with a short-term benefit period, such as five years, instead of until retirement, the premium would be lower to reflect the reduced insurance company's liability over time.

The Takeaway 

Disability insurance can be one of the most complicated types of insurance you buy. Yet, it can play an important role in financial planning. Selecting the right disability insurance policy requires balancing the need for adequate coverage with the cost you can afford.

Consulting with a financial advisor or insurance specialist can provide personalized insights into the type and amount of coverage that best suits your individual needs - and help you weigh the cost of coverage against the level of protection you want if you were unable to work.