Disability Insurance Overview – Income Replacement Part 1

May 13, 2024 | AEB Insights, Employee Benefits

Introduction:

According to the Social Security Administration (SSA), “more than one in four of today’s 20-year-olds in the workforce will become disabled before they retire.” [1]  Many disabilities have long-term effects, but frequently, a short-term disability (STD) plan can help employees afford their basic living expenses (rent, groceries, transportation, and child care) while they recover.

“If you have 10 or more employees, a group disability benefit may be a valuable addition to your employee benefits package. Group disability plans typically provide a totally disabled covered employee with a benefit of up to 60% of their pre-disability income, to a specified maximum, such as $10,000 a month. It can help to cover personal expenses as well as provide business overhead protection.” [2]

The Hartford

Income replacement (disability) insurance is a type of coverage that helps provide financial protection if income loss occurs due to disability or illness. It replaces a portion of the insured’s income— typically a fixed percentage, for a specified period of time to help maintain their financial stability.  Disability insurance comes in numerous “flavors” from Short- to Long-term plans and then specialized coverage for Key Employees (aka Key Person) or to help a business remain operational (Overhead Expense) should the business owner become disabled.   Coverage can exist as either group- or individually-based plans: Short-term Disability (STD) or Long-term Disability (LTD) Insurance. [2]

Employer-Provided Disability Insurance

If a business can afford it, offering disability benefits may become a powerful tool to attract and retain employees. Turnover can often be disastrous to a company, especially when losing employees with special skills or talents makes them difficult to replace. Further, some disability insurance may actually cover part of women’s pay during pregnancy and maternity leave. The federal FMLA (Family & Medical Leave Act – U.S. Department of Labor) already mandates the option for 12 weeks of unpaid leave to secure their position remains available until their return.

About This Income Replacement Insights Series:

This is the first of a 5-part series of Insight articles to provide the overview in this introductory post and dive into more specifics in Parts 2 through 5.  “Income Replacement” is considered as synonymous with “Disability Insurance” but may also be present in some life insurance policies. For the purpose of this Insights series, our focus is on Disability Insurance.  These are the series topics:

  • Disability Insurance Overview – Income Replacement Part 1 – you are here
  • STD (Short-Term Disability) Insurance – Income Replacement Part 2
  • LTD (Long-Term Disability) Insurance – Income Replacement Part 3
  • Key Person Disability Insurance – Income Replacement Part 4
  • Overhead Expense Disability Insurance – Income Replacement Part 5
Disability Insurance Overview - AEB Insights Income Replacement Part 1 - employee pushing in a wheelchair

Given the above-referenced statistics, sadly, only about 40% of employees have short-term disability insurance coverage. So when an employer does offer this as a group disability benefit, it’s a powerful tool in assisting an impacted employee to recover and not suffer so greatly from financial stress.  For the remaining healthy employees in the organization, it leverages loyalty, increased job satisfaction, and peace of mind should their lives be touched by disability.  Employees who do not have such protections in their benefits plan may otherwise leave the workforce.  Further, those without any protection can take two or more years to recover financially over those with even some coverage.

 “Only 14% of Americans own some form of disability coverage. 51 million Americans lack sufficient disability insurance coverage.” [3]

— LIMRA Insurance Barometer Study, 2021 source via New York Life

If an employer does not offer a group policy, employees certainly can proceed with an individual disability income plan on their own.  Or they may be able to fill the gap with an employer-sponsored plan and to expand the amount available should an individual employee need to survive financially if they become disabled.

According to Peck, a middle-of-the-road individual policy may cost $2,000-3,000 in premiums per year, while group coverage for ten employees can cost $300-500 for the entire group. [4]

Source via NBC News

Overhead Expense Policy Options to Explore

OE Options to ExploreDescription
Renewable after age 65A Renewal Option may continue the policy beyond the termination date if the owner works at least 30 hours per week and is not disabled at the time of the request. Certain limitations apply.
Total Disability BenefitIf enabled, the policy would pay benefits if the insured cannot work in his or her regular occupation because of a total disability, as defined by the policy.
Partial Disability BenefitIf enabled and the owner is partially disabled, the policy could reimburse  50 percent of the covered business expenses (up to the policy maximum) for up to six months.
Benefit and Expense Carry-forward FeatureThis option provides that while the insured remains continuously disabled, unused benefits and unreimbursed expenses may carry forward to future months of continuous disability (subject to policy limits).
Conversion OptionThis option may be available for those business owners whose needs change after two years from the effective date AND before turning 60.  The owner may request conversion of this policy to an individual disability income policy. Certain limitations may apply.
Waiver of Premium BenefitWhile the business owner is disabled, the carrier waives future premiums due and will refund any premiums already paid since the disability began.
Presumptive Total Disability BenefitWith this enabled, the carrier presumes that the business owner is eligible for the total disability benefit if an injury or illness results in loss of speech, hearing in both ears, sight in both eyes or use of two limbs, as defined by the policy. [2]
Survivor BenefitIf the business owner dies while receiving total disability benefits, the carrier will pay the owner or the owner's estate up to three times the base amount but not more than any remaining maximum benefit. This benefit is not available in some states.
Salary ReplacementThis rider may be available to occupation classes 3A, 4A, and 5A and potentially at no additional cost. It allows the business to hire someone (other than a family member) to perform its duties and to have that person's salary included as a covered expense.
Residual Disability RiderThis rider adds residual disability and recovery benefits to the business owner's coverage. When enabled, the carrier could pay a residual disability benefit if the business loses at least 20 percent of its income while the owner attempts a return to work. Policies may also pay a limited recovery benefit for up to 12 months if, immediately after a disability for which the owner received benefits, said owner returns to work for at least 30 hours per week in his or her regular occupation.
Future Purchase Option RiderAs the business grows and its expenses increase, this rider allows it to purchase increased benefits at two-year intervals, regardless of health (subject to financial underwriting requirements).
Disability Buy-Out PlanWhen a disability prevents one business owner from fulfilling obligations to the other business owners, a disability buy-out plan can help mitigate this risk.  These policies are structured to fund business partners to purchase an owner’s interest in the business if he or she becomes totally disabled. This coverage maximizes the financial return when a company is transferred while minimizing tax liability.
Options described below are not necessarily available with all carriers and policies.

Supplemental Disability Insurance

While the same policy provisions and benefits of individual disability insurance apply, there is a maximum amount of supplemental benefits an individual is eligible to receive based on their income and any existing group benefits in force.


Overhead Expense Policy Options to Explore

OE Options to ExploreDescription
Renewable after age 65A Renewal Option may continue the policy beyond the termination date if the owner works at least 30 hours per week and is not disabled at the time of the request. Certain limitations apply.
Total Disability BenefitIf enabled, the policy would pay benefits if the insured cannot work in his or her regular occupation because of a total disability, as defined by the policy.
Partial Disability BenefitIf enabled and the owner is partially disabled, the policy could reimburse  50 percent of the covered business expenses (up to the policy maximum) for up to six months.
Benefit and Expense Carry-forward FeatureThis option provides that while the insured remains continuously disabled, unused benefits and unreimbursed expenses may carry forward to future months of continuous disability (subject to policy limits).
Conversion OptionThis option may be available for those business owners whose needs change after two years from the effective date AND before turning 60.  The owner may request conversion of this policy to an individual disability income policy. Certain limitations may apply.
Waiver of Premium BenefitWhile the business owner is disabled, the carrier waives future premiums due and will refund any premiums already paid since the disability began.
Presumptive Total Disability BenefitWith this enabled, the carrier presumes that the business owner is eligible for the total disability benefit if an injury or illness results in loss of speech, hearing in both ears, sight in both eyes or use of two limbs, as defined by the policy. [2]
Survivor BenefitIf the business owner dies while receiving total disability benefits, the carrier will pay the owner or the owner's estate up to three times the base amount but not more than any remaining maximum benefit. This benefit is not available in some states.
Salary ReplacementThis rider may be available to occupation classes 3A, 4A, and 5A and potentially at no additional cost. It allows the business to hire someone (other than a family member) to perform its duties and to have that person's salary included as a covered expense.
Residual Disability RiderThis rider adds residual disability and recovery benefits to the business owner's coverage. When enabled, the carrier could pay a residual disability benefit if the business loses at least 20 percent of its income while the owner attempts a return to work. Policies may also pay a limited recovery benefit for up to 12 months if, immediately after a disability for which the owner received benefits, said owner returns to work for at least 30 hours per week in his or her regular occupation.
Future Purchase Option RiderAs the business grows and its expenses increase, this rider allows it to purchase increased benefits at two-year intervals, regardless of health (subject to financial underwriting requirements).
Disability Buy-Out PlanWhen a disability prevents one business owner from fulfilling obligations to the other business owners, a disability buy-out plan can help mitigate this risk.  These policies are structured to fund business partners to purchase an owner’s interest in the business if he or she becomes totally disabled. This coverage maximizes the financial return when a company is transferred while minimizing tax liability.
Options described below are not necessarily available with all carriers and policies.

How much is enough?  How are disability needs calculated?

AEB works hand-in-hand with employers on strategically designing Employee Benefits Plans,  Further, AEB works directly with individual employees to understand their benefits and educate them about any customizable options.

When planning for disability needs, everyone should examine their monthly income versus expenses to ensure enough money is available to cover the cost of living. The COVID-19 pandemic taught everyone that saving money to cover several months of living expenses is prudent. However, that is not always feasible for everyone especially with our present economy.

Total Monthly Income:

If one becomes disabled, what are the potential sources of monthly income?

  • What is the monthly benefit amount of any current group disability coverage?
  • What is the monthly benefit amount of any current individual disability coverage?
  • Is there a spouse or partner’s after-tax income (net) that might be available to supplement monthly expenses?
  • Any other sources of monthly income?

Total Monthly Expenses:

What monthly expenses must one consider in calculating the minimum disability benefit?

  • Mortgage or rent
  • Homeowners or renter’s insurance
  • Utilities
  • Home maintenance costs
  • Car payments & insurance
  • Car expenses – gas & maintenance
  • Child care expenses
  • Food & Clothing
  • Bank & credit card payments
  • Medical expenses
  • Savings, investments & retirement funds (e.g., IRA) available (not income but required payments or deductions)
  • Insurance premiums, e.g., life insurance or other premiums not included in a paid employee benefits plan (perhaps family coverage)
  • Other monthly expenses (e.g., miscellaneous household, education, entertainment, and sports)

The above elements should be analyzed to determine the Total Monthly Income available to the employee compared to their Total Monthly Expenses and whether additional monthly income is needed should they incur a disability.

How does AEB help in designing income replacement plans?

In the strategic design of Employee Benefits Plans, as a broker, AEB works for the employer and not the insurance company. Therefore, our expertise and knowledge of the business and industry carriers and their available plans will result in leveraging the best and most cost-effective plans for a business.  AEB traverses the benefits of shopping and plan design experience for the following options:

  • Risk Assessment—Insurers have a Standard Industry Code for every occupation, which considers characteristics of industries that are considered high-risk and might have a higher premium cost. However, those in lower-risk jobs are not penalized.
  • Recommend that employees secure disability insurance before they need it and while healthy. Many policies require medical underwriting, and that may include a confidential review of their medical records, blood tests, and a physical (not usually required for group plans).
  • Consider stacking older policies, as applicable, to adjust benefits based on any salary increases that have occurred over the years to ensure the monthly benefit reflects the insured’s true income.
  • Figure out average income. As disability plans use annual net incomes as the basis, disability income needs can be tricky for individuals who have flexing income. Using the last three years of income tax returns, proof of income provides total income and then gets divided by 36 to derive the monthly income requirement.
  • AEB does the comparison shopping on the employer’s/employee’s behalf.
  • AEB will advise the employer and employee on discerning the best possible plan within budget and needs. While everyone wants low costs, going cheap might not be the best strategy. Likewise, there may be better options than the most expensive plan. AEB will present the information and transparently communicate our expert recommendations.
  • Drop disability coverage as employees reach age 65. Why? If a doctor diagnoses and certifies an employee as disabled at age 65, they will be likely considered “retired” by the insurer, and the insurance policy won’t pay. It’s essential to know the policy fine print for what the insurer considers “retirement age” so as not to pay for a benefit one might never receive.

Conclusion

Income Replacement in the form of Disability insurance covers both group and individual Short-term Disability (STD) Insurance and Long-term Disability (LTD) Insurance Plans. When companies offer Disability coverage as part of their Employee Benefits Package, they not only provide a safety net for their employees but also have a robust and competitive tool to attract and retain top talent. This demonstrates a commitment to the well-being of their workforce and can significantly enhance their employer brand. Again, Associated Employee Benefits (AEB) works with both employers and employees to navigate the terrain of what can be complex and confusing to most with our expertise.

 


Reference Sources¹

Cited references with some as direct quotes.

  1. Disability Income.
  2. Disability | California Business Benefits. cited by The Hartfords as stated above
  3. LIMRA Insurance Barometer Study, 2021 – New York Life
  4. NBC News
  5. Which Benefits Should You Offer Your Employees? – Market Business News. 

Review the following relevant AEB content:

Other Posts in this series as they are published:

  • STD (Short-Term Disability) Insurance – Income Replacement Part 2
  • LTD (Long-Term Disability) Insurance – Income Replacement Part 3
  • Key Person Disability Insurance – Income Replacement Part 4
  • Overhead Expense Insurance – Income Replacement Part 5

​¹Outbound links all open in a new browser window or tab

Data accuracy effective:  13 May 2024 (laws and statistics can change, and we will endeavor to update when they do)

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