Disability insurance is financial protection for your most valuable asset the ability to work and earn an income. So why is it so commonly overlooked and misunderstood?
Homeowners insurance protects where you live. Car insurance protects what you drive. Health insurance protects your well-being.
To protect yourself against the risk of losing your paycheck due to injury or illness, there's disability insurance. In this article, we cover everything you need to know about this important
- Disability insurance is protection for your greatest asset your income. This type of insurance coverage replaces a portion of your monthly income if injury or illness prevents you from working.
- Having disability insurance provides financial security for you and any loved ones who may depend on your ability to earn a paycheck. The disability insurance benefits you receive from your policy can be used however you want, from monthly bills and out-of-pocket medical expenses to childcare and groceries.
- You may also hear disability insurance referred to as disability income insurance or income protection insurance.
Table Of Content
- What Is Disability Insurance?
- How does disability insurance work?
- Disability insurance underwriting
- Real-World Example of Disability Insurance
As its name suggests, disability insurance is a type of insurance product that provides income in the event that a policyholder is prevented from working and earning an income due to a disability.
In the United States, individuals can obtain disability insurance from the government through the Social Security System. They can also purchase disability insurance from private insurers.
How does disability insurance work?
Disability income insurance is an agreement made between insurance companies and policyholders. In exchange for the monthly payments you make, the insurance company agrees to pay you a monthly benefit amount if you suffer a disability that affects your ability to work.
Disability insurance is designed to replace a percentage of the income you lose due to your inability to earn a paycheck. Having disability insurance means being able to meet your financial obligations paying bills, covering household expenses, providing for your family while you’re unable to work.
A disability insurance policy will spell out.....
How much you will pay in premium. Just like any other type of insurance, this is the payment you must make each month to keep your coverage in force.
How the policy defines disability. Some policies will pay out a monthly benefit if an injury prevents you from working at your normal job, but allows you to do other types of work that will nonetheless reduce your income. Other policies will not pay benefits if you are able to work in another type of profession, even if you earn less money.
How much you will receive in benefits. In most cases, your benefit amount will be a percentage of your income. Policies typically pay 60 to 80 percent of what you earned before your disability.
How long your benefits will last. The benefit period may be a certain number of months or years, or up to a certain age.
Disability insurance underwriting
Your risk of becoming disabled plays a large role in determining how much you will pay for coverage. So how exactly do insurance companies calculate your risk of becoming disabled?
Individual disability income insurance requires underwriting. Whereas group plans help insurers spread their risk among a large group of policyholders, issuing an individual policy requires the insurance companies to assess the risk of a single applicant.
Before you get caught up in the cost, it helps to understand the various factors that insurance companies look at when assessing risk.
- Your age
The older you get, the more likely you are to become disabled. Naturally, the cost of disability insurance increases as you age. That’s why buying disability insurance is a smart investment for healthy young professionals.
- Your gender
All other factors being equal, women can pay up to 40 percent higher premiums for disability insurance. That’s because they file more claims than men and for longer time periods. (For what it’s worth, men get the short end of the stick when paying for life insurance.)
- Your health history
Your health status today can foreshadow your risk of disability in the future. Insurers will take into consideration
- Past or current tobacco use
- Chronic conditions
- Family medical history
- Your current height and weight
- Results from blood and urine tests
Once again, the younger and healthier you are, the better off you will be when buying.
Real-World Example of Disability Insurance
As a rough estimate, disability insurance typically costs about 2% of the annual salary of the person being insured. Of course, the actual amount will depend on the insurance carrier and on policy features such as those discussed above. Different individuals will have different preferences in terms of how much they are willing to pay in exchange for greater or poorer protections from potential disability.
To illustrate, consider two hypothetical workers. Worker A is a professional working in a highly specialized field. It took Worker A ten years of post-secondary education to become qualified in their field, and this has allowed them to generate a relatively large income of $250,000 per year. Worker B, on the other hand, is a high-school graduate who regularly switches between jobs and earns about $30,000 per year.
Worker A knows that, if they become disabled, they may still be able to work in another field, but this would very likely require a significant loss of income. For this reason, they decide to purchase a relatively expensive disability insurance plan that has a flexible definition of disability.
Because of Worker A’s high income, they can easily afford their relatively high premiums. Worker B, on the other hand, decides to opt for a plan with lower premiums even if that plan has a stricter definition of disability. In addition to having fewer resources available to pay for premiums, Worker B is also less reluctant to work in an area outside of their current occupation, since the nature of their work is less specialized.