Long Term Disability

Most employers allow some short-term sick leave, which might last from a few days to as much as six months, depending both on employer policy and on duration of employment. In the U.S., some state laws (for example, Hawaii, New Jersey, New York, and Rhode Island) require most employers to provide disability benefits for up to 26 weeks. In California, most employers must provide coverage for up to 52 weeks.

No laws currently require employers to offer long-term disability (LTD) insurance but it is estimated that almost half of mid-size to large employers provide long-term benefits for at least five years. Typical group long-term disability benefits replace about 60 percent of salary, start when short-term benefits are exhausted, and continue anywhere from five years to life. Often, group long-term insurance is fully paid for by employers without contributions by employees. (That's why employer-paid disability income benefits are subject to income tax.)

The basics of long term disability insurance

Many people don't realize the potential danger of becoming disabled. According to the U.S. Census Bureau, you have a one in five chance of becoming disabled. A 1997 study released by the census bureau reveals that more than 152 million people between the ages of 21 and 64 — the prime working ages for most Americans — have some form of disability. According to the American Council of Life Insurers (ACLI), a person age 35 is six times more likely to become disabled than die before he or she reaches age 65. With statistics like that, the need for long term disability (LTD) insurance becomes perfectly clear.

Becoming disabled can have devastating financial implications by stripping you of your ability to make a living. While some people can get by without working for a few months by tapping into their savings, few people can afford to stop working altogether for an extended period of time.

That's where long term disability (LTD) insurance can help you. LTD policies provide you with income for a long period of time, such as two years, five years, or until you retire. Most people who have LTD insurance get it through their employers, although you can buy individual LTD insurance on your own.

LTD picks up where short term disability (STD) leaves off. Once your STD benefits expire (generally after three to six months), the LTD policy pays you a percentage of your salary, usually 50, 60, or 66 2/3 percent. You then receive benefits until you reach age 65. The average premium for a group LTD policy in 1999 was $180, according to John Hewitt & Associates, a disability research company based in Portland, Maine.

If you pay your own premiums and do so with after-tax dollars, your disability benefits will be tax-free. If your employer pays for the policy, most likely with pre-tax dollars, your disability benefits will be taxable.

Most disability insurers will work with employers to try to get you back to work as soon as possible. While disability insurers want to see people healthy, rehabilitated, and back to work, they also save significant dollars if a claimant quickly returns to work. "Once you hit the LTD timeframe, you begin to manage the claim, in addition to paying it," says Eric Reisenwitz, senior vice president of group underwriting and disability claim operations for CIGNA Corp.

You'll most likely find your disability insurer "managing the claim" if you are "partially disabled" — meaning you can still work, but in a job that pays substantially less. LTD will pay you additional money if you decide to take a lower paying salary, as outlined in the following example.

Let's say you worked in a warehouse lifting crates making $40,000 annually. You then hurt your back at home and are forced to take a desk job that pays $20,000 annually. If your LTD policy was paying you 60 percent of your original $40,000 salary, it will now pay you 60 percent of what you are making in the lesser job. So now instead of staying at home and collecting $24,000 from your LTD policy only, you work at the lower paying job and make $36,000 (in addition to the $20,000 salary, you also get $12,000 in disability benefits, which is 60 percent of $20,000).

"They get their income from a new job, and they still get some kind of benefit," says Tracie Foster, LTD product director at Hartford Life. "We want them to be better off working than not working."

Monica Burnett, national accounts disability director for MetLife, says that some insurers will also reimburse the employee for child care expenses if the employee's spouse must go back to work as a result of the disability. "A lot of times, that's a huge factor in whether or not a person can return to work," she says.

Drew King, vice president of marketing at JHA Associates, says that some disability insurers give employers an incentive to have workers return to work on a part-time basis. He says it's common for insurers to give employers a premium reduction on the group policy if they allow a partially disabled person to come back to work on a part time basis.

If you become disabled and begin receiving benefits, you no longer have to pay premiums. Also, if you pay your premiums with after-tax dollars, your disability payments will be tax-free. If your employer pays for your group disability insurance with pre-tax dollars, your benefits will be taxable as income.

If your employer does not offer group disability insurance, or if you feel your existing group policy does not provide adequate coverage, you may want to consider buying an STD or LTD individual policy. According to the ACLI, a 35-year-old person who has a disability for 90 days is likely to be disabled for an average of three years. If you do not have individual LTD, going three years without working could be financially devastating.

You can buy this through financial planners or the same agents who sell you life insurance or annuities, or, more rarely, though, auto and homeowners insurance agents. If you choose to buy it individually, King estimates that the average premium could cost more than five to 10 times as much as a group policy, depending on your age, occupation, and annual income. You must take a medical exam to prove your insurability.

Individual disability pays you a flat amount each month, and most often you will not be paid more than 80 percent of your current salary. The insurance company examines your occupation, income, and other sources of insurance when determining whether it will cover you and what your premium will be. When it determines your rate, the insurance company places you in a rating class with people who have similar characteristics such as age, occupation, medical condition, and income.

Most policies are sold on a "non-cancelable" or a "guaranteed renewable" basis. Non-cancelable means that after you take a medical exam and the insurer issues the policy, the insurer cannot cancel the coverage or raise your premiums. If you buy a policy on a guaranteed renewable basis, the insurer cannot cancel the coverage as long as you pay premiums, but it can raise rates. However, the insurer cannot raise rates on an individual basis. Rather, it will raise rates if you are part of an insured group that has experienced a very high number of claims.

Generally, you can buy individual disability policies that will cover you for two years, five years, or until you turn age 65. Most individual policies also have features that allow benefits to keep pace with inflation or gradual salary increases, such as a cost of living adjustment (COLA), which adds a percentage to your coverage each year.

Though disability insurance can be costly if you buy it on your own, King says it is an essential part of a person's financial plan. "Everybody should have some kind of disability insurance protection," King says. "Since you're much more likely to become disabled than you are to die, you can make a coherent argument that you need disability insurance more than you need life insurance."