What Is Disability Insurance & How Does It Work?

If you are young and keeping great health until now, then the thought of having disability insurance may have never crossed your mind. 
But adversity can strike without warning. If you rely on your ability to earn income in order to support your living expenses or save for retirement, then your inability to work due to illness or injury can have severe financial consequences on you, your family, and your loved ones. Long term inability to work can be even more difficult to manage.
Disability Insurance is a way to mitigate the financial risk that can come from losing income due to illness or injury. In this article, we will walk you through the basics of disability insurance, so you can evaluate whether it is right for you and your situation.

Definition of Disability Insurance

As the name suggests, disability insurance indemnifies the policyholder from the loss of his income (partially or wholly) in the event of his disability. It comes into play only when the employee cannot perform his job and earn money due to the mishap. It entails him to a periodic benefit because of the premiums he paid to the insurer.

Types of Disability Insurance

There are generally two broad types of disability insurance: short term disability insurance and long term disability insurance.

  • Short-term Disability Insurance (STDI)

Short-term disability coverage typically spans from three to six months – perhaps up to one year. This coverage typically replaces 60% to 70% of base salary and has a short waiting period from the onset of the disability — typically a few weeks.  

  • Long-term Disability Insurance (LTD)

Long-term disability insurance provides coverage if you are out of work for a longer period of time — the policy typically pays benefits after 90 days of disability. It replaces a part of your earnings every month as decided by the terms in the contract — typically 40% to 60%. Benefits typically continue to pay for a longer period of time, typically until the disability ends or retirement age. Such policies may suffer from insufficient coverage, and it is not uncommon for the policyholder to subscribe to supplemental LTDs.

Below is a summary of typical differences between Short- and Long-Term Disability policies.

Point of DifferenceShort-Term Disability InsuranceLong-Term Disability Insurance
Primary MotiveTo cover the period after a serious illness or injuryTo act as income replacement if you suffer from any disability
Coverage PeriodBelow one yearCan last up to decades
Waiting Period (Elimination period)Less than 2 weeksCan range between 30-720 days
Average CostUp to 3 percent of the average annual salaryUp to 3 percent of the average annual salary
Coverage AmountUp to 80 percent of your average annual income.Up to 60 percent of your average annual income.

Irrespective of the policy you opt for, each policy will have specific terms that must be met for the coverage to kick in.

How Does Disability Insurance Work?

Disability insurance, like any other policy, comes in many forms, and you can choose from a plethora of providers. Similarly, its pricing depends on your age, the policy amount, term, the meaning of disability, and other aspects.
Have a look at some factors below that you should consider before buying disability insurance. Pay close attention to these concepts when evaluating insurance options.

  1. Compare quotes

Every insurance policy has its way of judging liability. So it is probable that you will get different rates from different insurers. If the quotes are confusing, use a comparison tool and choose what suits you the best.

  1. See what they cover 

Every disability insurance policy comes with its definition of the word ‘disability.’ If you are opting for an own occupation disability insurance, the provider will pay you if you cannot operate in your profession. It has no restrictions if you work in any other manner.
If you select any occupation, you are eligible for payout only when you cannot work in any field. Because of its stringent nature, it is cheaper than the other type.

  • Premium amount

Premiums depend on the length of the policy, type of coverage, your health, policy value, and several other factors.

  • Benefit period

Short term insurance typically covers you up to twelve months.  The benefits of the policy terminate when the disability ends or at the time that the benefit period expires. Whereas if you opt for long term insurance, it can range between two years up to retirement. 

  • Elimination period 

The elimination period is the amount of time between the beginning of the disability and when the benefits begin. The elimination period (or waiting period) should be assessed based on how quickly after the disability, would you want the benefits to begin.
There are various other aspects that need to be carefully considered while evaluating policies specific to the type of policies under consideration, such as the price of the policies, and your health and financial situation. 

Can We Cancel or Renew the Policy?

There are two versions of disability insurance policies

  • Non-cancelable
  • Guaranteed renewable

In a non-cancelable policy, if you are paying your premiums regularly, the insurance company cannot cancel the policy, increase the premium amount, or reduce the benefits. It ensures that you won’t have to re-apply, therefore it protects the policy value from degrading due to your health or other reasons.
If you opt for guaranteed renewable, the insurer cannot cancel the policy but has the option to increase the premium. The provider can only do so to a group of policyholders at once and not a particular insured person alone.

Do you Get Riders’ Benefit?

Yes, you can boost your policy by adding riders’ benefits. There are several additional benefits available, but here are the most common ones:

  • Basic disability benefit rider – The basic disability benefit riders entail policyholders to receive a partial sum if they suffer from an injury that reduces their productivity but doesn’t cause total disability.
  • Student loan protection rider – If you are a student, the student loan protection rider helps you repay the covered student loan only if disability impacts your ability to earn income. 

How Much Should You Pay?  

The cost of disability insurance depends on several factors. Long-term disability premiums cost between 1% to 3% of your annual salary. In most organizations, employers provide it to their employees. But if you are self-employed or did not receive it from your employer, then the price may vary between providers.
The price that you pay for a policy is generally determined based on multiple factors, including, but not limited to:

  • Age – The price for coverage increases with age. It is, therefore, generally less expensive to obtain coverage for younger people.
  • Gender – As per records, women are known to file 40 percent higher premiums for disability insurance and have significantly higher spans. It has pushed insurers to charge higher from them when compared to men.
  • Health history – Your health status and other health-related factors, such as chronic conditions, current height and weight, urine test results, blood test results, and any addictions currently or in the past, can have a significant impact on your policy premium amount.
  • Job occupation – Certain jobs are more susceptible to injuries than the rest. The risk of likelihood between desk jobs and more hands-on jobs can be significant, leading to different risks and, therefore, different policy premiums. 
  • Annual income – The higher you earn, the more willing the insurer will be to give you a better policy value. The insurer also entitles you to more benefits in most cases.
  • Other factors – Several other factors can affect your policy, such as claims history, cost of living, and rules and regulations in your area of residence.

Is Disability Insurance Worth the Cost?

In the States, people are better equipped financially to deal with death than disability. But the chances of the latter are up to five times more than the former. Here are some astounding facts about adults in the USA –

  • 89.9 million working Americans receive disability insurance as part of their salary package.
  • About 40 percent of the US households have enough liquid savings to manage their expenses for three months in case of disability.
  • Four out of ten adults in the States cannot pay an emergency $400 expense.
  • 5 percent of working Americans suffer from short-term disability every year(can be because of injury, illness, or pregnancy)

Disability insurance is a deeply personal decision, and care should be taken to evaluate the cost-benefit for your situation. To put some numbers into perspective — approximately 89.9 million American workers are already covered by some form of disability insurance. This, however, also means that roughly 1 in 3 workers do not have adequate coverage.

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