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Building Wealth through Saving and Investing

Risk Management via Insurance – Disability Insurance



This is a guest post series by Brian Poncelet who is an independent certified financial planner (CFP) working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning. The first post was about reducing risk with life insurance.

From The Wealthy Barber: “Disability insurance is the most neglected of all forms of insurance, yet for many people, it’s the most critical insurance need…. A thirty year old has a one in four chance of becoming disabled for one year or more at some point in his or her life…When people are disabled, they don’t just cease to be an asset to their families…they become a liability.”

When I review benefit hand books, many of my clients are surprised to learn the details of the actual coverage that they carry. Most disability benefits only cover 60% of the employee’s salary and exclude bonuses. Many plans will only cover the first five years of disability and most plans are not indexed to inflation. Many clients are unaware that their disability benefits are not portable and a move to a new company results in a different benefit plan.

As the working population ages and companies are more cognizant of expenses, there is a growing trend for employers to offer “flex dollars” benefits. With this plan the employee is given an allotted sum of dollars from which he must choose from a shopping list of benefits (health, dental, life, short term disability, long term disability, critical illness insurance). While the employee can top up each element of coverage, in general, as the employee gets older, the same dollar allotment buys fewer benefits.

Who needs to buy individual disability insurance privately?

  • Individuals on Flex Plans: Since disability insurance is one of the more expensive items on the flex dollar shopping list, many people will choose an inadequate amount of coverage or none at all, resulting in the individual being underinsured.
  • Individuals who make frequent employer changes such as is seen in the IT industry. You can’t take your coverage with you and there is no guarantee that the next company will offer comparable coverage.
  • All self employed individuals need to put disability insurance in place for replacement of income and business overhead expenses. A challenge that I frequently observe is the individual who shows minimal personal income to CRA as a tax planning strategy. This can place the individual at a disadvantage when attempting to show a realistic personal income stream to the insurance company.

The Disability Contract

When you pay for the premium out of pocket there is no tax-deduction, but you receive the benefits tax free. This compares to a company paid policy where you are taxed on the benefits.

A personally owned non-cancelable disability insurance policy is a contract between the individual and the insurance company. As long as the premiums are paid, the policy cannot be cancelled or altered in any way without the individual’s consent.

There are three common clauses used to determine the criteria and length of time for which an insurance company is obliged to pay a claim if you become disabled. This determines whether you can be forced to work, even in some other field at a reduced level of income. These clauses are known as:

  1. Any occupation” requires that you must be unable to work in any occupation, regardless of the change in duties or income.
  2. Regular Occupation” clause states you must be unable to perform the important duties of your own occupation and not working in any other gainful occupation.
  3. Own Occupation” clause permits you to receive full benefits if you are totally disabled not working in your field but choose to work in another field.

Ask yourself “How likely is it that I could be totally disabled out of my specialty and still be able to work in another?”

Additional contract terms to know:

Elimination Period (waiting period)

This is the length of time that must elapse after the onset of the accident or sickness before the insured becomes eligible to receive disability benefits. The typical elimination period for private coverage is 90 days.

Non-Cancelable Contract

Under the provisions of this contract, as long as the premiums are paid, the insurance carrier cannot:

  1. cancel the policy
  2. change any provisions or add restrictions
  3. increase the premiums or add any changes to the existing policies

Features of Disability Insurance

Waiver of Premium

It is important to continue premium payments even after you become disabled especially since you may not receive benefits for 90 days. Many insurers take over paying future premiums while the insured is receiving a disability benefit and some will refund the premiums that were paid during the elimination period.

Future Increase Option

This benefit allows one to increase the benefit by a certain amount at specified intervals without providing evidence of health. You only need to prove earnings. This may be of interest to those who want a robust policy now but to keep premiums low, they take the lowest coverage and enhance the coverage at later time. A chartered accountant, who buys disability insurance and later becomes a roofer, would be an extreme example.

Cost-of-Living Benefit

This benefit ensures that while on claim, the purchasing power of your benefit dollar is increased at specific periods (every 6 or 12 months). There are two formulas which can generally be utilized when applying for coverage:

  1. CPI index (with or without minimums and maximums)
  2. Simple interest

Portability

As a general rule, you want the plan to remain as unrestrictive as possible so that future changes in your status or location can be accommodated. An example would be an oil engineer who moves to Saudi Arabia but owns disability insurance purchased 10 years before. Only private plans offer this feature without restriction.

Like all insurance, disability insurance is not well understood by most people. The old adage is true “you get what you pay for”, so do your research.

In the next, and final, edition of the risk management series, Brian Poncelet will discuss critical illness insurance, how it works and how it compares to disability insurance. In case you missed it, read the first part of this series on reducing risk via life insurance.





22 Comments, Comment or Ping

  1. Brian, I have a couple of questions. If someone had own occupation professional disability insurance, and they changed careers to “self employed”, would they need to re apply for a new DI policy?

    Also, are the premiums for self employed DI higher than own occupation DI premiums for the same income insured?

  2. Hi Ft,

    Great question! The answer is no you do not have to reapply!

    Example: Lets say you have a Dentist who is tired of looking at people’s teeth, he/she now wants to be a roofer. As long as the policy is in place before he/she changes careers, you are in good shape.

    I tell any one who will listen, if you are working at a job that has benefits and are thinking about being self-employed…get a disability policy now! It may take 2-3 months to get it placed… if you become self employed during this time there will be problems.

    If I understand the question:

    ” Also, are the premiums for self employed DI higher than own occupation DI premiums for the same income insured”?

    Short answer is no, The premiums are based on income and what kind of job you are doing which includes daily activities. Example a Chartered Accountant who also helps fixing machines at the print shop.

    Hope this helps!

  3. Brian, another question, is it more difficult for someone who is self employed to qualify for disability insurance than a person working for someone else?

  4. 4. John

    Thanks for writing this article. I’m a small business owner and was clueless about disability insurance until I came across a website at http://www.disabilityinsuranceadvisor.com. What an eye opener! Most people completely miss the need for disability insurance or figure they’re covered at work. Group plans give a huge false sense of security. This article just reinforced my decision to get the coverage. Thanks.

  5. Hi Ft,

    Someone who is self-employed needs to show income to get coverage. The problem is many self-employed people make much more than they show (for lots of reasons). So the coverage is going to be much lower than they need.

    One idea for people who are self-employed show a low income, but have a mortgage is look at Blue Cross, which would coverage mortgage payments for the 20 -25 years they may have to make payments. This is not perfect but better than nothing.

    All Member Plans operate on a not-for-profit basis. (Blue Cross) each plan may be different for different provinces.

  6. Disability insurance is not really required if working for an employer who has liability insurance in place for his employees. Is this correct or should I take it out anyway?

  7. 7. Cannon_fodder

    Our company has a disability insurance component to the benefit plan. What they do is ask for us to pay for it so that any benefits paid to us through the plan would be tax free.

    We get 2/3 of the first $3,000 of pretax monthly income + 1/2 of the next $9,000 of pretax monthly income up to a max of $6,500. However, this only kicks in after 120 days and I can’t find any mention of what our short term disability coverage is.

    I don’t even think our employer allows us to opt out. It would be interesting to compare an individual plan for cost/benefit vs. our employer provided one.

  8. Hello Cannon_Fodder,

    What you have is group disability. This would not have features such a a cost of living increase, partial disability (if you can only work part time you would still get a paycheque) there is also many other features not offered with group disability plans. Plus if you leave the company in many cases the coverage stops.

    Yes, the cost maybe higher, but at claim time which is better something you can collect, or have a harder time with?

    regards,

    Brian

  9. 9. Tim Landry

    A few comments (First of all, I have specialized in “Living Benefits” for almost 40 years): I would rank partial/residual disability coverage at the top of any list of key features – and note that it is almost never included in a group plan. Those of us who earn our living using primarily our knowledge and communication skills – and those of us who are motivated to try to work even if our ability to do so is impaired – will have significant problems collecting under a group plan which almost certainly does not cover anything but “total” disabilities. Further group carriers tend to think “in theory” when that “two year regular occupation period” expires. The father of our receptionist at my former office was a general handyman type at a school board. He developed a SEVERE back problem – to the point where they had to raise the kitchen counters in his home so he could use them. After two years, the carrier said he could do filing – which based on his education training experience and prior income was a perfectly reasonable job. One problem – the files outside my office have seven drawers. The ones he can reach without bending? Fine – he can use them. The ones where he has to bend? Forget it – instant back agony.

    Another thing – mentioned previously – my dad went to work for Bell Canada in 1936 and other than the Royal Canadian Navy during WW II, that was his only employer. Not true any more. Stats Canada says we now have three separate CAREERS and 8 employers over our working lifetime. Now another thing to think of: Canada wishes/needs to be competitive in world markets. We – along with our neighbor to the south – are among the most expensive economies in the world. Why do you think so many employers – and I mean MAJOR ones – are now hiring under contract? It reduces their costs – because they do not have to supply benefits and makes them more competitive. This is very unlikely to change. Let’s assume you have a job and are earning $X annually and someone comes along and offers you a 30% raise. MIGHT you consider it? What happens if that new employer does not offer benefits? If you are healthy – fine. But what happens if you have elevated blood sugar – or full blown diabetes? What happens if you have been treated for stress? or anything else?

    If you want to truly uderstand the risk – let me tell you a story. My brother used to be President of the Canadian subsidiary of a US corporation – they make a well known oil treatment for cars. While there he had a group plan and back then that meant I could do nothing for him. The former owner decided to sell the company and the new owner wanted his guy to run Canadian operations – totally normal. So my brother decided to set himself up as a self-employed graphic designer working from home – with no established income – again we could not insure him so he had to take his chances.

    HE LOST!

    Easter weekend 1988 he was driving down to the Toronto airport when someone coming in the opposite directio just had to pass another car – even though there are solid lines clearly indicating “NO PASSING”. Result? A head-on collision at a combined speed of about 120 mph. I hate to tell you this but cars are NOT built for that. It took them an hour to get him and his wife out of the car. He had been basically split in half by the impact with the steering wheel. We did not expect him to survive the weekend. He did – but he has now had three hip rebuilds and will walk with a cane for the rest of his life – but that is NOTHING. The blood transfusions which saved his life also gave him Hepatitis C. By the way – he found out he had this disease when he was applying for disability insurance. Of course he is uninsurable and would give anything to have even $1,000/mth of DI.

    I was a technical guru when it came to DI. Once Chris had his accident, I realized how few policies actuaries sell – and I have become an evangelist for personal DI. BUY SOME – even if you can only afford $1,000 or $750 – buy it with Guaranteed Insurability. It guarantees your ability to buy new coverage without proof of health – and IT ALSO GUARANTEES YOUR ORIGINAL OCCUPATION CLASS.

    PS – if you are incorporated and self-employed, the definition of income is MUCH more liberal than just the salary you declare

  10. 10. Physician disability insurance

    Very well written and informative. You are completely correct when you say that it is important for self-employed individuals to have a disability policy, because if they become disabled, this is their only way of protecting their income.

  11. 11. sam

    hi Brian,

    i am meeting an agent this week for disability insurance…he is from RBC insurance…is there anything i need to look for..any tips..

    should i go for 5 years or till age 65..

    any particular company you prefer for disability insurance….

    i have life & critical from Manulife..

    thanks

  12. 12. sam

    hi Brian,

    a continuation of my earlier post..

    i got a quote for $73/month which would cover me for $1,900/month..RBC..
    i am 40 years..this quote is for age 65..

    any suggestions regarding the premium..

    thanks

  13. Sam,

    The big thing for any disability insurance is to get coverage until 65. The problem is if it is serious (the disability) five years later… the disability may come back.

    Since I don’t know what you do for a living or if the disability covers own occupation or partial disability it is hard to comment on price.

    Insurance is something we don’t like to pay for but if you need it you don’t want to find later you are not covered! Disability insurance is like having insurance on your RRSPs etc.if you become disabled. If you can take two years off or longer with no pay, you don’t need it.

  14. 14. sam

    hi Brian,

    thanks again for your prompt reply..
    I work as an accountant..
    what do you prefer i do..own occupation or partial disability..

    you have been so nice, i would have loved to work with you..but i believe you do not entertain clients below a certain networth..

    thanks again for all your replies..

  15. 15. Sheldon

    Brian

    I have a disability already (muscular dystrophy). Will I be able to get a disability insurance policy and which firm would you recomend.

    Thanks
    Sheldon

  16. Hi Sheldon,

    Sorry to hear about your disability, but to get private coverage this would not happen.

    However, if you are incorporated you have some options. Call me for details.

    regards,

    Brian

  17. 17. Frank

    I am not self employed and have scolosis, which recently lead to my 2nd back surgery at the age of 31. I was lucky as I am in management so I was able to be off for a month then am able to work from home, would I qualify for DI insurance? As the only income in our family it would have been very stressful if anything went wrong.

  18. 18. Tim Landry

    As someone who has severe scoliosis as a result of polio at age 5 you should be able to get DI but regrettably it will almost certainly exclude your back. We cannot expect an insurer to cover something we already have – but one condition excluded out of all the possibles is still a good deal

  19. Frank,

    It sounds like you have DI at work. Tim is right on getting your own DI policy.

    One thing you could consider getting is Critical Illness insurance. This is not to say it is better, just different. For example if you had Cancer, Stroke or Heart Attack this would pay a lump sum. For DI you could be back at work in in as little as three months. Also you you died before 30 days, the premiums spent could be sent back to your family. The face amount could be as high as two million dollars. This could also be converted into long term care at a later date.

    If you have any questions, you can drop me a line.

    Brian

  20. I strongly advise overseas travelers and those on foreign assignments to review their DI plan certificates. Many of the plans have exclusions while residing overseas especially in high risk areas like the Middle East and Africa.

    Often for the high risk area coverage you can consider Accidental Death & Dismemberment plans to supplement DI plans.

  21. 21. Thomas

    Some situations when disability insurance is not necessary:

    1. You have enough money to retire but are still working.
    2. Both spouses earn enough for the family to survive on one of their salaries.
    3. You have enough cash saved-up to wait until Social Security Disability benefits will kick-in.
    4. Your employer has a sick leave donation or sick leave “bank” program.

    I carried both long and short-term policies for about 10 years after my divorce. I discontinued them when I reached a point where I could get by for the rest of my life on savings and investments and Social Security disability.

    What did I do with the money I saved? Easy. put it into my 401K.

  22. Some good points.

    If you have no debt and can take a two year vacation don’t worry about disability coverage. The fact you are still working suggests you may not be there yet.

    Why use your savings as your blanket? If you are in the stock market and it goes down is that the best time to sell?

    The 401K is like our RRSP here in Canada is really putting your taxes into the future.

    So any money you are saving is also for Uncle Sam as well.

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