Individual Disability Insurance a Primer

This is where we probably should have started with disability insurance, but being such geniuses we decided to take a long road to grandmas house (i.e. we never thought of it until now).  So, if you're wondering what disability insurance is all about, how it works, and why you should have it.

Today (finally) we're going to touch on all the high points with an introductory lesson on individual disability insurance.

How to Determine a Claim

The tricky thing about disability insurance is in the triggering event that puts you on claim.  Unlike life insurance, which is really easy to prove you've satisfied the requirements to receive benefits in the form of a claim (you are either dead or alive) disability insurance is a tad trickier.  Contract language is important, and we learned already that the specific definition of disability is important as it can vary.

For this reason, there are times when people have a certain degree of frustration with their insurance carrier, because they feel they are entitled to benefits, but the claims department says no.  Generally speaking when it comes to the definition of disability, the fewer words you see on paper to define the contract's definition the better.

What are you Insuring?

Insurance is about risk, and it's mitigation.  Disability insurance is about insuring your ability to earn an income.  Unlike most risks you and I face in our life, income loss is one that is arguably impossible to self insure (or retain on your own to use industry vernacular).  It's impossible to reasonably retain the risk because you are ensuring against the loss of something you do not yet have in your possession.

Since a lot of people have a hard time thinking of themselves as “disabled” think of disability insurance more about protecting your specialty.  Here's an example:

Let's say you're a moderately successful attorney who has found a decent niche locally within real estate law (that's what all the attorneys spend their time doing in VT, since there is little else going on).  You have a great Rolodex of real-estate brokers, banks, mortgage broker's etc. and you've developed a sharp sense of the market, few people in the state know what you know about the legal side of buying and selling real estate.  For this, you earn a pretty good living.  Disability insurance ensures that you'll continue to earn this pretty good living if a sickness or injury (and the vast majority of the time it's a sickness and not an injury) takes you out of work.  It means that the life style you've worked so hard to build, won't be blown asunder if you develop cancer and have to be out of work for a while while you undergo treatment.

Why Insure it?

Unless you're sitting on a substantial wealth created from the Opium trade or other related ancestral wealth built legacy, chances are good that your income drives the majority of what you're able to do and dictates the standard of living you have.  Though you might try to deny it (since you are, after all, super human and all that nonsense) if your job went away there's a good chance life as you know it would come crashing down to a dark time of worry and un-fun financial instability, the likes of which are difficult for most of us to understand unless we've actually experienced it.    If someone decided to get in a car after having way too much to drink came barreling down the same street you unfortunately decided to cross at the same time and met you in the most unfortunate of circumstances, chances are good that your widow would hire an attorney and sue the drunkard for something known as your Human Life Value this roughly the present value of all the money you could have reasonably been expected to earn between now and the time you would have likely retired.

If instead of the drunkard in the car, it was a blood vessel in your brain that popped, life insurance could recover the lost income if you die.  But with modern medical science being what it is, the more likely scenario is you might just survive the event, and if you do disability insurance is the safety net that ensures as much normalcy can remain in your (and your family's) life as possible.  In fact, speaking from a probability stand point, you're much more likely to survive and be disabled.  According to the CSO tables, you are twice as likely to become injured or sick and unable to work than die during your working years.

Underwriting, the Ugly Side of Disability Insurance

The most common reason listed from agents for lack of focusing on disability insurance  is the difficulty they have in getting a case placed, and this complaint is not without merit.  Disability insurance has a much more thorough and picky underwriting process than life insurance.  It's critical both about the medical risk, and your financial eligibility for benefits.  The moral hazard issues is a serious consideration on the table for a disability underwriter (i.e. those who reasonably expect to use it are definitely in the market for it, and insurance companies don't write guaranteed claims).  If you have some weird emotional baggage about the insurance industry, this section is going to incite and nurture your hatred, for the rest pitch-forky among you, this is an attempt to enlighten and make you aware of how the insurance company looks at it.

Medical Underwriting and Disability Insurance

By far the worst of the two types of underwriting that place for this product.  Medical underwriting is precise and minor health issues can easy trigger a rating, a rider to eliminate coverage for certain issues deemed preexisting, modification, postponement, or flat out decline (with declines being frequent and frustrating).  Keep in mind with the probability of being disabled twice as likely, it means medical underwriting is going to be twice as critical.  We'll expand a bit on what the potential outcomes mean:

A rating for disability insurance means pretty much the same as it does with life insurance.  The insurance company will issue the policy, but they will also increase the premium by a certain percentage to account for the increased risk of incident.  These increases generally range from 25% to 100% and move in 25 bp increments.  Often times ratings will accompany (or be accompanied by) some of the other possible actions listed above.

Riders when added by underwriting mean something is being excluded from the policy.  As an example, let's say that you've had a history of migraines.  The underwriting decision may be to issue the policy with a rider that excludes coverage of being out of work due to migraines.  Riders typically come in 3 styles:

  1. Temporary
  2. Conditional
  3. Permanent

Temporary riders are riders that have an expiration date.  They aren't all that common, but underwriting is hedging against an imminent problem that it believes will go away in the near future.  A good example would be a pregnant proposed insured.  Underwriting may exclude complications from pregnancy for up to a year after issue of the policy, at which point a complications from a new pregnancy would be covered.

Conditional riders are the most common.  They have an indefinite life, but can be removed if the insured can provide adequate proof to underwriting that the condition that led to the rider is no longer a concern.  In truth, even situations that are likely to go away will receive this rider, and the insured will need to be re-underwritten in the future to remove this rider.

Permanent means underwriting will not revisit the placing of the rider on the policy, and will not remove it with further underwriting.  It's not actually used all that often, (because internally underwriting knows if it really ever plans to remove a conditional rider).  Typically this rider would also come with other restrictions like a rating or modification.

Modification means that underwriting did something to he policy that changed (reduced) the benefits from he policy as applied.  Perhaps you wanted a policy that paid benefits to age 65, but underwriting would only agree to a policy that paid for 5 years.  Or maybe underwriting decided they did not want to place the residual (partial) disability rider on your policy.  There's a lot of discretion that underwriting has with respect to this.  Underwriters can make slight changes, or significant changes; it all depends on the severity of current health issues for the proposed insured.

Postponing a policy means underwriting would like you to do something to further prove that a potential health issue is not an increased risk.  Let's say you have a health condition that is manageable, but it's been a while since the last time you saw a specialist for the condition.  Underwriting might postpone issuing the policy until you see the specialist and he or she confirms that the condition has improved or not become worse.  Usually a postponed policy has a time limit, meaning the insured must do whatever underwriting has asked within a certain amount of time, or else they will close the file on the case, and the insured will need to begin again from step one on the application process.

Decline simply means that underwriting has declined your application for disability insurance because they do not want to insure the risk, meaning they expect you have higher than average probability of becoming unable to work due to illness and/or injury and they do not feel that a rating, exclusion rider, or modification will make insuring the risk manageable.

Financial Underwriting not as Bad, but not a Breeze Either

Most people barely notice the financial underwriting that takes place in a life insurance application.  Until you reach up into the few million range, financial underwriting requirements are fairly lax.  Disability insurance has a very different approach.  Again, because the risk is higher, and because disability insurance policies often easily place the insurance company on the hook for way more money than life insurance policies, proof that you actually earn the income you want to insure is a little more stringent.  Providing proof of income in the form of a w-2 or 1099 is very common place, and providing a few year's worth of tax returns is very standard.  Traditionally, underwriting will only include Adjusted Gross Income for business owners, so if you take liberal advantage of your available tax deductions, your insurable income might take a hit (no worries, there's special form of disability insurance that covers all of those business expenses).  This is far more involved than simply putting a number on a line of one of the pages in a life insurance application.  Keep in mind that the requirements are no more invasive than what a bank would ask you to provide if you asked them for a loan.

Certainly a different, and yet very critical product.  A lot of agents neglect this product because of its underwriting difficulties, and we don't intend to make light of those complexities.  However, if your agent has never brought this topic up, he or she is doing it at your peril.  Disability insurance, despite it's trickiness can be a savior of your finances.

2 thoughts on “Individual Disability Insurance a Primer”

    • Hi Angela,

      One could apply elsewhere, but if there is a postponed or declined disability insurance application, the probability of an approved application elsewhere is really small.

      There are a couple of “impaired risk” disability carriers, and their usefulness in such a circumstance is very dependent on the reason for the postpone or the decline.

      Postponing is much less of a problem than a decline. Traditionally, a postponed case simply means, there is some condition that underwriting either wants to see resolved, or wants the applicant to undergo additional medical review before moving forward with the application. Again, details matter, but for a lot of these circumstances, the applicant can be approved once undergoing whatever additional medical review is necessary, or once whatever is causing the postponement is resolved.


Leave a Comment