Disability Insurance: Payments and Pitfalls

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A massage therapist hurts their hand in a silly accident playing volleyball. For most of us, a broken finger or torn ligament in our hand is a serious inconvenience, but not an insurmountable one. For the massage therapist, it is their career.

Until that therapist’s hand is better, they are considered totally disabled. If they don’t have insurance, their only option is to find another job until their hand is in good enough shape to return to massage therapy, which could take many months or even years. Meanwhile, the therapist can’t devote the time necessary to find a replacement for their clients (because they are working at another possibly lower paying job), and they may lose their client base and career in so doing.

There is another way.

Disability Insurance (DI) is yet another tool in the arsenal of insurance products that may be a life-saver for some people, but that also can unveil some bitter surprises at the worst times. Let’s look at the facts:

Three Definitions of Occupation

All disability insurance policies will operate under one of three different definitions of occupation which determine the level of coverage you receive:

Any Occupation

This is the least expensive (and of course the least comprehensive) form of coverage you can have. It states that the insurance company will pay out disability benefits if you cannot perform “ANY occupation” for which you are reasonably skilled, trained, or capable of being trained for.

So although you are a massage therapist and are paralyzed from the neck down, if the insurance company thinks you could sell pencils over the phone, you are out of luck for getting any benefits. (This is an exaggeration of sorts, but you may be surprised at how close to the mark it is).

Regular Occupation

The insurance company will pay benefits if you are unable to perform the duties of your “regular occupation”. So as a massage therapist, you will receive disability benefits if you can’t perform the job of a massage therapist. The catch is, they’ll fight your claim if you can’t attend to your own clientele in the clinic you work in (because of stairs, or a specialized kind of massage therapy), but you can still work within the field of massage therapy – just somewhere else or outside of your specific area of expertise.

However having said that, this is the most common form of insurance people purchase.

Own Occupation

This is the crème-de-la-crème of definitions of occupation, and is only usually purchased by very specialized (and high-income) medical professionals and executives. It is rarely if ever part of a workplace group disability plan.

It states that if you are unable to perform the duties of your “own occupation”, you will receive benefits. So if a specialized doctor can’t attend to their own patients in their own clinic, they will receive benefits. (Never mind if the doctor could perform medical services elsewhere or in a different area of specialty).

Two kinds of Disability Insurance

Short Term Disability (STD)

STD is typically only used as a rich benefit by workplaces, as it is cost-prohibitive for individuals and can often be circumvented with proper emergency fund planning. It provides for a replacement of income if you are disabled starting as early as three days after the disability occurs, and lasting up to six months (usually 90 days though).

Some workplaces will provide short term disability coverage, but not through an insurance company. Instead they will pay your salary out of pocket until the long term disability coverage kicks in, as they see it as being less expensive overall than paying the pricey premiums for STD.

Long Term Disability (LTD)

This is the most common form of insurance (both within workplaces and for individuals requiring coverage). The average policy has a 90 day waiting period, and benefit periods ranging from two years to age 65.

Important Terminology

Waiting Period

Sometimes referred to as the qualifying period or elimination period, this is the amount of time you have to wait between when the disability occurred and when you will start to receive payments from the insurance company. The longer the waiting period is, the less expensive your premiums will be. (The flip side being of course that you have to foot your own expenses for that length of time).

The standard waiting period for Long Term Disability is 90 days, but can be as long as 180 days or as short as 30 days. Short Term Disability can have waiting periods as short as just a few days.

Benefit Period

Although this goes by a few different names as well, it refers to the length of time disability payments will continue once they start. If you have a two-year benefit period with a 90 day waiting period, then you will receive two full years of payments starting 90 days after you became disabled. It is worth noting that payments will stop as soon as you are deemed able to resume your work, even if the benefit period has not yet expired.

Benefit Amount

This is the amount of money that is paid each month as disability income. There are regulations around how big the benefit amount can be (usually a maximum of 70% of your gross salary), since insurance companies don’t want to fully replace your pre-disability after-tax income. The rationale is that if your cash flow is fully replaced while disabled, you don’t have much incentive to get better and off the DI cheques.

Premiums

This is the monthly fee you pay for your insurance. The shorter the waiting period, the more you pay. The longer the benefit period, the more you pay. The higher the benefit amount, the more you pay. The older you are, the more you have a volatile family medical history, or a volatile personal medical history, the more you pay.

Some policies lock in your premium rates for life based on your age, health, and medical history at the time of application. Other policies will rate the premiums, increasing them every few years (and within this realm some will guarantee what your rate increases will look like while others retain the right to increase premium rates by any amount and at any time).

Perilous Pitfalls

Taxation of Premiums and Benefits

In Canada (and I believe in the U.S. too), how you pay your premiums affects how the benefits are taxed. This is especially important, because if your DI benefit payments are taxable and are only 70% of your gross salary to begin with, you will be lucky to end up with half of what you used to bring home after-tax to live on (and with possible increased medical expenses to boot).

Basically if you deduct your DI premiums from your taxes (which those who are self-employed are entitled to do as a cost of doing business), your benefit amount will be taxable. If you instead use after-tax dollars to pay for your premiums, then the DI benefit amount is non-taxable.

Hence, my advice is almost categorically to ensure that you do not deduct your premiums, and if participating in a workplace plan ensure your employer is not paying for the premiums and instead is deducting them from your net pay. A little short term premium pain will result in long term survival if you become disabled and dependant on the benefits being tax-free.

Making Claims

Although you may have a legitimate disability claim and a waiting period of a few weeks, you may be surprised to discover that the cheques aren’t flowing like they should at the end of your waiting period.

In order for your DI payments to start, the insurance company needs to make darn sure that your claim is legit. So they will order third party doctor’s reports, additional tests, or other forms of clarification to ensure they are really on the hook. This can take time, and often surpasses the initial waiting period. Rest assured that once approved, payments will be retroactive, but it can be a terribly sore bone of contention for those in need of benefit payments.

A Note About Group Disability Plans

Many people rest well at night knowing that they have disability insurance coverage through work. What they don’t know is that they might only have an LTD plan, with a waiting period of 6 months, a benefit period of two years, “any occupation” as their definition of coverage, and their premiums are fully paid for by their employer and not taxed. This means that the employee is on the hook out of pocket for 6 months after the disability occurs, they have to be severely disabled to even qualify under the “any occupation” definition, and even if they do qualify their benefit amount will be fully taxed such that they will be lucky to see even half of what their previous take-home pay was.

Or, work plans will often cover under the “regular occupation” definition for the first two years, then switch to “any occupation” until age 65. People take comfort in thinking that they have coverage to age 65, but realize sadly that after two years they are being denied coverage because they are reasonably skilled or trainable for another job under the “any occupation” definition. It is worth noting that statically speaking, the average length of a long-term disability is longer than two years.

Do I think that people need disability insurance? Absolutely I do. But I also think that people who have coverage and think they’re golden should carefully examine their policies to ensure they don’t get caught in the typical DI pitfalls and end up penniless (and bitter with insurance companies) when they are in critical times of need.

If you want to re-examine your policy for cost-effectiveness, check out this article with a tool to help you potentially save a few extra bucks.

Disclosure: I have no affiliation with any insurance companies or vested interest in disability insurance.