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Are You and Your Business Prepared To Handle Long-Term Disability?

Consider long-term disability policies carefully.

April 1, 2014
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Disability of a key executive can destroy a business. Disability of any worker can strain a family. Before age 65, one is much more likely to suffer a long-term disability (LTD) for six months or longer than one is to die. Fortunately, this risk can be insured.

A company or the worker and one’s dependents can be the policy beneficiaries. Where the company is the beneficiary of the LTD (or life) insurance policy, it is referred to as “key employee” (a.k.a., key man) insurance. It refers to the function of the policy rather than a specific type of insurance. The benefit finances the company’s recruitment, hiring and training of a replacement executive. If the worker and dependents are the beneficiaries, they can use the benefits to pay normal expenses and costs of care.

Before purchasing LTD policies, there are many things to consider.

An insurer’s financial health depends on the quality of its management, underwriting, and investment decisions. It is important to examine, among other things, the company’s A.M. Best rating. If the company goes bankrupt, the policy is useless.

One should select a policy that will cover beneficiaries’ cash needs. As an estimate, one should average at least three months of expenses, adjust for unusual months, and add a premium. When faced with a crisis, it is better to have over-insured than to have under-insured.

An elimination period is analogous to a deductible. It is the length of time one must wait to receive benefits. It could be 30, 60, 90, or 180 days. Policies with longer waiting periods have lower premiums. The benefit period is the length of time a policy pays. Usually, the choices are two years, five years, until age 65, or life. Policies with shorter benefit periods have lower premiums.

There are different policy types. One distinction is between total disability and residual disability policies.

A total disability policy pays when an insured cannot work at all. “Total disability” is defined in the policy. A restrictive definition may define it as the complete inability to engage in any gainful occupation. If an insured can work for a few hours, the policy won’t pay. “Own occupation protection” defines disability such that if one cannot perform that particular job, one would be eligible for benefits. A residual disability policy pays the proportion of the insured’s lost income if the insured cannot work full-time and the disability results in a loss of at least 20% of one’s income.

To illustrate the difference, suppose an injured worker can work for only a few hours per week, earning 35% of her pre-disability income. Under a total disability policy, the policy would not pay because she is not totally disabled. Under a residual disability policy, it would pay a 65% monthly benefit (i.e., 100% - 35% = 65%).

Another distinction is between non-cancelable and guaranteed renewable policies. Each can be renewed up to age 65. Non-cancelable policy rates can’t increase, whereas guaranteed renewable rates can. If affordable, it can be very valuable to lock in the premium with a non-cancelable policy.

There are a variety of policy riders and options. A cost of living adjustment (COLA) rider offsets inflation and is especially important over long benefit periods. A future purchase option allows insureds to increase coverage every one to three years regardless of an insured’s future health and in spite of common health problems. A catastrophic disability rider provides benefits above income to cover costs associated with disability. Depending on the terms, policies may pay when the insured cannot perform two or more activities of daily living (e.g., bathing, eating); suffers cognitive impairment; or loses sight, hearing, speech, or two or more limbs.

 When employers provide LTD insurance as a fringe benefit, the policy benefits are taxable. The insured can receive tax free benefits by paying tax on the premiums. If the policy selected by the company does not suit the worker’s needs, it may be worthwhile to just purchase a better policy. Consider the terms carefully, and if necessary, consult with a knowledgeable professional. 

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