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Total disability is not defined the same way across every policy. Some insurers apply a strict any occupation standard, similar to Social Security, requiring that the insured be unable to perform any occupation for which they are reasonably suited by education, training, or experience. Other insurers use the more liberal own occupation standard, defining total disability as the inability to perform the duties of one's own occupation. As would be expected, the "own occupation" definition makes it easier to qualify for benefits.
Partial disability is generally defined as the inability to perform one or more of the regular duties of one's own occupation, or the inability to work full-time, resulting in a decrease in income. The partial disability benefit covers a partial loss of income for an insured who can report to work but cannot perform all of the regular duties of the job. This benefit is typically 50% of the total disability benefit and is limited to a stated period of time. Benefits under a partial disability policy may be paid as a flat amount or as a residual amount.
Partial disability covers a partial loss of income for insureds who are unable to perform some, but not all, of their regular job duties.
Residual disability provides benefits for loss of income when a person returns to work after a total disability but still cannot work as many hours, or at the same earning level, as before becoming disabled. Many insurers have replaced partial disability benefits with residual disability benefits, which help offset lost earnings. If the insured can only work part-time or in a lesser-paying position, the residual benefit makes up the difference between current earnings and pre-disability earnings.
A residual disability benefit is calculated as a percentage, based on the relationship between current earnings and earnings prior to disability.
Recurrent disability is a policy provision specifying a period of time — usually 3 to 6 months — within which the recurrence of an injury or illness will be treated as a continuation of a prior disability rather than a brand-new one. This matters because a recurrence treated as a continuation does not expose the insured to a new elimination period.
The elimination period is a waiting period, measured from the onset of disability until benefit payments begin. It functions as a deductible measured in days rather than dollars, and exists to exclude coverage for short-term disabilities from which the insured is likely to recover quickly. Elimination periods commonly range from 30 to 180 days. Just as a higher dollar deductible lowers premiums for medical expense coverage, a longer elimination period lowers the premium for disability income coverage. Because benefit payments are made in arrears, an insured who selects a 90-day elimination period becomes eligible for benefits on day 91, but the first payment does not actually arrive until day 121. Choosing an elimination period therefore requires the insured to realistically judge how long they can go without income following a disabling event.
The elimination period is a "time" deductible designed to exclude coverage for short-term disabilities and to reduce the filing of minor claims.
A probationary period is a separate waiting period found in some disability income policies. It does not replace the elimination period — it applies in addition to it. The probationary period runs from the policy's issue date, typically 10 to 30 days, during which benefits will not be paid for a disability caused by sickness. It applies only to sickness, never to accidents or injuries, and exists to protect the insurer against adverse selection by applicants who purchase a policy shortly after developing a condition requiring immediate treatment.
A probationary period applies to sickness only — never to accidents or injuries.
Injury may be defined under either an accidental bodily injury standard or an accidental means standard. Accidental bodily injury means that the resulting damage to the body was unexpected and unintended; accidental means requires that the cause of the accident itself was unexpected and unintended. A policy using the accidental bodily injury definition provides broader coverage than one using the accidental means definition.
Sickness is defined as either a sickness or disease contracted after the policy has been in force for at least 30 days, or a sickness or disease that first manifests after the policy is already in force.
Disability insurance, like other forms of health insurance, may be written on an occupational or nonoccupational basis. Occupational coverage pays benefits for illness, injury, or disability resulting from accidents or sicknesses that occur either on or off the job. Nonoccupational coverage, by contrast, pays benefits only for accidents or sicknesses that occur off the job. Many individual disability policies are written on either basis, but most group plans are nonoccupational only, since on-the-job accidents and injuries are assumed to be covered separately through Workers Compensation.
A policy written on an occupational basis covers accidents or sicknesses occurring on or off the job. A policy written on a nonoccupational basis covers only claims arising off the job.
Benefit limits describe the maximum monthly benefit an insurer is willing to accept as an individual risk, and the monthly benefit payable under most disability income policies is based on a percentage of the insured's past earnings. It is common for a policy to cap the benefit at roughly 66% of the insured's average earnings over the two years immediately preceding disability.
Insurers rarely, if ever, write a disability income policy that reimburses an insured for 100% of lost income. Paying benefits equal to or greater than prior earnings would give the insured little financial incentive to return to work as soon as possible; paying an amount somewhat less than prior earnings preserves that incentive.
Most insurers also reduce the benefit paid under a policy to account for any amounts the insured is receiving from Social Security or Workers Compensation, so that the insured cannot profit from the disability. Disability income policies generally exclude losses arising from war or military service, intentionally self-inflicted injury, residence overseas, or injuries sustained while committing or attempting to commit a felony.
An applicant's age is an important rating factor for disability income insurance. As people age, their chance of mortality increases, as does their likelihood of suffering an accident or illness, and they tend to recover more slowly than younger people. For these reasons, premium rates typically climb as an applicant ages.
Gender also influences eligibility and rating. Men, statistically, have a shorter life expectancy than women, making them a higher mortality risk, while women tend to develop more health problems as they age, making them a higher health risk.
Insurers use one of two methods to determine the benefits payable under a disability income policy: they may calculate benefits as a percentage of the insured's pre-disability income, taking other sources of disability income into account, or they may use a flat-amount approach that pays a stated sum in the event of total disability. Because a moral hazard can arise from other financial factors, insurers weigh several underwriting considerations when deciding how much disability income to offer an applicant.
Bob and Jim each earn $100,000 a year and both apply for disability income coverage. Bob owns his home outright, carries no mortgage, and has $500,000 invested in bank CDs. Jim, on the other hand, is still paying off a mortgage of $1,500 a month, plus car payments and student loans. If Bob became disabled, the combination of disability income and interest earned on his CDs might leave him far less motivated to return to work than Jim, given how different their financial obligations are — which may make an underwriter reluctant to offer Bob as large a benefit as Jim.
The insured's occupation is a critical underwriting factor. The more hazardous the applicant's occupation, the higher the premium the insurer will charge. Professionals such as attorneys and physicians pay the lowest premiums and receive the most favorable definitions of disability, while workers in more hazardous occupations, such as construction, pay higher premiums and receive less favorable definitions because of their greater risk of disability.
Avocation refers to a person's hobbies or personal interests, and insurers must take these into account. Dangerous or high-risk avocations both increase the likelihood that a loss will occur and increase the likelihood that any resulting loss will be severe. To assess an applicant's avocations, an insurer typically has the applicant complete a questionnaire covering hobbies and personal interests.
Finally, insurers evaluate an applicant's past and present physical condition. A person in good health is less likely to become ill or suffer an accidental injury. Height and weight are considered as part of this evaluation, since statistics show that people who exceed the recommended weight for their height by more than 20% have higher rates of heart disease, cancer, diabetes, and respiratory illness.
Premiums paid on personally owned disability income policies are nondeductible to the individual. In exchange, disability income benefits are received income tax free by the individual.
An individual disability income policy is applied for and paid for by the individual directly, rather than through an employer as with group disability income. Premiums on individual disability income policies are paid with after-tax dollars, and benefits are not taxable as income.
This is distinct from medical expense insurance, where unreimbursed medical expenses paid for the insured, the insured's spouse, and dependents may be claimed as an itemized deduction to the extent they exceed 7.5% of the insured's adjusted gross income (AGI). This deduction only applies if the insured itemizes deductions on their tax return.
Disability income benefits received under a group plan are taxed based on who paid the premium. If an employer pays half the cost of the coverage, half of any benefit received is taxable as income to the employee — the taxable percentage of the benefit mirrors the percentage of the premium the employer paid. The same logic applies to an individual disability income contract if the employer pays any part of the premium directly.
In general, whoever claims the tax deduction is the one whose beneficiary eventually owes tax on the corresponding benefit. Disability income premiums paid by an individual are never tax deductible; the IRS treats individually paid premiums as paid with "after-tax" dollars, similar in concept to a nonqualified annuity, where the portion of a benefit attributable to someone else's prior deduction is taxable to the recipient.
Premiums paid by an employer for group disability income coverage are deductible to the employer as a business expense and are not considered taxable income to the covered employee. Benefits received by an employee that are attributable to employer-paid premiums, however, are fully taxable to the employee as income.
When the employer and employee share the cost of coverage, the employee's contribution is not deductible, but benefits attributable to the employee's share of the premium are received income tax free. How a given group plan taxes its benefits depends on how the premium is funded:
For example, if an employee contributes 40% of the premium and receives a $1,000 benefit, only $600 (the 60% attributable to the employer's contribution) is taxable to the employee as income, while $400 (the 40% attributable to the employee's own contribution) is received tax free.
Disability insurance premiums paid by an employer are deductible as a business expense; the resulting benefits are taxable income to the employee.
Short-term disability (STD) group plans usually provide a benefit period of less than two years. These plans commonly place a maximum dollar amount on the benefit regardless of earnings, and typically include an elimination period, except for disabilities resulting from accidents.
Long-term disability (LTD) group plans usually pay benefits for two years or longer. Group long-term disability plans are often reserved for management employees. The elimination period usually coincides with the end of the benefit period under a companion short-term disability plan, and the LTD benefit period may extend to age 65. Lower-wage employees are typically limited to a benefit of about 66⅔% of monthly wages, while higher-wage employees are typically limited to about 50% of monthly wages.
It is also common for an employer to provide short-term disability coverage to all of the company's employees. The elimination period on such a plan can be as short as zero days, and the benefit period is generally no longer than two years — often as short as six months or one year.
Short-term and long-term disability policies serve the same core purpose — replacing income while the insured is disabled — but differ in when coverage begins and how long it lasts. Short-term disability is intended to cover the insured immediately following a serious illness or injury, while long-term disability is intended to sustain income replacement if the disability lasts much longer — years, or even until retirement, depending on the plan. The two are designed to work together: short-term disability pays benefits during the waiting period before long-term coverage begins, at which point the insured transitions from one policy to the other. Having both in place helps ensure that an unexpected disability does not derail the insured's finances for months or years.
When deciding whether to purchase short-term coverage, long-term coverage, or both, cost and the insured's own ability to self-insure are worth considering. Someone without an emergency fund sufficient to cover a few months of living expenses benefits significantly from short-term disability coverage, even if only for a limited period — and short-term coverage is most valuable when an employer offers it free or at low cost, since privately purchased short-term coverage can be nearly as expensive as long-term coverage despite its shorter duration. Someone with substantial emergency savings but concerned about the impact of a long-term disability on their finances and retirement plans, on the other hand, may prefer to purchase long-term disability coverage. Private long-term disability coverage can be a better value than employer-provided coverage over time, since it is often cheaper in the long run and remains with the insured when changing jobs.
Like other types of policies, disability income insurance carries stated minimum and maximum benefit amounts. Typical policies set a minimum benefit somewhere between $50 and $100 and a maximum as high as $10,000. Overall, disability income benefits generally may not exceed 50–70% of the insured's gross earned income.
The benefit period is the length of time over which monthly disability benefit payments will continue for a given disability, once the elimination period has been satisfied. Most policies offer benefit periods of 1 year, 2 years, 5 years, or to age 65, and some plans offer lifetime benefits. The longer the benefit period, the higher the premium.
Under a disability income policy, the insured must notify the insurer of the onset of a disability within 20 days, or as soon as reasonably possible thereafter. If the disability continues and benefits are needed for two years or more, the insurer has the right, at its own expense, to examine the insured as often as is reasonable in order to verify that the disability is continuing.
The automatic increase provision raises an insured's monthly benefit each year for roughly five years, generally increasing total coverage by about 25%. Because the insured is effectively purchasing more coverage each year under this provision, premiums rise accordingly — the purpose of the rider is to keep the insured's coverage in step with inflation.
Disability income contracts must include a beneficiary designation because they typically also provide accidental death and dismemberment benefits. Since AD&D pays both a life benefit and a health benefit, a beneficiary designation provision is required.
Inflation can erode the purchasing power of a disability benefit over time. The cost of living adjustment (COLA) rider helps guard against this erosion by automatically increasing the insured's monthly benefit once claim payments have begun. Typically, the first increase occurs at the end of the first year of the claim, with annual increases continuing for as long as the insured remains on claim. Some COLA riders provide compound interest adjustments, while others provide simple interest adjustments.
In order to avoid overinsurance, insurers offer several riders that coordinate a disability policy's benefits with Social Security. The Additional Monthly Benefit rider pays approximately the same amount that Social Security would pay, but only for one year, on the assumption that Social Security benefits will commence by the end of that year.
The Social Insurance Supplement (SIS) rider — a rider, not a separate policy — pays a benefit approximately equal to what Social Security would pay, but if Social Security actually does pay, the SIS benefit is reduced dollar for dollar by the Social Security payment. SIS riders are used to supplement or replace benefits that might otherwise be payable under Social Security Disability, generally in three situations:
These riders may also replace or supplement benefits payable under other social insurance programs, such as Workers Compensation.
The integration of benefits provision is designed to prevent duplication of benefits, or "overinsurance." Under this provision, when an insured who holds an individual disability contract becomes disabled, the insurer reduces its own benefit by an amount equal to whatever other disability payments the insured is receiving.
A residual rider, when attached to a disability income policy, pays benefits for the loss of income following disability, rather than simply for the inability to perform the duties of an occupation. This coverage matters greatly to a professional whose disability disrupts the business and causes a loss of clients, even after the professional has fully recovered from the disability itself.
If an insured has been totally disabled, rehabilitation may be needed to help the insured return to work, whether in the same occupation or a different one. A rehabilitation benefit covers a portion of the cost of enrolling in a formal retraining program to help the insured return to work, and it typically pays a specified sum — often expressed as a multiple of the monthly indemnity — to cover costs not paid by other insurance.
A disability that results from the same underlying cause as a prior disability is known as a recurring disability. If the insured has been back at work for a specified length of time, a recurrence will be treated as a brand-new disability, exposing the insured to a new elimination period. If the insured has not been back at work for that specified length of time, the recurrence will instead be treated as a continuation of the original disability.
Donating a body organ is covered under a disability income policy when the transplant is performed in a life-threatening situation.