DISABILITY INSURANCE PROBLEMS

While the initial area of focus is on the amount of long-term benefits one has, it is equally important to consider the provisions of the policies themselves.

A Minnesota physician felt he had the best disability insurance coverage money could buy. If he were disabled, he would receive $4,000 a month for life, starting within two weeks of disability. Then he had a heart attack and was advised to give up his practice. He filed a claim with his disability carrier, which ruled “no benefits.” The policy clearly stated that as long as the policyholder could earn a living, he was not entitled to benefits. Could the physician teach? Yes. Could he consult? Yes. Could he perform routine physicals for an insurance company? If necessary. Then he could earn a living and that disqualified him from collecting one penny on his policy.

Next to malpractice, disability coverage is the most important insurance a person engaged in personal services can have. Unfortunately, too many of these persons have weak coverage, but find out only when it is too late. Why? Because, most of them have only a policy through their professional association and assume that is sufficient. Or because they have not updated their insurance to take advantage of the newer, more liberal coverage. Or they evaluate their coverage only in terms of the monthly benefit payout. However, the payout is only the tip of the iceberg. Fine print criteria can be crucial in evaluating a disability policy. Whether the policy is one you are considering for purchase or one you already own, here are the key sections to examine:

• Definition of disability

The most restrictive policies say a policyholder is disabled (hence eligible for benefits) only if he or she is unable to earn a living in any occupation. Policies that are more liberal define disability as an inability to perform your occupation for two years, and thereafter any occupation.

Next on the ladder is inability to perform the occupation for which you are suited for, say, two years, then any occupation for which you are suited by education, training or experience. The best policies pay off if you cannot perform your specialty to the extent you cannot earn your previous level of income. Some policies specify that if you can earn only partial income from your specialty, you can collect partial benefits to cover the lost income. For example, consider a physician specialist who has a heart attack and must give up obstetrics. His or her $100,000 income drops to $50,000 as a general practitioner. Under most good policies with a partial or residual disability clause, he or she would be entitled to a proportionate amount of benefits because of the inability to perform all the functions of the specialty.

A policy may even pay off fully in case of a partial disability. For example, a “presumptive disability if the policyholder loses eyesight, hearing, speech, or use of two limbs,” even if the impairment does not prevent him or her from resuming the practice. Any person who is so impaired should not have the additional worry of whether he or she will be able to collect on a disability policy.

You will also want to make sure the policy does not have a relation-to-earnings clause. This allows the insurer to review your earnings at the time of disability. If your earnings are lower than when you bought the policy, because you are partially retired, the company can reduce the benefit proportionately. Another small print pitfall is a provision permitting the insurer to wait until all your professional income (such as receivables) have stopped before paying full benefits. A Connecticut group’s insurer pounced on a corporate agreement that gave disabled officers a three-month salary after disability. “As long as you’re receiving income,” said the insurer, “you’re not fully disabled.”

• Definition of sickness

Some policies regard sickness as beginning with “origination.” That means if the disabling illness is congenital or predates the purchase of the policy, the insurer may not have to pay. You would be better off with newer policies that use the word “manifest,” regarding the sickness as having begun when it first became known.

• Exclusions

As a rule-of-thumb, the fewer the exclusions in a policy, the better. Some standard exclusions bar payouts from disability stemming from an act of war or nature, normal pregnancy or mental or nervous disorder. You will most often find these restrictions in older policies.

• Renewal guarantees

Does your carrier have the right to raise the premium or cancel the policy? Under most professional or trade association contracts, it does. A New Jersey doctor who moved to Pennsylvania, for example, found that his New Jersey medical society’s disability coverage was automatically canceled. He was 55 years old, and the only disability insurance he could obtain came at top premium.

A guaranteed renewable policy, on the other hand, may be renewed until age 65. The cost is about 10 to 15 percent more than for a policy without that guarantee. Some of these contracts have clauses that permit the premium to be increased at a stipulated maximum.

A non-cancelable policy guarantees both premiums and renewals for a stated period. However, you will have to pay an extra 20 to 25 percent or more a year above the cost of a policy without those guarantees. Most consultants think a non-cancelable policy is well worth its higher cost.

OTHER FEATURES

Other policy features are also worth considering. Guaranteed future insurability, for example, promises that up to a certain age you can purchase additional coverage without a physical examination, regardless of your health. That age limit is typically 52, although some carriers go as high as 60.

A spouse’s transition provision pays monthly benefits to your spouse for a period of time (typically six months) if you die during the insured disability period.

An overhead expense disability policy helps cover such ongoing practice expenses as office rental and staff salaries, typically for a year or two.

The more features you add, obviously, the higher the premium. The policy can become so expensive that you are left with the same sophisticated decision that you must make about life insurance. Are you better off paying a smaller premium and investing the difference to build your nest egg? Moreover, if you omit features to reduce the premium, where do you begin? Some features, insurance experts feel, are a poor use of premium money. Here are the ones you should weigh most critically.

• First-day coverage

Benefits are paid as soon as disability begins. Most policies have a waiting period before benefits are payable. The shorter the waiting period, the higher the premium. Try to estimate how long adequate income will continue from salary, group insurance, accounts receivable, personal investments, corporate or partnership agreements before you really need disability benefits. If you can wait 30 days, your premiums will be much less than if you could wait only seven days, and 90 and 180 waiting periods are even less expensive yet.

• Long-term coverage benefits to age 65 or for life

This is much more expensive than coverage for a year, or for up to five years, and it may be unnecessary. Statistics reveal that many of all disabilities that last one week or longer are over within five years. As you get older the need for lifetime coverage rather than five-year coverage diminishes, since retirement funding should supplement the need for disability insurance.

• A return-of-premium provision

This says that if you have few or no claims over a 10-year period, the insurer will rebate some of your premiums to you. It sounds like a good deal, but it is so expensive that it is regarded as a poor use of money. It tends to discourage policyholders from filing small claims, and when they do file, the first claim dollars they receive are their own.

It is a good idea to review your coverage every few years. If you have an assortment of policies, add up the monthly benefits. You may find that inflation has eaten away the coverage of your older policies. What seemed to be sufficient protection 20 years ago - say, $1,000 a month in benefits - may be laughable today.

One way to protect against inflation is to buy an “indexed” policy, the newest wrinkle in disability insurance. It increases coverage annually to keep up with the cost of living. Some policies tie the increase to the Consumer Price Index. Others raise coverage annually at a set rate, such as 6 percent. Most will raise the benefit until it is twice the original amount, which would take about 12 years at 6 percent compounded annually. Some contracts have no ceilings at all. This indexing feature generally increases cost about 25 percent.

As they increase coverage, however, some purchasers will find that they have reached a carrier’s ceiling. A doctor earning $90,000 a year, for example, will generally be limited to a policy paying about $3,300 a month. That is less than $40,000 a year. There are ways to increase the maximum benefit. You can purchase a rider that pays the equivalent of any Social Security benefits denied because your disability fails to satisfy Social Security definitions. This can be very significant, since over 75% of initial Social Security disability claims are now being denied.

Excess coverage is also available through special “surplus market” writers such as Lloyd’s of London. However, it is very expensive. It might cost $7,500 a year for $20,000 of monthly coverage. In addition, you can generally add professional association coverage on top of your individual policies with no questions asked. If you try to add more individual coverage, though, the new insurer will count the coverage you already have against the allowable maximum.

Stepping up coverage may not be necessary at all. You may have other sources of income that will adequately supplement disability pay. Examples are personal investments that produce good income, or a retirement plan that is about ready to pay out. You may also find some expenditures can be eliminated in case of disability, golf club membership, for example, or one of the family cars. After reviewing your coverage, non-practice income, and needs after disability, you may even decide to drop a policy. The best candidates for reducing or eliminating coverage are older professional persons who have paid off their mortgages and no longer have dependent children.

When you are younger, with a lot of financial obligations and a big gap between lifestyle or maintaining an unusually high mortgage for tax purposes, or have investments that are highly leveraged and illiquid, your need for disability coverage is the greatest.

Another decision for the professional practitioner or closely held business owner is whether to pay for the plan individually or let your corporation do it. If the corporation pays, it can deduct the annual premiums, but any benefits will be taxable as income to you. If you pay for the policy, you cannot deduct the premium payments, but you will receive the benefit tax-free.

As a rule, you are better off if the corporation pays the premium and takes the tax deduction currently. You are likely to be in a lower tax bracket when you collect any benefits. In addition, a typical disability insurance policyholder pays much more in premiums over a lifetime than he or she collects in benefits. If you do not need disability coverage, great. If you do need it, make sure you can collect the benefits for which you have paid. At a most critical point in your life, there are two letters you don’t want to receive - those which start:

“Dear policyholder: We have received your claim. We’re sorry, but the wording of the policy....”

“Dear policyholder: We regret to advise you that our master contract with your association has been terminated....”