Understanding Today’s Disability Insurance Contracts

Understanding Today’s Disability Insurance Contracts: The Heart of the Matter

Today’s disability insurance market is a complicated one. Since the major retreat in the individual disability insurance marketplace of the 1990s, most of the insurers that chose to stay in the disability insurance business have dramatically changed the contract language in their new disability portfolios.¹ Many major players in the industry left the market during the early 1990’s due to a large spike in claims among Physicians which resulted in large losses for the companies. Prior to this unforeseen increase in claims, companies were competing by selling very large monthly indemnity benefits (up to $25,000 per month payable for life) at very low premiums without requiring proper financial documentation. “Mental/Nervous disorder” claims also became more numerous and large blocks of business were negatively affected. Because of this market pullback, today’s prospective disability insurance buyers need to have sophisticated contract-reading abilities to fully understand what they are purchasing.

The purpose of this article is to help prospective buyers understand the importance of the “total disability” definition in their contracts and the different “own-occupation” clauses that exist within this definition. The article provides an explanation of most of the current total disability definitions available in today’s disability insurance market and how simple changes in wording can make a big difference in benefit payments to the insured. This article also summarizes a few of the optional policy benefits that an insured or prospective insured should understand about this vital coverage.²

Understanding Disability Policies

There are many options to consider when analyzing a disability policy, including Partial or Residual disability provisions, Cost of Living Adjustment riders, and Future Increase Option riders. (See the sidebar entitled “Other Insurance Contract Features” for more information on these and other options.) The heart of a disability policy, however, lies within the section of the contract that defines “total disability” and deals with protecting the insured’s ability to work in his or her “own occupation” as it relates to the disabling accident or illness.

The term “own occupation” usually is one of the first definitions in a disability policy and should be read carefully by prospective consumers. This disability definition delineates the circumstances in which an insured is considered “totally disabled” and eligible for disability income benefits. In today’s market, policies vary widely due to variations in this definition.

True Own-Occupation Clauses

Prior to 1996, most major insurance carriers’ contracts were essentially the same. The majority of top-tier disability policies had a standard own-occupation definition of total disability. This standard, or “true,” definition of own occupation might read something like this: “You are considered totally disabled if, due to sickness or injury, you are unable to perform the material and substantial duties of your regular occupation.”

What this meant was that if an insured (such as an attorney, physician, dentist, or accountant) became totally disabled in his or regular occupation,³ the insured would receive the full disability monthly benefit, even if he or she chose to work in another gainful occupation after suffering the total disability. The insured’s benefits would not be reduced because of his or her earnings in the new occupation, as long as the sickness or injury prevented the insured from working in his or her former occupation.

In essence, the true definition of own occupation protects an insured’s ability to perform the duties of his or her specific occupation for the entire benefit period—with no reduction in benefits—even if the insured chooses to earn income in another job after becoming totally disabled in his or her regular occupation. Furthermore, the true own-occupation provision can help compensate the insured for any lost income growth the insured likely would have enjoyed had he or she not become totally disabled. This is because benefits are not offset by any new income the insured may choose to earn in a new occupation.

Unfortunately for consumers, very few carriers are offering this vital benefit for attorneys, dentists, most physicians, and other “white collar” professionals. Today, it is more common for insurance carriers to use a “modified” own-occupation definition in their contracts.

Specialty Own-Occupation Clauses

An enhancement to the true Own Occupation definition described in the previous section would be a total disability definition that defines a “recognized” specialty as the insured’s “own occupation.” The specialty would have to be recognized by the ADA or AMA for a Dentist or Physician or by the ABA for an attorney. If the insured practices such a recognized specialty at the time of total disability, then he/she would be entitled to their full disability benefit if they couldn’t practice such due solely to injury or illness – regardless of future earnings made in another occupation.

Modified Own-Occupation Clauses

When carriers use a modified own-occupation definition in their contract, it means they have added language to their own-occupation clause that potentially reduces the level of disability income benefits to be paid. For example, a modified own-occupation clause might read something like this: “You are considered totally disabled if, solely due to sickness or injury, you cannot perform the material and substantial duties of your regular occupation and you are not working in any gainful occupation.”

In this example, the own-occupation clause stipulates that the insured will be paid the full disability benefit if the insured cannot work in his or her regular occupation. However, by adding the words “and you are not working in any gainful occupation,” the carrier has significantly altered the definition. Under the modified definition, if the insured chooses to work in another occupation after the disability, the carrier will consider the insured to be “partially or residually disabled” and will pay benefits based on his or her percentage loss of earned income (if the policy has a residual disability clause).

An attorney who purchases this type of contract could suffer financially upon return to work in a new occupation. This is because when an insured earns 80 percent of pre-disability income in a new occupation, benefits on the policy go away. Disability income policies usually only provide coverage for between 50 to 60 percent of earned income to begin with, so the difference in benefits can be dramatic for the person who retrains and enters a new career after suffering the disability.

A carrier also might use a one-, two-, or five-year own-occupation clause in its disability insurance contracts. For example, a one-year own-occupation clause might read something like this: “For the first twelve months of a covered claim, you are totally disabled if, due to sickness or injury, you are unable to perform the material and substantial duties of your regular occupation.”

Such modifications of the total disability definition simply change the terms under which the insurance company considers someone totally disabled and eligible for benefits. These modified contracts give individuals who can no longer work in their regular occupation a certain amount of time to be considered totally disabled—even if they begin working in a new career. If an insured is working in a new occupation, once the timeframe is up, the definition changes and benefits can be reduced. In some cases, benefits are eliminated all together.

Loss of Earnings

Loss of earnings contracts are disability contracts that avoid defining total disability altogether. These contracts include wording such as “total disability is not defined and is never required.” Some individuals might think this type of language offers more protection, because it stipulates that the insured does not have to be totally disabled to receive benefits. However, because the contract does not define total disability, it strictly adheres to a “loss of earnings” formula to determine the disability benefits, whether the insured is working in his or her regular occupation or another. Therefore, the contract essentially will pay benefits the same as the modified contract described above.

Any Occupation Clauses

Today, many carriers are offering “any gainful occupation” and “any gainful reasonable occupation” clauses in their new policies. These policies essentially define total disability as the inability to perform the duties of either any “gainful occupation” or any “gainful, reasonable occupation” for which the insured may be suited by training, education, or experience. Some will go on to further temper this definition by including language that states “with due regard to pre-

disability earnings.” Such contracts are more restrictive than either the true or modified own-occupation contracts described above. The insurance company essentially has the right to determine what “reasonable” occupation the insured could work in and can stop benefit payments if the insured refuses to do so.

Combinations

Some carriers have started offering contracts with total disability definitions that are a mix of two or more of the definitions above. These can be considered quite restrictive and confusing to read and digest. An example would be a “modified” definition coupled with an “any reasonable occupation” clause after a period of five years of total disability.

Monthly Benefit Amounts

Benefit amounts inside individual DI policies are a function of taxable “earned” income and range from 30% or less to 65% of such income. Because benefits are now capped at about $25,000 per month (coverage from all sources including group LTD), people earning very high incomes are not able to cover as high a percentage of their earnings as those making less. An insured earning $200,000 per year can effectively cover much more income with disability insurance than someone making $1,000,000 or more per year because of today’s benefit limits.

Elimination or “Waiting” Periods

All personal and Group DI policies have Elimination or “Waiting” periods that must be satisfied before benefits become payable after the onset of a disabling injury or illness. A prospective insured can choose between a 30, 60, 90, 180, 360 or 720 day elimination period on their individual DI policy. Group LTD plans generally have a 180 day wait and is the same for all employees enrolled in the plan. In addition, this 180 day wait must be satisfied by consecutive days of total disability before benefits are payable. Individual DI policies commonly have a 90 day wait period that can be satisfied with days of total and/or partial disability.

Pre- Existing Conditions

Insurance companies will generally exclude Pre-Existing Conditions from coverage for the first two policy years on individual DI policies. Group LTD policies will typically exclude benefit payments for the first year of the policy for such (from the start date of coverage). A pre-existing condition is generally defined as a condition for which the insured sought treatment for during a specified time period (commonly 3 to 12 months) prior to the start date of the coverage or for which a prudent person would normally seek treatment or medical advice due to experiencing symptoms of a medical condition.

Miscellaneous Contract Provisions

Most Group LTD and Individual DI contracts have provisions outlining “rehabilitation” programs designed to help the disabled policyholder return to work if possible. Such plans are typically voluntary for the insured with incentives for participation included in the policy. These range from additional monthly indemnity being paid to full reimbursement from the company for the cost of the program.

Group and Individual DI policies only cover the insured person and do not include any “domestic partner” language. There are a few Individual DI plans in the market that pay a benefit on a “spouse” if they suffer a “catastrophic” disability which is defined in the policy. Survivor benefits are rare in disability plans and if they are offered, they typically take the form of a refund of premiums paid for the current year or the equivalent of a few months worth of monthly indemnity.

Conclusion

Disability insurance contracts are one of the more complicated personal insurance policies that a professional can own, because they contain numerous contract definitions and optional features—all of which determine disability income benefits during a claim. They also are considered one of the more important aspects of personal financial planning, as they protect arguably the most valuable asset a professional can own: the ability to earn a living in his or her “own occupation.”

The heart of a disability insurance contract is the total disability definition, which determines under what circumstances the insured is entitled to benefits if he or she suffers an injury or illness that prevents future work in his or her regular profession. Therefore, it is prudent for the prospective insured to read this definition first before moving on to the other available options in a policy.

The true own-occupation definition offers the most comprehensive coverage to the insured because it does not reduce benefits if the insured eventually retrains and works in a new occupation after suffering total disability. Carrying one of the many modified definitions can cause reductions in benefits for the disabled professional who chooses to work in a new occupation. In some contracts, the insurance company has the right to choose for the insured—or take away the insured’s benefits completely.

The bottom line is that consumers should purchase coverage as if they will have to use it someday. It is paramount to read the contract carefully before purchasing disability insurance, and to work with a professional who has extensive experience and knowledge of the various contracts available in today’s disability insurance market.

SIDEBAR

Other Insurance Contract Features

The important features to look for in a quality disability contract include:

Future Increase Option (FIO): This feature allows the insured, on each policy anniversary (until a certain age), to increase his or her monthly benefits without any medical underwriting. The insured only has to prove financially that he or she qualifies for the increased coverage. The best FIO options allow the insured to buy as much additional coverage as he or she qualifies for each year.
Compound Cost of Living Adjustment (COLA): This is an inflation-fighting feature in a disability income contract. It essentially increases an insured’s claim check on each claim anniversary by either a given percentage or the Consumer Price Index, whichever is less. Common COLA percentage increases range from 3 percent to 6 percent annually. This coverage is vital for younger professionals, because an individual’s benefit purchasing power is eroded by inflation over time.
Long-Term Benefit Periods: A serious injury or illness could result in a permanent inability to practice law and the corresponding financial hardship for
the attorney. Long-term benefit periods protect against the longer term loss of income that can result from such injuries or illnesses.
Residual Benefits: This benefit pays for “partial” disabilities and the corresponding earnings loss that the insured suffers. If this feature is not on an insured’s policy, the insured will be paid only if he or she is “totally disabled.” Companies will measure “pre-disability” earnings to establish a base-line average earned income in order to determine a percentage loss of income in order to calculate benefit amounts for payment.
Catastrophic Benefits: This optional benefit pays extra monthly income (up to 100 percent of pre-disability income) for “catastrophic” disabilities that render the insured unable to perform certain “activities of daily living.”

David M. Richards is a Disability Insurance Specialist and Financial Representative with The Guardian Life Insurance Company of America, New York, NY—(303) 714-5875, david_richards@wealthsg.com and on the web @ www.cbadi.com

Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS), 6455 S. Yosemite St., Suite 425, Greenwood Village, CO 80111. Securities products/services and advisory services are offered through PAS, a registered broker/dealer and advisor (303-770-9020). PAS is a member of FINRA, SIPC.

Material discussed is meant for general illustration and/or informational purposes only and is not meant to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed reliable, please note that individual situations can vary, therefore the information should be relied upon when coordinated with individual professional advice.

NOTES

1 “The State of Disability Insurance in America 2002,” The Disability Insurance Advisory Group.
2 A helpful resource for individuals interested in learning more about disability insurance is the Life and Health Insurance Foundation for Education (LIFE) website, available at http://www.life-line.org. LIFE is a nonprofit organization dedicated to addressing the public’s need for information and education about life, health, disability and long-term care insurance.
3 “Regular occupation” is commonly defined as the regular occupation or occupations that the insured is engaged in full time (thirty or more hours per week) at the time of disability.

This article first appeared in Law Practice Management