In today’s competitive marketplace, many advisors frame their expertise within the broad context of financial services, which may include investment advice and personal insurance planning. With respect to the latter, at the outset of an advisory relationship, clients are often asked to provide detailed information related to personal insurance coverage and employee benefit programs. Assuming information is gathered as part of this process on personal Disability Insurance (DI) and group Long Term Disability (LTD) coverage, what should the savvy advisor do with it?
At a minimum, someone on the advisor’s team should review the coverage to make sure that it meets the client’s current income protection needs. Simply knowing that someone has a particular type of disability coverage may not provide truly meaningful information, since the nuances of disability contract language can yield very different levels of coverage from one policy to the next. And the consequences of not knowing how a client’s coverage works can be significant if his or her coverage limitations create financial difficulties when an unexpected illness or injury occurs.
In fairness, disability insurance initially may appear to be a complicated subject area to an advisor who does not work in this area of planning on a regular basis. Here are some key points to consider when reviewing a client’s disability protection:
Start by determining how much coverage a client has, how soon he or she would start to receive benefits after becoming disabled, and for how long benefits would be paid. Policy provisions that describe these coverage elements are known as the “Monthly Benefit,” “Elimination Period” and the “Benefit Period.” You should be able to find this information on the “Schedule of Benefits” page in an individual DI policy or LTD certificate of coverage.
Renewal And Benefit Guarantees
It is always important to determine whether the coverage and specific benefit amounts are guaranteed. Individual DI contracts offer the highest level of guarantees—in part because the policy is usually owned by the insured individual—and are most often guaranteed to be renewable. The rates may be guaranteed as well, and total disability benefits are usually based on a fixed indemnity amount.
In contrast, group LTD contracts offer a lower level of guarantees. The employer—not the covered employee—is the policy holder. LTD plans are generally renewed annually. Benefits can be changed at any time by the employer or at renewal by the carrier. Unlike DI benefits, which are based on a fixed indemnity amount, LTD benefit amounts are most often determined by a formula based on the employee’s covered earnings in the year before he or he makes a claim. It’s important that your client understand that earnings covered under LTD may not include bonus compensation or overtime pay. Finally, year-to-year fluctuations in earnings can result in benefit amounts going up or down.
Information on renewability and rate guarantees can usually be found on the face page of a DI policy or group LTD certificate of coverage. Other important provisions, such as those described in the rest of this article, will be found in the body of the policy or in an attached rider.
Definitions Of Disability
Next, determine how your client’s coverage defines disability and whether a partial (often referred to as residual) disability would be covered. Depending on the product, there may be separate definitions for Total Disability and Partial/Residual Disability. These definitions determine the amount of benefits that would be payable in any given claim scenario.
To understand how different these provisions can be, consider the following scenarios in which an insured individual meets a policy’s definition of Total Disability and his or her benefits become payable:
• Scenario 1 – The insured individual continues to receive full benefits to age 65, even though he or she returned to work in another occupation.
• Scenario 2 – The insured individual chooses to return to work in another occupation, and receives reduced payments that are offset for earnings from the new occupation up to age 65.
• Scenario 3 – The insured individual does not go to work in another occupation, but after 24 months is no longer considered disabled because he or she could work in another occupation.
Clearly, DI plans will perform differently for your client based on their respective definitions of disability.
As with renewability and benefit guarantees, the provisions of DI contracts tend to be more liberal than those of LTD plans. For example, most individual DI policies would not require a person to work in another occupation if they could, while many group LTD plans would include this requirement after some period of time, such as 24 months.
Partial/Residual disability benefits work differently as well. Individual DI contracts may require a loss of as little as 15 percent of pre-disability income to qualify for partial/residual benefits, while most group LTD contracts require a loss of at least 20 percent. Moreover, a few LTD contracts may increase the minimum income loss requirement to at least 40 percent after two years of disability.
Increases To Coverage
It is also important to determine whether a disability policy includes provisions that will allow for increases in coverage as income goes up. In general, LTD benefit amounts are recalculated annually and coverage can go up automatically if income goes up—subject to a maximum percentage of covered earnings (typically 60 percent) and a benefit cap imbedded into the plan set up by the employer.
As noted earlier, individual DI plans are issued with a specified indemnity amount. A DI policy may include an “Automatic Benefit Increase” feature that increases the indemnity amount annually for a limited number of years immediately after the policy is issued. A policy may also include a “Future Increase Option” that allows the insured individual to purchase more coverage subject to proof of increased earnings, but without having to demonstrate medical insurability.
Cost Of Living Adjustments
COLA adjustments apply specifically to benefits paid while on claim. COLA features are available with both individual DI and group LTD plans. Keep in mind, however, that—as the policy holder—the employer determines which features will be included in a group LTD plan. Many employers choose not to add a COLA feature to their LTD plan, usually as a means of keeping the cost of the plan low. Individual DI policies—which typically are purchased and owned by the insured individual—often include an optional COLA rider.
Retirement Income Protection
An extended period of disability is likely to interrupt the retirement accumulation plans of even the most committed saver/investor. Most DI and LTD policies provide benefits to either age 65 or 67, which may result in a significant drop in income after that age. Therefore, it is important to determine if a client’s disability coverage includes a feature that helps protect those sources of income that will be used after retirement. In a worst-case scenario, a client may need to rely primarily on Social Security retirement benefits. Products are available that can help provide a pool of money after the coverage ends that may help mitigate the effects of lost retirement contributions that could not be made during a long-term disability.
As stated at the outset of this article, the nuances of disability insurance contracts can make it complicated subject. With the goal of providing truly comprehensive planning, advisors should make sure that disability insurance coverage is thoroughly reviewed—even if it means partnering with an outside expert on DI options to help provide the best service possible to their clients.
Mark R. Ameigh, CLU, is senior competition analyst with Berkshire Life Insurance Company of America, the Guardian company that issues its individual disability insurance policy. He has worked in the disability insurance industry for more than 30 years. He can be reached at [email protected]