DISABILITY INSURANCE – DURING A DISABILITY #3

How is “Loss of Income” determined when calculating “residual” benefits?

It is extremely easy to determine how much you are earning NOW. We look at financial statements, tax returns, or other documents and that will tell us. The reason this part is easy is that no one can debate the meaning of “now”. The questions arise when we look at what you WERE earning. “Were” creates many potential variables. Is it over the previous 6 months – the previous year – the previous 5 years?  All of those may give different answers and we need to know which base will be used when we do the math to calculate how much income you have lost.

One general comment – which makes this whole issue even more important: Most people who purchase individual disability insurance are not salaried employees – or if they are, salary only represents a part of their income. This type of individual has an income structure that tends to fluctuate – month to month and year to year (even week to week).

Of course, these clients establish a lifestyle based on what they reasonably expect to earn – and those expectations are based on what their general earnings history has been. Equally, however, these types of individuals can have sudden growth in income if they develop new clients or some other event occurs which triggers a sudden growth in income. Just as easily, they may have a temporary drop in income. The industry has generally created two definitions of “pre-disability income” in order to address these two different situations.

1. Sudden growth (and the client gets unlucky – a disability occurs at the worst possible time): Generally the companies offer an option of determining your “pre-disability income” based on something like “the best 6 consecutive months in the 24 months prior to claim”. It would not be reasonable to expect them to base the calculation on a shorter period (the best week prior to claim, for example) as anyone could have an unusual week – and no one should base their lifestyle on one week’s income.
2. Normal ups and downs – or even relatively steady decreases in income – in this case the company will look at the best two consecutive years of the three years prior to claim. I believe one carrier still uses “of the 5 years prior to claim” but given all that has happened in the economy and the insurance industry, I would not expect that to continue.

In any event, option #1 addresses one end of the scale and option #2 addresses the other – and the contract then guarantees that whichever of these two numbers is the greater will be the one used as the base to calculate how much income you have lost.

So – we have what you ARE earning and what you WERE earning. Is this all we need to know? Not really – because if we just use those two numbers, the effects of inflation will be ignored and may easily reduce the percentage of benefit payable if inflation causes the income you ARE earning to increase. In order to avoid that problem and treat the claimant equitably, once the “pre-disability income” is calculated based on the previous methods, that income is automatically increased based on the increase in the Consumer Price Index, so the only growth in your “post-disability income” is the real growth – not whatever may be caused by inflation.

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