Disability Exposure:  If you are unable to work, is your family covered?

by Edi Alvarez, MSc, CFP®


Frequently people purchase life insurance to support their family in the event that they die.  It seems clear that no one wants to leave a love one in the lurch if they “pass on” but it is not clear why they do not have similar support if they become disabled. This discrepancy seem particularly difficult to understand since loss of income due to a disability (disability exposure), before age 55, is more likely than death. (1)  In America 4 out of 10 of today’s 20 year olds will become disabled before reaching age 67 and yet 67% of private sector workers have no long term disability. (2) Have you given thought to how you would support yourself if you had an accident or an illness that left you unable to earn income? (1)


Surprisingly most long-term disabilities are a result of (unforeseen) illness (86.5%) and not (preventable) injury or accidents (13.5%). (1) In addition, a highly educated professional’s earning potential is one of their largest financial assets.  For example, if you earn on average $80K to $200K annually over 35 years, you have an earning potential of $2.8M to $7M.  This income potential is lost or reduced if you are unable to perform your professional role.


A disability is usually categorized based on how long it keeps you from earning income.  A condition that prevents someone from working and lasts no longer than 6 months is appropriately called short-term disability (STD).   An example of STD could be pregnancy. The second is long term disability (LTD) and it is usually defined as lasting more than 6 months, although some agencies (like SSDI) require that the disability last longer.


You may believe, as many do, that your employer or government programs will cover your expenses if you are disabled. In the past, employers commonly covered employee income disability for both LTD and STD through group insurance. Unfortunately this type of coverage is now less common and when available has reduced features. This is a benefit that is still available in the public sector.  It is common for workers to need additional coverage to fully fund this exposure (the possibility that they will need income if they become disabled).  Government LTD coverage usually includes Workers’ Compensation (covering injuries attained while at work, which are only 3.5% of all LTD) and Social Security Disability Insurance (SSDI). Few disabilities qualify for Workers’ Compensation benefit. (1) We all pay into Social Security Disability Insurance (SSDI) automatically through payroll tax but few take the time to determine what it will cover.  The reality is that SSDI has very strict guidelines and very low monthly benefits.


Social Security strictly defines disability as “the inability to engage in any substantial gainful activity … which can be expected to result in death or … last for a continuous period of not less than 12 months.”  (3) Notice that it states “any” activity – it does not say unable to do “your own occupation”.  You don’t qualify for SSDI monthly benefits if you are able to do any “gainful” work.  Currently, even after appeal, 50% of SSDI applicants are rejected. (1)    If you do qualify for SSDI and you paid the maximum while employed you can expect to receive a maximum of $2,500 per month (or $3,700 for a family) in SSDI benefits. (3) Without supplemental resources most could not support their lifestyle even if they qualify for this benefit.


There are three ways to fund exposures:

(1) Avoid the exposure as best you can,

(2) Self-fund the event ad hoc, or

(3) Obtain insurance.


Families usually cover STD exposure through employer-sponsored insurance; accrued, unused vacation or sick days; and emergency savings.  STD exposure in a few states (like California and New York) is covered by State Disability Insurance (or SDI).  Because of the potentially devastatingly large financial impact, LTD exposure can’t usually be covered by family assets or self funded.  When a disabling illness or injury strikes, the impact on life and family is profound and there are fewer options.  Remember that government programs are strictly regulated and limiting with respect to LTD.  Although too late to make changes, it is at this point that employees often learn what benefits they have available from their employer.  It makes better sense to review your coverage while you are healthy.  Your LTD insurance should

·         cover at least 60% of your income

·         last until you retire

·         define disability as “inability to perform own occupation.” 


Understanding your LTD coverage might provide you with an opportunity to lobby for a better policy or to investigate private LTD insurance.


Even with employer sponsored LTD insurance a professional might still need to purchase additional Disability Insurance.  As an example, a professional earning a reasonable income would likely have, if disabled, less than 50% after tax from an employer LTD insurance. Would you be able to scale down your expenses by 50% at a time when you may have additional disability related expenses?  In addition, when you review your employer LTD insurance you may be surprised that your disability is not covered (because you can do other work) or that it is only covered for a limited time.   In all insurance policies “the devil is in the details” and in LTD insurance you need to be crystal clear on the definitions that will for benefits.  


Well paid professionals and small business owners often cover LTD exposure through private LTD insurance and consider government provided insurance benefits only as a last recourse.  More expensive private LTD insurance will yield benefits that are tax free which will reduce your tax burden during a LTD event.


Private LTD insurance is unlike many other insurance purchases because they follow a very thorough underwriting process that requires clarity on your earnings, type of profession; as well as, your health.  


Self-employed professionals or entrepreneurs will have a more difficult time obtaining private LTD insurance.  Particularly home-based businesses will need to provide evidence of business activities and work environment. Unless you belong to an already monitored profession (such as attorneys and physicians) underwriters will not be comfortable approving a LTD insurance for at home businesses or the self employed individual.  Without details and evidence on the LTD risk in your profession an underwriter is likely to reject your application or reduce your coverage.


What if you can’t afford private LTD insurance? Then look at your employer group plan and select the best from what is available. If your employer does not currently sponsor a LTD insurance then encourage them to provide some form of disability insurance coverage.


Private LTD insurance can be expensive and some insurance is not always the right insurance.  Insurance is something you hope to never use and therefore should not consume too much of your current budget.  It is my observation that private LTD insurance are quoted at about 2-4% of gross income but this can vary dramatically on many factors.   Since this is a long term commitment, review the impact that this insurance premium will have on your ongoing annual budget and future goals.


Before a LTD event, take the time to review what you might need, what your employer provides and what if anything you can do to better cover your disability exposure.  Above all, if you are considering LTD insurance, consider the following:

·         Is the insurance guaranteed renewable and non-cancelable? – you need a policy that keeps premiums constant until retirement and does not modify your coverage.

·         Be clear on how “total disability” is defined – make sure that you understand the definition used to qualify you for benefits.  Does “totally disabled” refer to your current job or to any job?  Aim for a definition that will allow you to collect benefits if can’t perform your “own occupation” not “any occupation”.

·         Partial or residual disability should be included – will you receive benefits if you are partially disabled or while working part-time. Are there benefits if you are not “totally and permanently disabled”.


Take the time ahead to maximize the disability insurance available with your employer and review private disability if it fits in your budget.  Don’t wait until you need it to find out that you missed this important employer benefit.


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This quarter I’ve made disability exposure education my focus and would appreciate your thoughts. I welcome stories on how you handle disability exposures in your life and as always, appreciate your feedback.




1.  America’s Health Insurance Plans – Society of Actuaries Disability Chart Book Task Force (2004).  Disability Insurance: The Final Piece in the Financial Security Puzzle.  The Actuarial Foundation p 1-75


2. Social Security Basic Facts (2011).  Press Office. http://www.ssa.gov/pressoffice/basicfact.htm


3. Clements, Donna (2009). 2010 Guide to Social Security.  Mercer LLC Publisher Louisville, Kentucky, pages 36-42 


© 2011 Edi Alvarez. All rights reserved.