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    Protect Your Assets: Don't Neglect Disability Insurance

    by Michael P. Franks

    Suppose you had spent months training for a marathon and on race day, as you prepare to go to the starting line, you discover that your shoes—your most critical piece of equipment—have a huge rip in them, or they are just plain missing. And ... you don’t have any other backup pair.

    It may be hard to believe that anyone would be so careless as to leave their most important asset unprotected. Yet according to the Bureau of Labor Statistics less than a third of all workers in private industry have long-term disability insurance, and only 40% of professional workers have disability coverage.

    Individuals insure their homes and all their possessions. Many people would not leave their driveway unless their car insurance is paid up. And, most wage-earners insure their own lives—and sometimes even their pets!

    But for those who are working, it is not unusual to neglect the insurance of their most valuable asset—the ability to earn a living.

    Excuses often used are: “I am covered at work,” or “It won’t happen to me.”

    But the chances of it happening are greater than many people realize. The most frightening statistics show that the probability a 25-year-old will be disabled for at least 90 days before the age of 65 is 54%. For a 40-year-old the odds are only slightly lower at 48% (see, for example, the Web site www.disabilitycanhappen.org). The consequences can be dire—almost 50% of mortgage foreclosures are due to disability.

    Disability insurance can also be thought of as protection for your current investment holdings, including any retirement plan assets, since you would be forced to use up these assets should the worst-case scenario play out.

    Employer-Sponsored Plans

    Many employers offer group disability coverage as a standard part of their benefits package. It’s worth taking some time to understand the details.

    Disability insurance may be one of the few benefits where, if given the chance, you should pay with aftertax dollars. If premiums are paid with pretax dollars, benefits are fully taxable. Paying premiums with post-tax dollars, in contrast, results in tax-free benefits.

    Group benefits can appear to be more ample than they are. Most group plans have caps on the amount of income they will replace, expressed as a maximum dollar amount or, for example, by excluding bonus income or limiting the benefit period. Plus, policies offered through work may not be portable. Leaving a job could cause you to lose coverage. Purchasing extra coverage to supplement employer-provided coverage is often appropriate. To do so, remember that even with supplemental individual insurance, your combined potential disability benefit will likely be less than your current earned income.

    In order to avoid making disability more attractive than actually working, companies set participation limits on how much insurance you can buy. In most cases, those limits are set at around 70% of your income, although recently wage earners may have tighter limits.

    Physicians, in particular, may have a difficult time replacing 70% of income. Doctors historically have been one of the most active professions in making disability claims. To protect themselves, insurance companies began to limit the monthly benefit available. Most companies will offer benefits to physicians up to $10,000 a month, although some are increasing the maximum potential benefit to $15,000 per month.

    When you apply for an individual disability policy, the carrier will look at existing group plans when setting your coverage limits. Group carriers, however, do not incorporate individual plans. A planning implication for job changers—for example, doctors or lawyers moving from sole practices to larger employers—would be to maximize your individual coverage before being offered the group plan.

    In general, unless you have other means of paying personal bills, consider purchasing as much supplemental insurance as the companies will allow.

    Staying on Course

    Knowing the lingo will help you understand the available coverage.

    To collect benefits, your disability must match the definition described in the language of your policy.

    There is a broad range of definitions, of which the most difficult to qualify for is the definition used for Social Security disability benefits.

    The “own occupation” definition is the most generous to the insured, with “modified occupation” and “any occupation” declining in favorability:

    • With own occupation you are considered totally disabled if you are unable to perform the exact duties of your current job.
    • Modified occupation references the duties of a job for which you are trained or qualified, and
    • Any occupation would be just that—any gainful employment.

    Not surprisingly, the stricter the definition of disability, the higher the premiums.

    To illustrate, suppose you were a marathoner whose love of running grew from studying physical therapy in school. After college, you developed into a world class runner earning a living racing. But one day, you ruptured your Achilles tendon, and now you can never run competitively again.

    With own occupation coverage, you would qualify as totally disabled. Under modified occupation, since you could still work as a physical therapist, you would not be considered disabled. And, as long as you can still ask “Do you want fries with that?” you would not be disabled under the any occupation definition.

    You can combine two of the coverage options. Split-definition coverage might offer own occupation coverage for the first five years, and then loss of income coverage thereafter. The result is a cheaper premium and a chance to retrain and re-enter the job market in a new role.

    Watch the Clock

    Other key terms have to do with timing issues.

    The probation period is the time in which the policy must be in force before certain conditions are covered. It usually lasts two years, and is used to protect the insurance companies from having to pay for pre-existing conditions.

    The elimination period is the time from when the disability occurs until benefits begin. It is most often set somewhere between 30 to 365 days. Needless to say, the longer the elimination period, the lower the premiums.

    The benefit period is how long benefit payments last. A short benefit period—e.g. of two or five years, has a relatively low premium and can function at best as a transition fund. More useful policies are more expensive, but offer benefits up to age 65 or 70.

    When you are reviewing your disability policy, make sure that you confirm that the benefit periods in your policies are adequate.

    It is also important to realize that disability benefits will help pay regular expenses up to retirement, but rarely provide sufficient funds to maintain a retirement savings program.

    Going the Distance

    A crucial piece of the contract to understand is the durability, or the right to continue your policy. You want language that will protect you if you become in some way uninsurable.

    The most desirable language is non-cancelable guaranteed renewable. Under this type of policy, the insurance company cannot change your premium, monthly benefit amount, or benefit period regardless of any change in your health status. Simple guaranteed renewable policies are growing in popularity because of lower expenses, but they don’t provide as much protection. While the insurance company cannot cancel guaranteed renewable policies, they can, with the approval of the state regulator, raise rates by class of insured. Conditional renewable policies offer less protection because the insurer can disallow coverage or raise premiums if certain conditions are met.

    It is rare, and not usually recommended or possible, for someone returning from disability to immediately resume a full work schedule. Thus, the best policies offer partial disability coverage or residual benefits. These are designed to replace a portion of income lost, as you make a gradual return to work.

    Certain riders can also be attached to your coverage to create additional protection. A guaranteed insurability rider allows the insured a chance to increase coverage at certain specified times, regardless of health status, as long as the earned income requirements are met.

    The cost-of-living adjustment rider periodically increases the benefit payments to prevent the loss of purchasing power.

    These riders can be particularly helpful to young buyers whose income is expected to grow and who will need increasing coverage for a long time regardless of health status.

    Lastly, when choosing a provider, you want someone who will be there when you need them most.

    A.M. Best, Moody’s and other services rate the financial strength of insurance companies. You can also check complaint records with the National Association of Insurance Commissioners at www.naic.org.

    For background reference, the larger players in the market today and candidates to begin comparison shopping are UNUM Provident, Northwestern Mutual, Mass Mutual, and Berkshire.

    Leaders of a Pack

    Business owners, whether sole proprietors or partners, must make special considerations for protecting against injury or illness. Not only should they think of their own family’s expenses, but how a prolonged time away from work would impact the viability of their business.

    Sole proprietors of professional businesses are able to buy disability overhead expense insurance to help cover rent, insurance, and payroll expenses typically for 12 to 24 months.

    Partners in successful businesses should be talking with their insurance agent about purchasing disability buyout insurance as protection in the event a partner becomes disabled. These policies provide either a lump sum or a series of payments that can be used to buy out the partner’s share.

    Teaming Up

    Teaming up of employees from the same company to buy supplemental disability insurance can often lead to a discount. When a group of employees (sometimes as few as four) from the same company buy insurance, it can be considered a multi-life policy and qualify for unisex rates. Unisex rates are lower than regular male and female rates, in most cases substantially lower for females. With the risks spread across a greater pool of people the insurance companies are able to charge lower premiums.

    This planning strategy works best if team members all purchase coverage around the same time. Policies already in place are not adjusted once the member limit is met, and only a new applicant would qualify for the discounts. Again these are individual policies, bought with aftertax money, not group insurance paid for by employers, so the benefits would be received tax-free.

    Summary

    Disability insurance protects a valuable asset—a worker’s ability to earn a living.

    Purchasing coverage well involves paying attention to details, and working with a strong company. Some potholes to avoid are:

    • Paying premiums with pretax dollars,
    • Having a cancelable policy that leaves you uninsured,
    • Purchasing a policy that does not last long enough,
    • Not increasing benefits as your income rises, and
    • Neglecting to protect a business from the impact of losing a key person.

    If disability or incapacity strikes, disability insurance won’t be the elixir that fixes everything. But ample disability coverage can significantly ease the great financial burden that usually accompanies an inability to work.


    Michael P. Franks is a financial advisor with Hogan Financial Management, a fee-only financial planning firm located in Milwaukee, Wisconsin. The firm maintains a Web site at www.hoganfinancial.com.


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