Disability insurance is the most complicated type of personal insurance you can own. Even experienced insurance agents can find it challenging, so I pity the poor lawyer that attempts to find enough time in the day to read and understand their policy.
If you’ve read my prior columns, you already know that there is a huge financial risk of going without disability insurance. As a result, it’s extremely important understand how your disability insurance will pay a benefit in the event of a claim. Without getting into too many details, here are 4 questions you should ask about your disability insurance:
1. How does my policy define an eligible disability?
Don’t assume that having an illness or injury that prevents you from working as a lawyer is enough to qualify you for a claim. Depending on the type of coverage you own, the definition of disabled can vary and significantly impact your ability to qualify for benefits.
A typical employer provided Long Term Disability (LTD) program provides the weakest level of protection. Most of these contracts define a total disability as “unable to perform the essential duties of your own occupation and not working elsewhere…”. If you can’t work as a lawyer, you should qualify for benefits. However, if your claim lasts longer than 24 months, most LTD plans will only continue your benefits if you are “unable to perform any occupation for which you are reasonably able to perform by education and training…”. This is the most rigid definition and is intended to cover only the most serious disabilities. If the insurer believes your disability is not preventing you from working in a different occupation, you will no longer be considered disabled and your benefit will cease.
A typical personally owned Disability Insurance (DI) policy offered to lawyers defines totally disabled as “unable to perform the essential duties of your regular occupation…”. This is essentially the same as the LTD definition with one major difference; the definition of Totally Disabled will not change to “any occupation” after 24 months on claim. As long as a disability prevents you from working as a lawyer and you are not working elsewhere, most DI policies will continue to pay you a benefit to age 65 and in some cases for life.
2. How much money will I receive if I am disabled?
Personally owned DI polices offer monthly benefits based on a percentage of income after expenses, but before taxes. When you apply for this insurance, you are required to submit to extensive financial and medical underwriting, but once your policy is issued, your monthly benefit will be exactly what is stated on the policy. It will not be recalculated based on your income immediately prior to being disabled or reduced by any unearned income you receive from other sources while on claim. Unearned income is income derived from sources other than working. This can include benefits from another disability plan such as Canada Pension Plan (CPP) or an LTD benefit.
Unlike DI, the LTD benefit may not necessarily be the amount stated on your policy. This is where things can get a bit complicated.
The initial benefit calculation for a typical LTD plan is simply stated as a percentage of your gross income as reported by your employer. Because of this simplification, an LTD plan may appear to offer more monthly benefit when compared with a DI policy as it’s based on gross income. For example, a gross income of $150,000 would typically translate to approximately $6,800 of LTD benefit. However, DI uses after expenses income, not gross. If we assume that the $150,000 income works out to be $125,000 after expenses, the monthly DI benefit would be approximately $5,600 per month.
While it sounds like LTD offers an $1,200 per month benefit advantage when compared to the DI in this example, at time of claim this may not be the case.
Unlike DI, the insurer is going to request proof of your pre-disability income if you submit a claim. If your income immediately prior to being disabled does not support your current disability benefit, the insurer will reduce it accordingly.
Assuming you are approved for the full amount of benefit you’ve purchased, the insurer will then calculate the maximum you may receive when your benefit is added to all other sources of unearned income. This is called an All Source Maximum and it is typically 85% of net after tax income for a non-taxable benefit (the most common LTD plan).
The impact this can have on an LTD benefit is best illustrated using our income example from above and assuming a lawyer with 2 dependent children and a net income (after taxes and expenses) of $7,250 per month. Based on a reported $12,500 gross monthly income, the lawyer is paying for a $6,800 LTD benefit. However, based on the insurer’s 85% all source maximum, the insurer will not allow this lawyer to collect more than $6,162 per month (85% of $7,250) from all sources of income.
If the lawyer goes on claim and qualifies for an additional $1,200 per month (taxable) from the CPP Disability benefit, the total of all sources of income is $8,000 ($6,800 LTD plus $1,200 CPP). As this exceeds the insurer’s $6, 162 All Source Maximum, the LTD benefit would be reduced by $1,838 per month. So, while this lawyer was paying for a $6,800 LTD benefit, the actual claim paid becomes $4,962 per month with another $1,200 payable by CPP for $6,162 per month in total.
A typical DI policy for lawyers does not have an All Source Maximum. So in the above example, the benefit would be $5,600, plus CPP for a total of $6,800 per month. That’s over $600 more per month and it provides significantly better contractual benefits when compared to LTD.
3. Do I have enough coverage?
If your annual income after expenses is $100,000, the maximum amount of benefit a DI insurer will allow you to purchase is approximately $4,800 per month. An annual income of $250,000 equates to about $8,900 per month of benefit and $400,000 annually would be covered by $11,700 of monthly benefit. As previously explained, LTD amounts may appear higher.
While most DI plans can easily cover very high incomes, most LTD benefits have overall maximums that are below the levels required for high income professionals. Check your coverage details, if your LTD benefit is equal to the policy maximum, you are probably under-insured.
4. What happens to my monthly benefit if I am well enough to return to work part-time?
It’s not uncommon to have a disability that does not prevent you from working part-time or even full-time at a reduced income. In my experience, approximately 40% of totally disabled lawyers are eventually able to return to work on a part-time basis. So knowing what your disability insurance will cover under these circumstances is important.
A typical employer provided LTD plan may continue to consider you totally disabled and pay you benefits while you participate in an approved rehab or in a return to work program. However, this is temporary and most insurers will terminate your LTD benefits when you are no longer totally disabled.
A personally owned DI policy typically includes benefits for partial disability claims. If you can return to work, but your disability prevents you from earning a portion of your pre-disability income (usually a minimum of 20%), you would be entitled to a percentage of your total disability benefit proportionate to your loss. For example, if your total disability benefit is $7,500 per month and your disability results in a 40% loss of pre-disability income, you may be eligible to 40% of your benefit ($3,000 per month).
Please note that my advice is not intended to replace that of a qualified insurance expert who has personally reviewed your specific benefits and insurance needs. Some or all of what I have described may not apply to your disability benefits.
If you want to learn more about disability insurance before speaking to an insurance agent, The Canadian Bar Insurance Association (CBIA) offers excellent insurance education articles and planning tools for lawyers at www.barinsurance.com.