There is a wide variation of disability income coverages and related disability policies. Many of these variations involve the definition of disability itself, the duration of benefits available, the elimination period, whether and how partial-disability benefits are provided, the waiver-of-premium protection, how recurring disability is handled, and how, if at all, cost-of-living adjustments are made to disability benefits.

Insurance companies that offer disability income policies are very concerned about overinsurance and consequently limit the amount of benefits relative to the individual’s income. As a result, many individuals with in-force coverage through their employers or other sources are ineligible for additional disability income protection.

Anyone who earns at least $20,000 per year from gainful employment and is not already covered by private disability insurance has a significant need for disability income protection. Obviously this includes the self-employed, business owners and partners, individual workers, and anyone who would have an inadequate income if he or she were to become disabled and be unable to continue working for compensation.

Unfortunately premier-quality disability insurance is not available for many occupations. Agents marketing disability income insurance must become familiar with the occupational classifications and direct their prospecting toward individuals engaged in insurable occupations. If their agency contract allows it, agents may direct a prospect to another insurer that would issue some coverage on a nonoccupational basis. As with life insurance, insurance companies differ widely in how they classify occupations for disability insurance. Some companies will not insure plumbers for disability income; other insurers will offer a special disability policy for plumbers; still other insurers will offer their regular policy to plumbers at higher than standard premium rates.

Further, many corporate events can alter employer-provided disability income protection and therefore increase the need for individual protection. First, corporate mergers or acquisitions may result in a change in management and management philosophy, which may result in the termination of previously provided benefits. Second, bankruptcy or severe financial problems may prompt management to cut back on employee benefits such as disability income insurance. Third, the insurance company that provides disability income protection through the employer could terminate the policy. In this case, if the employer is unable to find another insurance company willing to write the coverage, there will be no replacement disability protection. Even if coverage could be obtained from another insurer, management may decide not to seek replacement coverage.

Since most employers do not provide disability income insurance, it is quite possible that an employee who leaves a job in which he or she had disability income protection may not be provided with that protection by a new employer. Such job changes create a definite need for individual disability income protection. One advantage of relying on individual protection rather than on employer-provided group protection is that the individual is not subject to termination at the whim of corporate decision makers. Also individual coverage is portable and can go with the insured to new geographic locations and new career paths. Changes in occupation may require the insured to inform the insurance company of such changes, and the premium may be adjusted if there is a significant change in the risk classification for the occupation.

Disability income coverages are also important for partnerships and closely held corporations. Such coverages can provide the financial means for healthy partners or stockholders to purchase the ownership interest of the disabled partner or stockholder. Disability income policies can also be used by the business enterprise to replace lost income or revenue that results from a key person’s disability.

The primary objective of disability income policies is to replace lost income when an individual is no longer able to continue earning that income because of injury or illness. The concept is simple, but the variations of both risk and coverage provisions make disability income insurance very complex. As mentioned earlier, there can be multiple claims, and in most cases separate claims are mutually exclusive. However, it is possible to have multiple disabilities affecting an individual concurrently. One way that insurance companies differentiate between risks is by the definition of disability that they use in their contracts. For social security purposes, disability is defined as "the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months." This is one of the most restrictive definitions in use. Essentially, if a person is able to do anything for pay, he or she is not disabled. Only a few private insurance company contracts use similarly restrictive definitions, but these products should not be considered quality disability income products. They are commonly referred to in the insurance industry as "any occupation" definitions, which means that benefits are payable only if the individual is disabled severely enough that he or she cannot engage in any occupation.

Much more common in private insurance is a definition stating that disability is "the inability to perform the duties of any occupation for which the individual is reasonably suited by reason of education, training, or experience." This type of coverage will not provide benefits if the insured is able to enter a new career that is reasonably comparable to the one in which he or she was engaged prior to the disability.

The most generous benefits are available under disability income policies utilizing an "own-occupation" definition of disability. These policies define disability as "the inability to perform the material and substantial duties of the individual’s regular occupation." For example, these policies will even provide benefits for a surgeon who becomes disabled while insured and after recovery is no longer able to perform surgery but can still practice medicine. Many specialists within the professions will often insist on such definitions when they are seeking disability income coverage. (Some insurers have ceased issuing own-occupation coverages to health care providers in recent years.)

Many disability policies provide a two-stage definition of disability. They provide protection for the insured’s own occupation for a period such as 2, 3, or 5 years and then continue to provide benefits only if the individual is unable to perform the duties of any occupation for which he or she is reasonably suited by reason of education, training, or experience. Obviously this is less generous than a policy that would provide benefits for the inability to perform one’s own occupation to age 65 or for lifetime. However, the insurance company anticipates that the individual can use the benefits during the first-stage definition to prepare for an occupation that he or she will be able to perform when the second stage of the definition becomes effective.

To this point the definitions discussed have dealt with total disability. Currently many disability policies also provide benefits for either partial disability or residual disability. Both types of benefits (partial and residual) are intended to encourage insureds to return to the work force prior to total recovery. Some experts argue that the absence of these benefits encourages disabled insureds to malinger so that they can collect total-disability benefits. It should be emphasized that partial-disability benefits and, in many policies, residual-disability benefits are payable only following a period for which total-disability benefits have been paid.

Partial disability is usually defined as the inability to perform some stated percentage of the duties of the insured’s occupation or to perform at such a speed that completion of those duties takes a longer-than-normal amount of time. The more severe the limitations, the higher the benefit that will be paid. Theoretically, under such a contract, an individual could return to work on a full-time basis at full salary and still be eligible for partial-disability benefits.

Residual-disability benefits, on the other hand, provide for a replacement of lost earnings due to less than total disability. Here the focus is on how much income reduction has been sustained as a result of the disability rather than on the physical dimensions of the disability itself. Residual benefits are particularly well suited for self-employed professionals such as accountants, attorneys, and physicians whose caseload often determines their income. A disability that reduces their capacity for work would automatically lead to a reduction in income.

Policies providing residual-disability benefits usually specify a fraction (representing the proportion of lost income) that will be multiplied by the stated monthly benefit for total disability to derive the residual benefit payable. The numerator of that fraction is usually income prior to disability minus earned income during disability; the denominator of the fraction is income prior to disability. The contract will specify a definition of each form of income. The definitions differ from one insurance company to another, and these differences become extremely important for individuals whose income fluctuates widely. Some contracts may specify predisability income as the average monthly income during the 6 months immediately preceding the onset of disability; others may specify predisability income as the greater of the average monthly income during the 12 months preceding the onset of disability or the highest 12 months of consecutive earnings during the 3 years preceding the onset of disability. There are many variations, but the important concept here is that persons subject to income fluctuation should insist on a definition allowing the greater of two different base periods so that they will not be unduly penalized as a result of a single base period applied during a slump in income. Most of the definitions either explicitly or implicitly include not only income earned from work activities but also pension or profit-sharing contributions made on behalf of the individual. Thus an individual with a $60,000 nonfluctuating salary and a
10 percent pension plan contribution would be considered to have a predisability income of $66,000.

The income received during residual disability that is used to calculate the income loss is usually defined to include all money received during the period being evaluated even if the money represents payment for services rendered prior to the disability. A few insurance company definitions exclude payments made on services rendered prior to the disability from residual income.

Let’s consider an example. An individual with a $66,000 annual predisability income has a policy providing $3,500 per month for total disability. This individual has been able to return to work following a total disability and is earning $2,500 per month during the current period of residual disability. Subtracting $2,500 in residual earnings from the predisability income of $5,500 per month results in a lost income of $3,000 per month. The lost-income ratio ($3,000 ¸ $5,500) is then multiplied by the stated monthly benefit for total disability ($3,500) to determine a residual-disability benefit of $1,909 (rounded to the nearest dollar). Most residual-disability benefits cease whenever the income loss drops below 20 percent of the predisability income. In this example, residual benefits would cease when the monthly income exceeds $4,400.

It is also common to find a clause within residual-disability-benefit provisions that specifies that the minimum benefit payable for residual-disability periods is at least 50 percent of the benefit payable for total disability. At least one insurance company will provide 100 percent of the total-disability benefit during residual disability if the lost income exceeds 75 percent of the predisability income. Under most policies residual-disability benefits are payable to the end of the benefit period. For long-term disability contracts this would be age 65 or later. Some policies impose an 18- or 24-month limitation on residual benefits for partial disabilities beginning after a specified age, such as 54.

Another aspect of residual-disability coverages is whether or not they require a prior period of total disability for residual benefits to be payable. The more generous policies pay residual-disability benefits for partial disabilities not preceded by a period of total disability. Obviously this generosity increases the premium for the benefits. Policies that do require a prior period of total disability, often called a qualification period, vary as to the period’s duration; the most common qualification periods are 30, 60, 90, or 120 days.

Disability income contracts generally include some provision on renewability. Top-quality contracts will be at least guaranteed renewable to some specified age such as 65 or even lifetime, or better still they will be noncancelable. Guaranteed renewable means that the policyowner has the right to continue the coverage in force by paying the premium due. The premium itself may be increased on a class basis for all guaranteed-renewable policies in a classification, but the premium cannot be increased on an individual basis. The important point is that the insurance company does not have the option to refuse renewal of these contracts before the end of the guaranteed-renewal period. Noncancelable disability contracts guarantee not only that the individual can keep the policy in force by paying the premium but also that the premium will not increase.

Some disability insurance contracts have less generous renewability provisions than guaranteed renewability or noncancelability. These policies offer very questionable protection for the insured because the insurance company is allowed to refuse renewal of the contract in some circumstances. Some policies are optionally renewable, which gives the insurance company the option to refuse renewal at any anniversary date. Others are conditionally renewable and set forth specific conditions upon which the insurance company has the right to refuse renewal of the contract on the next policy anniversary. Sometimes the conditions refer only to items controlled by the insured, such as a change in occupation, but more often they refer to factors beyond the insured’s control, such as the performance factors of the insurance company itself. The real problem with any renewability provisions that are less generous than guaranteed renewability is that a policy may be terminated when an insurance company refuses to review the policy of an individual who has become uninsurable and can no longer obtain coverage from other sources.

Policies containing restrictive renewability provisions are often issued by companies that are not committed to the long-term disability market. Many life insurance companies move into and out of the disability income market on a relatively short-term basis. They often enter the disability segment of the business in the years following record profits reported by the disability income specialty companies. A few years later they are dissatisfied with the profitability of their disability coverages and decide to exit the market or to increase their premium structure to a point at which they are no longer competitive with market leaders. They handle the in-force coverage issued during their active years in different ways. Some companies reinsure all the coverage with another company that is committed to the disability market. Others choose to retain the coverage and work off that particular block of policies until they all expire as a result of nonrenewal, expiration date, or death of the insured. Some companies apply both techniques by setting a relatively low reinsurance threshold, maintaining the policies and servicing claims as they come due.

The insured is best protected under guaranteed renewable or noncancelable disability insurance policies from an insurance company that has a good track record and commitment to the disability income market. Some major life insurance companies have entered into agreements to have their own life insurance field force sell the top-quality disability products of a specialty company. This is explicit recognition of the specialty carrier’s success and the life insurance company’s inability to match its performance with the resources available to the specialty company. In many cases these agreements allow the field force to earn production credits in their own company for the disability coverages placed with the other insurance company. Some disability insurance companies even allow the marketing insurer to sell the coverage under its own name much like other private-able products.

Long-term-care (LTC) insurance, a related coverage, provides benefits to persons needing nursing home care or home health care. Some disability insurance policies make an optional rider available that provides extra benefits if the insured needs and receives nursing home care. These riders explicitly cover Alzheimer’s disease and do not require prior hospitalization as a condition for benefit eligibility.

Some disability insurers include a long-term-care insurance conversion privilege in long-term disability policies. This is essentially a form of guaranteed LTC insurability. It can be very valuable because the underwriting criteria for LTC issued at age 65 or later are often very stringent. LTC insurance is the closest thing to disability income insurance that can be purchased at age 65 or older but only if the person is in very good health.

Another related coverage is now available from a few insurers in the form of HIV (human immunodeficiency virus) riders to disability income policies for health care workers. The riders pay benefits for up to 10 years to insureds who become HIV positive and sustain at least a 20 percent reduction of income. Such policy riders are generally restricted to physicians, dentists, medical technicians, residents, interns, paramedics, ambulance drivers, and registered nurses.

Disability income policies generally have an elimination period before benefit payments begin. Most insurance companies give the purchaser an option to select the duration of this period. The elimination period is the time between the onset of the disability and the beginning of eligibility for disability payments. Since benefits are paid on a monthly basis at the end of the month, the first benefit payment will be 30 days after the end of the elimination period. Common elimination periods are 30, 60, 90, or 120 days. A few policies are available with a zero-day elimination period but only for disability due to accident; the premium increase to get rid of the elimination period is significant because it includes benefits for many more very short-term disabilities.

Obviously the longer the elimination period, the more severe a disability must be before benefits will be payable. Even a 30-day elimination period will preclude benefit payments for minor injuries and illnesses when full recovery takes place within the 30-day period. Premium levels are affected by the length of the elimination period, and longer elimination periods are associated with lower premium levels. However, selection of a particular elimination period should not be based solely on the premium differential.

Many factors should be considered when selecting the elimination period for a disability income policy. The ability of the insured to pay living costs and other expenses during the elimination period is of utmost importance. Another pertinent factor is whether or not the insured has other sources of funds available for short-term disabilities. For example, he or she may be employed by a firm that provides salary continuation or sick pay. In this case the elimination period chosen might equal or exceed the maximum salary continuation period from the employer. Individuals purchasing coverage in states that have nonoccupational disability coverages should choose elimination periods that equal or exceed the maximum benefit period under the state plan. The individual may have an adequate accumulation of emergency funds to sustain a relatively long elimination period without alternative sources of income during that elimination period. Insureds should not select an elimination period that is longer than they are able to financially sustain themselves, given the available sources of funds subsequent to the onset of a disability.

Insurance companies differ as to whether they require the elimination period to be satisfied with consecutive days or whether they allow the accumulation of nonconsecutive disability days to satisfy the elimination period. In some policies it is spelled out explicitly in the contract that the elimination period can be satisfied with nonconsecutive days. In other policies the language of the contract is silent on this point, and the company’s claims-handling philosophy must be ascertained to determine the answer. Policies requiring consecutive days of disability to satisfy the elimination period provide a less generous benefit than those allowing accumulation of nonconsecutive days to satisfy the elimination period.

Residual-disability benefits provided in many policies specify what is commonly known as a qualification period, which specifies the number of days of total disability that must be sustained before residual-disability benefits are payable. The most generous residual-disability policies have a zero-day qualification period and therefore require no total-disability period prior to eligibility for residual or partial benefit payments. Under that type of contract, residual benefits could begin at the end of the elimination period to replace lost income, such as the income lost by a surgeon suffering from severe arthritis. A policy that has residual benefits with a qualifying period equal to the elimination period could also start paying residual benefits at the end of the elimination period if the individual had been totally disabled for the entire elimination period and recovered enough to return to work with a reduced income immediately after the end of the elimination period. It is quite common for the qualification period associated with residual benefits to actually exceed the elimination period, but there is not necessarily a connection between the elimination period and the qualification period. In fact, many insurance companies do not offer a choice relative to the qualification period for residual benefits.

Most disability policies have provisions setting forth a specified period of recovery (usually measured by return to work) that automatically separates one disability from another. For example, suppose an individual became disabled as a result of an automobile accident and was totally disabled for 6 months. The individual then returned to work for 8 months before having a relapse and becoming totally disabled again from causes associated with the automobile accident. The new disability will be treated as a separate disability because the recovery and return to work exceeded 6 months, which is the specified period separating recurring disabilities in most disability income policies. If the return to work lasted fewer than 6 months, the second period of disability would be treated as a continuation of the initial disability, and no new elimination period would be applicable. However, because the individual had returned to work for 8 months, the second period of disability is treated as a new disability, and a new elimination period will be applicable before benefits are again payable.

For disability policies with a limited benefit period, it can be advantageous to have each relapse classified as a new disability. The advantage is that any new disability starts with a full benefit period. Consider a policy with a 2-year maximum benefit period in our example above. Six months of that benefit period were used up before the employee returned to work. When the relapse occurs with less than 6 months of recovery, the second period of disability will be eligible for only 18 months of benefit payments. In the case of an 8-month recovery, the insured will have to sustain a new elimination period but will then be entitled to the full 24 months of benefit payments if the disability lasts that long. The issue of qualifying for a new benefit period can be extremely important for short-term disability policies, but it is not a significant issue for policies providing long-term benefit periods running to age 65.

Just as disability income policies differ according to definitions of disability and length of elimination period, they also differ according to the duration of benefits that they will provide once the individual becomes disabled. Benefit periods are one of the most important factors in determining the level of disability income premiums. Most insurance companies offer choices for the benefit duration and charge the appropriate premium for the duration selected. Short-term disability contracts often provide choices such as 2 years, 3 years, or 5 years for the maximum benefit period. In the long-term category the maximum benefit period may often go to age 65 or even for lifetime. Some long-term disability coverages are automatically renewable to age 65 and conditionally renewable to age 70 or 75 if the individual continues to work at his or her occupation. Obviously the longer the potential benefit period, the higher the premium necessary to support such benefits.

Some companies differentiate between disabilities caused by injury and disabilities caused by illness. It is not uncommon for policies that use that type of classification to provide lifetime benefits if the disability results from injury but to limit benefits to age 65 if the disability stems from illness. Other companies offer a total range of options or the selection of the maximum benefit period for both injury and illness. For example, an individual could select injury to age 65 and illness to age 65, injury to lifetime and illness to 65, or the maximum of lifetime for both injury and illness. Companies that differentiate between injury and illness as a source of disability will not usually allow the maximum benefit period for illness to exceed the maximum benefit period for injury. In other words, you cannot choose the lifetime duration period for disability resulting from illness if you purchase coverage for disability from injury only to age 65.

The disability definition in concert with the maximum benefit period is the real essence of coverage. Coverage for a surgeon in his or her own occupation to age 65 is quite different from coverage to age 65 that provides own-occupation coverage only for the first 2 years and then provides coverage for any occupation for which the insured is reasonably qualified by reason of education, training, or experience to age 65. Comprehensive protection requires a combination of a generous definition of benefits and a maximum benefit period of age 65 or lifetime.

Short-term disability policies do not provide comprehensive protection against disability, but their main appeal is the premium savings associated with the relatively short maximum benefit period. The premium for a 2-year benefit period can be as low as 40 percent of the premium required to extend benefits to age 65. That percentage differential is for individuals aged 18 through 40. The percentage of premium reduction for short-term benefit periods reduces with age. At age 55 an individual is likely to pay nearly 50 percent of the long-term premium to obtain 2-year benefit coverage. As would be expected, 5-year benefit periods require higher premiums than 2-year benefit periods and range from 55 percent of the long-term premium for the ages between 18 and 25 to over 70 percent of the long-term premium by age 55.

Premiums for disability income policies are similar to life insurance policy premiums in that they are based on the policyholder’s age at the time of policy issuance and remain level for the duration of the coverage. Consequently an individual can lock in the greater percentage differential by buying the policy at a younger age and keeping it in force.

Short-term disability policies are sufficient to cover most disabilities since, by frequency of occurrence, well over one-half of all disabilities have durations of less than 2 years. The real shortcoming of these policies is that they do not provide adequate protection for the severe disability that lasts longer than the
2-year or 5-year benefit period. Consider a policy that provides $3,000 per month. If the individual is disabled, he or she receives $36,000 per year in benefits. For a 2-year benefit period the individual is limited to benefits of $72,000 per disability; for a 5-year benefit period he or she is limited to $180,000 per disability (paid out on a monthly basis for the duration of the benefit period if the disability lasts that long). A long-term disability policy to age 65 providing $3,000 per month in benefits could provide up to $1.7 million in benefits for an individual disabled at age 18.

In a short-term disability policy, the full benefit period is available for each separate disability the insured sustains, and an insured who sustains many separate disabilities could theoretically collect almost as much under short-term disability contracts as the maximum benefits payable under a long-term disability contract. The problem in selecting coverage is that no one knows in advance who is going to sustain a long, uninterrupted disability. Because individuals cannot control when and how they will be disabled, there is always the possibility that an individual could be disabled for longer than the benefit period available under short-term disability contracts. A short-term disability contract is clearly inadequate for a person who does sustain a catastrophic disability loss.

Some companies provide disability income coverages with benefit periods of 10 years, which are invariably classified as long-term disability contracts. The benefit period provides more protection than short-term disability contracts but is still less than lifetime coverage. In recent years the predominant maximum benefit period for long-term disability policies is to age 65. Such coverage ensures that the individual will have a source of replacement income until the normal retirement age for most individuals. The availability of medicare, social security, pensions, and other benefits beyond the age of 65 makes it less important to rely on disability income benefits beyond age 65.

Even those policies purporting to provide lifetime benefits for disability include limitations on disabilities occurring after specified ages such as 50, 55, or 60. Disabilities with their first onset after the specified age will often be limited to benefit periods of 2 or 5 years or may terminate at a specified age such as 65, 68, or 70. In other words, lifetime benefit payments are only available for disabilities that initially occurred before the specified age limitation and that remained continuous and uninterrupted for the remainder of the insured’s life.

Long-term disability policies are being issued to high-income individuals for significant amounts of coverage, such as $10,000 to $50,000 in benefits per month. Such policies present a potential liability of millions of dollars to the insurance company. For example, an insurance company could pay out $12 million between the ages of 45 and 65 for an individual insured for $50,000 in benefits per month. Even short-term disabilities under such policies result in benefit payments of $600,000 per year.

With such amounts at risk it is understandable that insurance companies are more restrictive in writing long-term disability policies than they are in writing short-term policies. Fewer occupations qualify for long-term disability coverage than for short-term disability policies. Long-term disability policies are rarely available to any occupation that involves physical labor or direct involvement in dangerous processes. For example, funeral directors are insurable for long-term disability as long as they do not participate in the embalming process. Pressmen who work in lithography are often eligible for long-term disability policies, but pressmen who work in printing plants are generally ineligible.

Long-term disability benefits continue for as long as the insured individual is disabled according to the contract provisions. Insurance companies often require repeated verification that the disability still satisfies the qualifications for benefit eligibility. Benefits for total disability will cease when the individual has recovered enough that the disability no longer satisfies the criteria of total disability. In long-term disability policies providing residual benefits, benefit payments may continue at a reduced amount when the individual has recovered enough to return to work but still sustains more than a 20 percent reduction in income. Total recovery of the insured will terminate any benefit payments under disability income policies. Short-term recovery with relapses often triggers a resumption of disability income benefits. Recovery is generally measured by a return to work. If the intervening work period is less than 6 months, the disability will be considered a continuation of the prior disability and the benefits will resume without having to satisfy a new elimination period. If the recovery and return to work last more than 6 months, most policies require that the recurrent disability be treated as a new disability rather than a continuation of the old one, and consequently, it must satisfy a new elimination period.

Obviously no benefits are payable under lapsed or terminated disability income policies. It is relatively unusual for such policies to lapse or to be terminated while an individual is disabled since most policies provide waiver-of-premium protection. Lapses and terminations usually occur before the onset of a disability and preclude the payment of benefits for subsequent disabilities. There is limited protection from lapses in the grace period that allows continuation of coverage by payment of premiums within 31 days after their due date. Most insurance companies will allow lapsed policies to be reinstated automatically if the premium is paid within 15 days after the end of the grace period. Lapsed policies will often be reinstated within 30 or 60 days of the end of the grace period without evidence of insurability if the insured applies for reinstatement. However, the insurance company has the right to impose evidence-of-insurability requirements in any case.

Residual benefits in disability income policies are designed to provide less than full benefits at the time during the recovery period when the insured is no longer totally disabled and is able to return to work but with a reduction in earnings. As mentioned earlier, this type of benefit is aimed more at measuring and offsetting the loss of income than at ascertaining the degree of physical incapacity. Obviously the loss of income must be due to the limitations resulting from the insured’s disability. Under some policies the total monthly benefit may be payable as a residual benefit if the lost income equals or exceeds 80 percent of the predisability income.

The basic philosophy behind providing residual-disability benefits or partial-disability benefits is to encourage an insured’s rehabilitation so that he or she can return to work as soon as possible. In the absence of residual benefits or partial benefits, the insured is often motivated to continue to meet the total-disability definition and not to risk a reduction in benefits by attempting to return to work.

Residual benefits may be payable for a relatively long period of time if the insured plateaus at some level of partial recovery. However, residual benefits are subject to the maximum benefit period provisions in the contract. For example, in a short-term disability contract providing the maximum of 5-year benefits, the combination of total-disability and residual-disability benefits is not permitted to exceed 5 years in aggregate for any one disability. Since residual benefits can and sometimes do exceed one year in duration, the residual-benefit provisions must deal with cost-of-living adjustments in policies that contain inflation protection. For residual benefits this means that the predisability income amount must be adjusted annually for continuous periods of disability. Without such adjustments the percentage of lost income would be underrepresented in the benefit calculation during periods of inflationary wage and price increases.

Each insurance company tends to have its own variation as to adjustment mechanisms for the predisability income amount during prolonged disability benefit periods. In general, the predisability income amounts are adjusted in much the same manner as the total-disability amount is adjusted under the cost-of-living adjustment provisions. This provision may be a flat stated percentage on a simple interest calculation basis, a compound interest escalation, or in some way tied to a consumer price index for items in general or for specific health care cost increases. Sometimes the provision is even a hybrid of a stated amount that can be increased more rapidly when consumer index prices exceed a threshold amount during any given one-year period. Another variation will have no increases at all unless there has been an inflationary index exceeding a stated threshold amount, such as 3 percent or 5 percent during the previous 12-month period.

Disability income policies specify the amount of monthly benefits to be payable during periods of total disability after the elimination period has been satisfied. At the time of policy issuance the stated monthly benefit amount will be in line with the insured’s income and should provide fairly complete protection. However, over time the stated benefit amount is likely to become inadequate as the insured’s income increases because of both inflation and job promotions. Disability income policies are available with provisions to counteract such erosion in benefit levels. These provisions fall into two different categories. First, there are provisions that provide increases in the benefit payments during periods of disability when benefits are being distributed. Second, there are provisions that are aimed at increasing the stated benefit level at various time intervals while the coverage is in force but the insured is not disabled.

Provisions dealing with increasing benefits during periods of disability are often referred to as either cost-of-living adjustments (COLAs) or inflation-protection provisions. They tend to provide either a fixed-percentage increase per year or a floating-percentage increase where the floating amount is determined by some external index such as a consumer price index. These benefits are almost always provided as an optional rider for an additional premium over and above the base policy. Many companies that do provide COLA riders offer purchasers a choice about the percentage increase ceilings on the rider. In other words, a COLA with a 3 percent annual increase will have one premium whereas a COLA with a 4 percent annual increase will have an appropriately higher premium. Some companies allow the purchaser to choose any rate between zero and 7 percent for annual increases.

In addition to these annual increase limitations, COLA riders usually contain an aggregate limit on benefit increases such as two times the original monthly benefit amount. For example, an insured may purchase a 5 percent flat benefit increase rider to a policy originally providing $2,000 per month in benefits and may subsequently become disabled for a continuous period of 20 years. After the individual has been disabled for one year, the benefit amount will increase to $2,100 per month, reflecting the 5 percent increase. After 2 years the benefit will increase to $2,205 if the increases are based on a compound interest adjustment or to $2,200 if the increases are based on a simple interest adjustment. If the COLA rider contains an aggregate limit of twice the original benefit amount, the policy will reach that upper limit of $4,000 per month after about 14 1/2 years of continuous disability if the adjustments are made on a compound basis. It will reach the $4,000 limit after 20 years of continuous disability if the adjustments are made on a simple basis.

COLA riders are extremely important in protecting the purchasing power of disability income benefits because insurance companies will not allow purchasers to obtain coverage for benefit levels in excess of their current discretionary income. Insurance companies are very concerned (with good reason) about overinsurance with disability coverages. Consequently they will not allow individuals to insure for excess amounts in anticipation of future inflation. The only way for insureds to keep future benefit payments in line with inflationary requirements is to obtain COLA riders with their base policies. However, purchasing COLA riders will not keep the initial benefit level in line with inflation prior to the onset of a disability. Many disability policies are in force for years before a disability occurs. Income and expense levels may have increased three-fold over that interval, but the level of disability benefits payable will not have changed unless additional coverage has been purchased in the interim.

There are basically three approaches to keeping disability income benefits in step with increased income for insured individuals who are not disabled. First, the oldest and least attractive method is to purchase new policies to supplement the in-force policies incrementally as income increases. The drawback to this approach is that it requires evidence of insurability every time incremental amounts of coverage are obtained. If the individual’s health deteriorates, additional coverage may not be available at any price.

The second approach to adjusting disability benefit levels is through a rider that guarantees the right to purchase additional coverage at specified future intervals up to some specified maximum age, such as 45, 50, or 55. This approach is similar to the first one in that additional coverage must be purchased every time an adjustment is needed. However, it differs in that additional amounts can be acquired at the specified intervals regardless of the health of the insured. These incremental purchases are subject to underwriting requirements regarding the individual’s current income. In other words, the insurance company will not issue new coverage if the incremental addition would increase aggregate disability income benefits above the underwriting guidelines for that individual’s current income on the option date. This is another way for insurance companies to prevent overinsurance and to minimize adverse selection.

Third, the most attractive way to adjust benefits upward for inflation while the insured is not disabled is to use riders that automatically increase the base benefit amount on a formula basis, such as a stated flat-percentage amount at each policy anniversary. Even this approach requires purchasing additional coverage, and the premium will be increased appropriately. As with the second approach, the additional increment of coverage will be purchased at premium rates based on the insured’s attained age at the time it is added to the policy. The real advantage to this approach is that the changes are automatic unless they are refused by the policyowner.

Insurance companies are not required to provide any inflation adjustments, and some insurance companies selling disability income policies choose not to make such riders available. Insurance companies that offer both options— purchasing additional coverage in the future and automatic percentage increases in benefits—will limit future incremental additions and make sure that they are in line with the earnings of the insured. Such companies will often refuse to issue the options if the insured has another policy that already contains such riders or if the base policy was issued on an extra premium basis because of health problems.

Insurance companies offering both automatic benefit adjustments and future purchase options as separate riders on the same base policy often suggest that the automatic increases be tied to inflationary expectations and that future purchase options be used to cover income increases due to career promotions. One problem with the latter suggestion is that many career promotions may come at ages beyond the guaranteed future purchase dates. In those cases the only way to increase coverage will be to purchase a new policy for which the individual must show acceptable evidence of insurability.

Premiums can be paid on an annual, quarterly, or monthly basis for these policies with premiums paid on a quarterly basis showing the lowest persistency. All the forms of automatic payment available for life insurance policies are also available for disability income policies. They can be set up on a payroll-deduction basis or an automatic bank draft plan. Premiums must be paid on a timely basis to keep the coverage in force, but the policies do contain a 31-day grace period for late premium payments.

In an attempt to make disability income insurance less costly, a few companies have introduced low-load policies. By reducing agent commissions and other expenses, the savings in premiums can be passed on to purchasers. It is not clear that this will result in more policy sales because it also reduces the incentive to the agent on a product that is already difficult to convince clients to purchase.

Most disability income policies automatically include the waiver-of-premium provision. For long-term disability policies some companies will waive premiums after 90 days of disability, while other companies will waive premiums after 60 days of disability. Some short-term disability policies may contain options as to what elimination period is applicable to the waiver-of-premium provision. Obviously the premium will vary according to the length of the elimination period. The shorter the elimination period, the higher the premium for the waiver-of-premium provision if it is charged separately. Disability policies differ as to whether the waiver of premium requires consecutive days or allows aggregate nonconsecutive days from short disability periods to satisfy the elimination period.

Some policies waive only future premiums after the waiver-of-premium elimination period has been satisfied; other policies will retroactively waive prior premium payments made after the onset of disability but before the waiver-of-premium eligibility requirements have been met. Once the insured individual recovers and no additional disability benefits are payable, premiums will no longer be waived and premium payments must be resumed.

Insurance companies do differ as to what mode of premium payments is assumed during a premium waiver. For example, if premiums are being waived on a monthly basis, the insured may recover shortly after a premium has been waived and would have to resume premium payments the following month. However, if premiums are being waived on an annual basis, recovery after 3 months or 6 months would result in an additional 9 months or 6 months of coverage without cost to the individual while he or she is not disabled unless other adjustments are made. Some insurance companies provide that policies on an annual premium-paying mode will switch to a monthly mode for purposes of waiver of premium during periods of disability. At least one company will actually change the mode from monthly to annually for waiver purposes after the insured is disabled continuously for a period of at least 12 months.

Sometimes policies differ as to whether or not the waiver includes the cost of riders under the policy. The higher-quality policies generally include all riders as part of the waiver, but other policies waive premiums only for the base policies, and thus premiums for supplemental riders will have to be paid even during periods of benefit eligibility. Premium waivers generally do not continue beyond age 65 even in policies providing lifetime benefits.

Some insurance companies offer on an optional basis a policy provision that will return some portion of premiums at specified intervals, such as 5 years or 10 years. For example, one company has an option that will return 60 percent of premiums paid at the end of each 5-year interval if no claims have been made during that 5-year period. This particular option can increase premiums by more than 40 percent over the base premium level. Other companies offer variations in the percentage of premium to be returned, such as 70 percent or 80 percent of the premiums paid, and in the duration of the interval over which the coverage must be without claims in order to collect the return of premium. The interval may be as long as 10 years under some company policy provisions.

The return-of-premium option is not available from some of the companies providing the highest-quality coverage for disability income policies. This type of option is definitely not an essential element of disability protection. Individuals who do suffer a disability and collect substantial benefits under the policy will find that the return-of-premium option merely increases the cost of coverage without increasing the benefit payable during disability.

The return-of-premium option has the strongest appeal to individuals who are convinced they will not become disabled. In fact, it may be the inducement necessary to convince these people to purchase disability income insurance.

There is one important negative aspect to return-of-premium options. The significant cost of this option may prompt individuals to limit the size of benefits they purchase to something less than the 60 percent or 70 percent of income generally available under most insurance company underwriting guidelines. The insured should have an adequate amount of disability income protection before considering the inclusion of a return-of-premium option. Protection levels should not be compromised in order to include an option that is not basic protection.

The higher-quality disability income policies may include some type of rehabilitation benefits, although many insurance policies do not include any such benefits. The policies that do include rehabilitation benefits tend to require the insurance company’s prior approval of the rehabilitative program in writing. Some companies limit the amount of rehabilitation benefits to 24 or 36 times the monthly total-disability benefit payable. Receiving rehabilitation benefits generally does not disqualify the individual from collecting total-disability benefits. In other words, the better policies will pay the full total-disability benefit and at the same time pay additional rehabilitation expenses over and above the monthly benefit payments. Policy provisions often require that rehabilitation programs be provided at accredited educational institutions, state or local governments, or otherwise licensed and recognized providers of sanctioned rehabilitation training. The objective of these programs is either full recovery from a disability or retraining the individual to accommodate a long-term or permanent limitation stemming from a disability.

In most cases it is extremely important that rehabilitative therapy be initiated as soon as possible after the onset of the disability. Unfortunately the insured is often the one who must initiate negotiations with the insurance company regarding rehabilitation benefits. The insured should inquire about viable rehabilitation treatment as soon as possible and then negotiate with the insurance company to determine which, if any, of the suggested treatments are covered under the rehabilitation benefits of the policy. Many policies require that the insurance company and insured agree to a written rehabilitation plan before therapy begins in order to qualify for reimbursement.

Pursuit of rehabilitative therapy without prior consent of the insurance company may negate rehabilitation benefits. It is extremely important for the insured to keep the insurance company informed of his or her status and treatment. Sometimes the insured will have to make a choice between different types of rehabilitative therapy that may or may not be acceptable to the insurance company. This situation forces the insured to choose between covered therapy or noncovered therapy and to absorb the cost of noncovered therapy.

Many disability income policies include provisions setting forth specific losses that will qualify for permanent total-disability status. They are referred to as presumptive-disability provisions because the individual is presumed to be totally disabled even if he or she is able to return to work or gain employment in a new occupation.

Presumptive-disability provisions generally include loss of sight, loss of speech, loss of hearing, or the total loss of use of or the severance of both hands, both feet, or one hand and one foot. As with other disability coverages, the presumptive-disability benefits will cease if the insured individual recovers to an extent that he or she no longer qualifies for the presumptive disability. For example, an individual may lose the use of both hands because of paralysis from a stroke or other causes. If the individual gradually recovers use of one or both of the hands, he or she no longer qualifies for presumptive disability benefits.

Presumptive-disability provisions differ as to whether or not the benefits will be paid as of the first day presumptive-disability requirements have been met or if the regular elimination period will still be applicable. Obviously the policies that provide presumptive-disability benefits from the first day of disability onset are more generous in terms of benefits.

Some disability income policies do not include presumptive-disability provisions. Policies that do provide for presumptive-disability benefits rarely charge a separate premium for the coverage and usually include it automatically as a part of the base policy.

The laws of all states require that disability income policies contain incon-testability provisions. These provisions give the insurance company a specified period during which it can contest the validity of the contract on the basis of fraud, concealment, or material misrepresentation in the application. If the insurance company has not canceled, rescinded, or otherwise terminated the coverage before the end of the contestable period, the insurance company will not be able to deny claims after the policy becomes incontestable even for reasons of fraud, concealment, or material misrepresentation in the application.

Generally the incontestable clause specifies that the policy will remain contestable for 2 years after the date of issue during the lifetime of the individual insured. Some insurance companies, however, include a provision that extends the contestable period for any disabilities occurring during the first 2 years of coverage. Under such a policy, if an individual were disabled for 13 months out of the first 2 years of the policy, the policy would remain contestable for 37 months (24 + 13). This type of extension provision is not found in the better disability income policies available in the marketplace.

Disability income policies differ as to how they treat disabilities intentionally induced by the insured for the purpose of donating vital organs or tissue to other human beings. The most generous policies provide the same disability benefits for such operations as for any other covered disability. The normal elimination period will be applicable, and then the appropriate level of benefits will be provided. Policies containing this coverage usually require that the policy be in force for a minimum of 6 or 12 months before benefits will be payable for such purposes. This is done to prevent people from purchasing disability policies with the express intention of making tissue donations.

If this protection is provided in a disability income policy, it is usually part of the base policy and covered in the base premium. Therefore this provision is rarely an option with a separate premium payable. Many insurance companies do not provide benefits at all for elective or voluntary surgery, which may be spelled out in the exclusion section of the policy or other sections setting forth limitations and coverage. If there is any question about whether the policy provides such protection, the question should be forwarded to the insurance company’s home office. Many companies that intend to provide benefits for voluntary surgery often make it an explicit part of their promotional materials for the coverage.

Many insurance companies make an optional provision available that requires a separate, extra premium to cover additional benefits payable when the individual is disabled under the base policy but does not qualify for social security disability benefits. The supplemental benefit is paid over and above the base disability benefit of the underlying policy. When claiming benefits under this option, the insured is generally required to apply for the social security or other social insurance benefits and then supply the insurance company with evidence that the benefits have been denied by the Social Security Administration or other governmental agency. Some policies further require that the insured must appeal the government’s benefit denial before benefits will be paid under this rider. Under most of these riders, the benefit payments are not retroactive and the first benefit payment will not be dispensed until the insurance company has accepted the denial of government benefits. In most cases the first benefit payment will be 13 or more months after the onset of disability. The delay occurs because it usually takes social security 5 or 6 months to process the claim denial after the 5-month elimination period. The insurance company then generally requires at least one month to process the claim to verify the denial.

The reason for this type of rider is that underwriting guidelines limit the amount of coverage that an individual can purchase to avoid overinsurance. In setting these guidelines the insurance companies often take into consideration the level of benefits that might be payable under social security for disability purposes. The maximum benefit available in the base policy can be supplemented under this rider so that the total benefits collected from the insurance company are essentially the same as would have been collected if the individual qualified for social security disability benefits.

It is quite common for an insured individual to satisfy the eligibility requirements of a disability income policy and be eligible to collect total- disability benefits from the insurance company while at the same time be denied disability benefits from the Social Security Administration. This occurs because the insurance companies generally use a much more liberal definition of disability than that used by the Social Security Administration.

Benefits under the social security rider will terminate for any period that the insured does receive benefits from social security or other specified governmental units in the contract. Provisions differ as to whether or not the social security rider benefits will continue during periods of residual disability. Some policies have the rider benefits terminate once the insured is no longer totally disabled. Benefits under social security riders terminate at age 65 even if the individual continues to be totally disabled. Election to take early retirement benefits under social security will also terminate benefits under a social security rider.

Under some policies the insurance company can require the insured to periodically reapply for social security benefits. Such requirements are reasonable and are merely used to ensure that the insured collects the maximum amount available under the governmental benefit provisions.

A few insurance policies will actually apply cost-of-living adjustments to benefits paid under the social security rider. Under such a policy both the benefits payable under the rider and the base benefit will be adjusted to reflect changes in the cost of living. These adjustments will be applicable after the individual has been receiving benefits for 12 consecutive months.

For an additional premium, some disability income policies provide the option of adding supplemental income benefits for periods of hospitalization. The intent of the additional benefits is to recognize that during a period of hospitalization, the insured’s need for income may rise because of deductibles, coinsurance provisions, exclusions, and other benefit limitations in his or her medical expense coverage. The benefit payable will be for a stated dollar amount, which under some policies begins with the first day of hospitalization and under other policies is subject to an elimination period that may or may not be the same as that for total-disability benefits. These riders generally contain a limitation on the duration of benefits for any single hospitalization.

Some contracts provide no elimination period at all, and hospitalization benefits are payable from the first day of hospitalization regardless of the length of the elimination period for total-disability benefits. Other contracts have a specified elimination period applicable to the hospitalization rider, which is often the same duration as the elimination period applicable to total-disability benefits although it may sometimes differ.

Many insurance companies issuing disability income policies provide participating contracts that pay policyowner dividends. In most cases little or no dividends are paid during the first 2 years of coverage, while under some policies no dividends are paid during the first 3 years of coverage. The level of dividends payable is a function of the company’s profitability on its disability income policies and thus subject to fluctuation. In general, dividends do increase with policy duration. As with dividends in life insurance policies, however, dividends cannot be guaranteed. Any dividend illustration is merely an extrapolation of past experience adjusted for expectations of future results.

Many disability income policies are issued on a nonparticipating basis and pay no policyowner dividends. Purchasers of these policies know the full cost in advance since there is no future reduction in cost through dividends.