The Voice is the e-mail newsletter of The Special Needs Alliance. This installment was written by Special Needs Alliance members Lisa Nachmias Davis of the New Haven, Connecticut law firm of Davis O'Sullivan & Priest, LLC, where her practice concentrates on elder law, planning for those with special needs, estate planning and administration, and advice to not-for-profit organizations. A member of the National Academy of Elder Law Attorneys (NAELA) and the Connecticut Bar Association's Elder Law Section executive Committee, in 2011 she was named one of the 25 best women lawyers in Connecticut and one of the top 50 women lawyers in New England by SuperLawyers, a Thompson Reuters business that rates attorneys.
March 2012 - Vol. 6, Issue 5
Disability insurance replaces the income lost when a previously employed individual cannot work because of a disability. For those already unable to work on account of disability, of course, this kind of insurance is unavailable. However, readers of The Voice also include employed individuals who are concerned that they may later become disabled (especially if others depend on them for their support), as well as the advisors of such employed individuals. This article will review types of private disability insurance and its availability, benefits, and options.
What about Social Security Disability?
Why might one want insurance to cover income lost due to disability? Don’t we have Social Security for that? Social Security Disability Insurance (SSDI) is certainly a wonderful program that spreads the risk of income loss due to disability among the entire working population. Everyone employed or self-employed in work covered by Social Security has an individual mandate to participate, once he or she meets the $450 minimum earnings threshold. A recent Voice article explains how long and how much one must work in order to be eligible for these widely-available benefits.
The SSDI safety net has its holes, however:
- Most people over 30 who seek to qualify must have earned at least 20 credits (about $24,000) within the ten year period prior to onset of disability. Someone with an irregular work history (or break in employment prior to disability) may fail to qualify.
- Applicants must prove that they will be unable to work for a period of at least 12 months or have a terminal illness (with a few exceptions). Since this can be hard to prove before 12 months have elapsed (unless the applicant has a condition so severe it is included in Social Security’s list of “compassionate allowances”), Social Security may wait until 12 months have passed before issuing a decision.
- Even assuming the applicant can meet the 12-month requirement, benefits cannot begin until month six, because the program has a five-month waiting period, during which time no benefit is payable. Supplemental Security Income (SSI), described in another article of The Voice, can fill this waiting period gap only if the applicant’s countable assets are low enough to meet the SSI requirements, and SSI at best pays only $698/month (the 2012 maximum Federal Benefit Rate, though some states supplement this amount).
- If the application filing is delayed, benefits can only be awarded retroactively for up to a year-six months for dependents-with a few exceptions.
- Initial applications are often denied, and it may take more than a year (and a 25% payment to the attorney) before disability benefits arrive.
- Finally, the maximum Social Security monthly benefit is $2,512, but the average SSDI payment is only $1,111 (in 2012, according to the Social Security website: www.ssa.gov). Sometimes the SSDI payment can be increased, e.g., with additional benefits for minor or adult disabled children, or for a spouse caring for a child who is under 16 or disabled, or is him or herself age 62 or over. However, the average SSDI payment for a disabled worker and his or her family is only $1,892/month (2012). This is generally far less than the worker earned when he or she was fully employed.
In short, SSDI is likely to be inadequate as the sole source of income for a previously employed individual. Those without employment during brief periods may be able to bridge the gap with personal savings, credit cards, home equity lines of credit, or loans from employer-sponsored retirement savings. Furthermore, withdrawals from retirement accounts necessitated by the disability of the individual or a family member do not trigger an early withdrawal penalty even if taken under age 59 (though income tax must still be paid on the withdrawn amount). In spite of such temporary cures, private disability insurance often stands between the disabled worker and a severely diminished standard of living.
Short and Long-Term Disability Insurance
By “disability insurance” we usually mean long-term disability coverage. “Short-term disability” can be an informal way of describing sick leave offered by an employer–anywhere from a few days per year to longer periods. As every employee knows, it’s critical to know whether unused sick leave rolls over from one year to the next, or expires at year’s end. During short-term disability, the employee may retain access to the employer’s group health insurance coverage according to the same premium contribution rules that apply to non-disabled employees.
By contrast, long-term disability insurance coverage through an employer will pick up where short-term disability leaves off. Eligibility for long-term coverage will probably trigger termination from the employer’s health insurance. In that case the employee should see if he or she can elect continued coverage with the employer’s health insurance plan through a federal law known by its acronym COBRA. COBRA applies to most employer health insurance plans if there are 20 or more employees. If a disabled employee is eligible for COBRA health insurance, the coverage will extend until Medicare begins 29 months from the onset of the disabling medical condition. Since a generous short-term disability plan may extend health insurance coverage out more than 24 months, the worker may be eligible for Medicare before losing access to an employer health insurance plan; COBRA participation does not delay the time limit for enrolling in Medicare Part B without penalty.
Group and Private Insurance
How to get long-term disability insurance? Long-term disability insurance is usually obtained through individual polices or group coverage. Group coverage is offered either through employer-sponsored group coverage or through some other kind of group (e.g., from professional associations). As with health insurance, there can be a wide difference in eligibility, cost, and coverage between group and individual policies–more so because disability insurance, unlike health insurance, is not subject to government regulations on access, equitable treatment, and portability.
Employer-sponsored group coverage is generally not underwritten: eligibility is based on employment status rather than individual evaluation, and the premium is based on general factors such as age. Where the premium is paid by the employer, as is often the case, the benefit will be taxable when received, just as wages would have been taxable income. Employer-sponsored policies will typically coordinate with SSDI benefits. For example, the plan may require the worker to apply for SSDI and may reduce the plan benefit by some or all of the SSDI benefit received. Employer plans may pay a set dollar amount or pay a set percentage of the employee’s salary. The plan may pay the benefit for a set number of years or until the employee is a certain age (usually age 65). Some employer plans allow employees to buy additional coverage under the same plan at the employee’s expense. Unfortunately, such group disability coverage is usually not portable. That is, if you lose your job, voluntarily or involuntarily, you also lose the coverage-possibly at a time when you are no longer insurable. Thus, even those fortunate enough to have access to employer-sponsored disability insurance may wish to investigate individual coverage.
Individual long-term disability coverage is “underwritten.” That is, both eligibility and the premium are tied to the individual’s personal health history and other characteristics. Typically, the insurer will want to review a full three to five years of medical history and may require some kind of medical exam. Underwriting is strict and may seem arbitrary. For example, a past diagnosis of any mental illness may result in either a total denial of coverage or (if the applicant is fortunate) a rider excluding coverage for disability resulting from mental illness. As with life insurance, a younger individual may want to purchase a policy primarily as a protection against later uninsurability. The idea is to get a disability policy while the medical record is still good and then to expect the coverage to continue even when health deteriorates. While group coverage typically lasts for an extended number of years, even until normal retirement age, many individual policies will only cover two, five, or some other limited number of years. On the plus side, benefits paid on individual insurance policies are not taxable (because premiums were paid with previously taxed income), and they are less likely to be reduced by SSDI benefits.
Finally, some professional groups offer “so-called” group coverage. However, it is not like employer-sponsored group coverage because there is at least some underwriting or question-based screening to weed out applicants with health conditions perceived to be risky. The only way this coverage differs from individual coverage may be that the premium is determined solely by the applicant’s age rather than being individually determined.
Here are some important concepts to understand when evaluating any policy, group or individual:
- Elimination period. This is how long the beneficiary must be unable to work before benefits are paid. A longer period of time results in a smaller premium, but it also creates greater exposure to economic hardship if at time of disability the short-term disability coverage is inadequate.
- Disability. Does the policy use Social Security’s definition, i.e., inability to engage in any substantial gainful activity (in 2012 that means, unable to earn $1010/month)? Or does it use a more generous definition, such as inability to engage in one’s previous employment or profession? “Own occupation” coverage pays benefits if a person can’t perform the exact job he or she held before becoming disabled. However, this type of coverage has become almost unobtainable and, if available at all, very expensive.
- Partial benefit. Will the policy give a partial benefit for part-time disability, such as the ability to work but only 20 hours per week?
- Coordination of benefits. Will the benefit be reduced by benefits received from another policy? The employer will want to confirm that the insured won’t get more income being disabled than being employed, and may do this by verifying other coverage already purchased.
- Coordination with Social Security. Coordination with SSDI can have a major disparate impact depending on income level. Sixty percent of last salary is a typical disability insurance benefit amount. For a higher-income worker, reduction of such a benefit by the relatively modest SSDI benefit amount may still provide a significant net benefit payment. However, for a low-income worker, SSDI might amount to 60% of his or her salary and therefore essentially wipe out the net benefit of the insurance.
- Benefit term. Does the policy pay for 2 years, 5 years, until 65, or possibly longer? The longer the benefit term, the more expensive the premium will be; the shorter the benefit term, the less likely the policy is to be worth the premium.
- Renewability and non-cancellation. Is the policy automatically renewable if premiums are timely paid, without regard to subsequent medical events?
- Waiver of premium. Will premiums still be payable when the policy is paying out a benefit, or will they be waived? Similarly, is there a provision for reinstatement in the event of a lapse in premium payment attributable to the disabling condition?
- Level or increasing premium? Although a younger person may purchase coverage to insure against future uninsurability, this only makes sense if the premium will be affordable in later years. Some individual policies have level premiums throughout the policy life, but others schedule increases with age.
- Future purchase option. Does the policy allow the insured to increase coverage without further underwriting (but you may be sure, with increased premium) upon proof that the insured’s income has increased? Some policies permit a future purchase to be made at a limited period of time, but once the window is closed, the option is gone.
- COLA or cost-of-living adjustment. Is the benefit indexed for inflation, and if so, how is it computed? Indexing the benefit or providing for set percentage increases in the benefit over time have a major impact on the size of the premium. Indexing is expensive.
- Benefit amount. How is the benefit amount determined? Is it some fixed percentage of former income or another amount? If it’s a percentage, what is included in former income? How is it computed for a self-employed individual?
Keep in mind that unless state law provides otherwise, it is not illegal for a disability insurance company to sell a policy 1) that can be canceled at the company’s whim, 2) that has outrageously excessive premiums, and 3) that will be wiped out by a Social Security offset. Buyer beware! Also, disability insurers can safely thumb their noses at the protections in the Americans with Disabilities Act: the Act has a carve out permitting disability discrimination in insurance.
Premium: How Much Makes Sense?
A big deterrent to the purchase of private long-term disability coverage, especially for those starting out at an older age, is the premium, particularly when viewed in contrast to the benefit that may be received. Suppose a policy with a maximum two-year benefit coverage that will pay out $3,000/month or a maximum of $72,000 overall. How many years would it make sense for a 50-year-old to pay a premium of $3,000/year for this coverage? Would it make more sense to simply save $3,000/year instead, as a form of self-insurance? These are difficult choices to make. Ideally they would be made with the assistance of a financial advisor who can evaluate the whole financial picture and gauge the risks.
In spite of its risks and drawbacks, disability insurance, whether offered through a group plan, a privately purchased individual policy, or both, may be a critical component of a family’s estate plan–particularly if the family has a disabled family member dependent on a parent’s or spouse’s earnings. Prudent buyers will examine the policy provisions carefully, understand how the benefits interact with SSDI and any other disability benefits, enroll when they are still insurable and when premiums are reasonable, and then maintain the coverage rather than letting it lapse. Later, when an insured individual suffers a disability and claims the benefit, it will be important to dovetail policy requirements with SSDI benefits. Just as IRAs and 401ks supplement Social Security retirement benefits, private disability insurance coverage may be necessary to complement Social Security’s very limited financial assistance for disabled individuals.