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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DISABILITY INSURANCE – DURING A DISABILITY #2

As discussed in the previous issue, there are many levels of disability.

Unlike death, which is either a case of “you either ARE or you ARE NOT,” disability is very much a “Where are you on the scale?” This actually has at least two causes:

(1)   Many disabilities progress from one level to the next – either getting better or worse, depending on the underlying cause. Examples: (a) cancer or MS generally get worse over time – going from a level which may have little or no impact on your ability to work to one where you are completely unable to work; (b) if you have a heart attack, generally you will not be able to work at all – you may be hospitalized and then spend time at home recovering. Then you will probably gradually return to full time work.

(2)   Totally independent of the nature of the disability, we have the nature of the person who is disabled. Some people will try to work from their hospital bed. I actually know a broker who called to discuss a pending case WHILE IN THE EMERGENCY ROOM OF THE HOSPITAL HAVING A HEART ATTACK! Let me just mention the concepts of pain threshold and motivation. These concepts are totally individual and subject to extreme variation.

To simplify the handling of this issue, the industry has developed two approaches. The first is the concept of total disability, which I discussed in my previous blog.

In this blog, I will address the concept of non-total disability.

There are actually two methods of dealing with this: partial disability and residual disability.

1. Partial disability – this approach examines which duties you can and cannot perform and/or how many hours you are able to work. It does NOT consider the income that you are earning. Generally, you have many choices as to how long benefits will be paid out – 6, 12 or 24 months; for 5 years or until age 65. The amount payable in this case is generally 50% of the amount payable in the event of total disability.

            For example, if the policy pays $4,000/month for a total disability, it would pay $2,000/month for a partial disability. If partial disability benefits are payable beyond 24 months, they GENERALLY reduce to 25% of the total disability benefit – or $1,000/month in this case.

2. Residual disability – this approach examines the income you lose due to your disability. It does not concern itself with what you can do or how long you can do it, but merely with the reduction in income. (Another way to differentiate the two approaches is: partial disability looks at capability while residual disability looks at efficiency.) If your income is reduced by less than 20%, no monthly benefit is payable. If the reduction in income is between 20% and 80%, a percentage of the benefit for total disability is paid for residual disability.

            For example, a 40% reduction in income would result in a payment of 40% of the total disability benefit – or $1,600/month using the previous example. The amount of the payment would vary each month depending on the level of income earned in that particular month. If the reduction in  income is 80% or greater, the full benefit is payable. This would allow the client to earn some income without affecting the amount of payment.

My next blog will deal with how the companies calculate what you WERE earning prior to disability, which gives the basis from which the loss is determined.

So, we have two approaches. Is one better than the other? Frankly, it depends on the client. If their income is directly linked to their efforts (e.g. they are in sales or are a fee for service professional), there would be little doubt that residual plans would more accurately compensate for any loss. On the other hand, if they own a company with a significant number of employees, they may possibly be sheltered from a reduction in income by the existence of those employees, therefore partial benefits might be the superior choice. Certainly partial benefits may be easier to collect, as there is no complicated accounting required in order to determine the loss of income.

Some products offer both features and allow you to choose the one which best suits your needs at the time of a claim, taking into account changes in work patterns over a career. Others mandate a choice at time of issue, which offers less flexibility.

The most important thing is that you have SOMETHING – be it partial or residual – so that you are not penalized for trying to work – or for the nature of your disability.

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DISABILITY INSURANCE – DURING A DISABILITY #1

The first word that needs to be defined is disability. We all seem to know what death means, but legally dead seems to need a definition. If the victim lacks a heartbeat, brain activity, and is not breathing – chances are that, unless they are a politician, they are most likely dead. The only ambiguity about death arises when dealing with disappeared and presumed dead or cause of death. However, as long as there is a body, it seems fairly easy to agree on whether or not the body is dead or alive.

Disability is not quite that simple. How disabled must you be in order to qualify for disability?  Does the plan only pay for total disability or does it cover situations where your ability to work is reduced, but not completely eliminated?

In this issue, I will only discuss how disabled you must be in order to be considered totally disabled. In general, the definition is divided into three parts:

1.      Own Occupation

2.      Regular Occupation

3.      Any Occupation

1.      Own Occupation

Generally imposes two requirements

1 - You must be unable to do your own job and

2 - You must be under the care of a physician appropriate to the disability (more on that later).

There is no requirement that you not be working. As long as you cannot do whatever it was that you were doing prior to disability, you will be considered totally disabled. This definition actually permits you to economically profit from a disability. For that reason, it is generally available only to the most favourable occupation classes. Some carriers even limit it to specific occupations within those classes. Frankly, it is of most value to those professions with manual content, such as surgery or dentistry. I find it difficult to imagine a situation where someone whose occupation is primarily knowledge-based would be unable to do his or her job, yet still be able to do something else.

Further, the purpose of insurance is to protect against a loss. I find that Regular Occupation does an excellent job of that.

2.      Regular Occupation

In addition to the Own Occupation requirements, Regular Occupation sets a third: that you not be working elsewhere.

It is NOT an issue if you are ABLE to do that other job. That will have no effect on your total disability claim. The only question is whether or not you are actually performing that other job. If you are, then total disability benefits will stop. By the way, when group insurance policies use the expression Own Occupation, they almost always mean Regular Occupation. I have never seen a group plan that did not include the phrase Total Disability does not exist if you are engaged in any gainful occupation.

Those two definitions are quite straightforward and not that difficult to understand.

3.      Any Occupation

Any Occupation leaves much more room for interpretation. First, a lot depends on whether or not there are any additional words in the definition. For example, it might read any REASONABLE occupation; it may even include a method of determining reasonable, such as based on your education, training and experience; finally it may even include an income test.

The bottom line is that, unless you are in the late stages of MS or other such MAJOR illness, you will have a much more difficult time qualifying under the Any Occupation category. One point to consider here is that almost all group plans begin with some form of Regular Occupation (often two years) and then switch to Any Occupation. This means that your clients will have to meet a tougher definition in order to continue qualifying for benefits. Some individual products also take that approach but USUALLY offer to extend the Regular Occupation period to age 65 – an offer I ALWAYS recommend to my clients. This is the most important rider, if the policy is constructed this way. I would NEVER put a disabled client through the stress that this Any Occupation feature can create.

Last item: under the care of a physician appropriate to the disability. This may seem obvious. If I have a problem with my heart, I would not be seeing the doctor who gave me my last colonoscopy. As a guy, I would never see an obstetrician PROFESSIONALLY. If I have a health problem, I want to see a doctor who specializes in that area of medicine. The only time where this MAY be an issue is with stress or other mental or emotional disorders. We MAY want to see our family doctor for this, but the insurer will want the treatment at least overseen by a psychiatrist.

More next time on “non-total” disabilities.  

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DISABILITY INSURANCE – BEFORE A DISABILITY

First off, I would like to thank Michael Taylor, Director of Brokerage, of Hunter McCorquodale Inc., for suggesting this approach. Any blame for the content lies with me, and credit and praise for the idea go to Michael.

Disability Insurance is COMPLICATED!

No, it is just DIFFERENT! In life, you have had to learn ideas, words, and concepts, etc.  You did not know all these things when you started out, you learned them as you went along, to the point where they have become second nature.

On the other hand, I do not know how to drive, so everything to do with a car is complicated for me, and I do not want to even think about a standard shift. For the majority of the population, however, operating a car is probably as simple as breathing. My objective here is to make Disability Insurance even simpler to understand than driving your car.

Before beginning with the terminology, let’s take a look at the most basic element of all: the types of contracts available. Our industry is infamous for making things difficult, so I will strive to make it easy.

There are 3 types of contract:

1. Non-cancellable and Guaranteed Renewable: A complicated way of saying that “Everything (wording, prices, EVERYTHING) is guaranteed.”
2. Guaranteed Renewable: A complicated way of saying that “EVERYTHING is guaranteed EXCEPT the price.”
3. Optionally Renewable: A complicated way of saying that “NOTHING is guaranteed.”

Now what do these three concepts mean to you – the consumer?

I am going to use the analogy of a mortgage. Those of us in our 60s remember when we could buy a home and the mortgage rate and conditions were guaranteed for the entire period of the mortgage, that is to say, for 20 or 25 years. Our parents would buy the house knowing that whatever the monthly mortgage payment was, it would NEVER change unless, of course, they remortgaged. This is contract option #1. You buy the plan today and regardless of any change in job, health, income, country of residence (ANYTHING) nothing will ever change.

Contract option #2 is today’s mortgage. You buy the house today and the payments are guaranteed for a limited period of time (for example 5 years). You know the house belongs to you, but you also know that the monthly payment can periodically change.

Contract option #3 would be like living in a motel. The daily rate can change, you can be asked to move, you never really know what the future will bring. You know what you have TODAY; you know what it costs TODAY, as for tomorrow? Who knows?

Let’s bring it back to disability insurance. Under Options #1 and #2, I can tell you the conditions of the policy, the amount you will collect. The only difference is that, for Option #1, I can also tell you the price you will pay for protection for the entire period of the policy; and, for Option #2, I can tell you that the price is subject to change but I cannot project the timing or the amount of those price changes.

For Option #3, I can tell you the rules as they apply today, but tomorrow they may change. There is no way I can predict the future.

By the way, Option #3 is any group plan, any association plan. There is nothing significantly wrong with Option #2. Option #1 is certainly superior but insurers are VERY reluctant to increase prices for “in force” policies as they know that this creates tremendous motivation for healthy clients to look elsewhere – leaving them with mostly unhealthy clients – and even worse claims experience. Frankly, I would avoid Option #3 if at all possible. I hate to play a game which has no rules. Actually, there ARE rules; it is just that they can be changed mid-game, and sometimes, even mid-play.

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DO NOT TOTALLY DEPEND ON YOUR GROUP LONG TERM DISABILITY INSURANCE! AND THIS IS THE BIG REASON!!!

All of the weaknesses pointed out in my last blog related to terminology: how easy or how difficult it can be to collect benefits, what problems are excluded, and whether you need to be “totally” disabled. I am not trying to say that these issues are unimportant, but they pale in comparison to the issue of whether or not the coverage will be there at all when you need it most.

Group insurance is based on two major assumptions:

(1) You will be working for the firm that offers the coverage when you become disabled and

(2) That firm will still offer the coverage.

Neither of those assumptions is reliable.

We no longer work for one employer. Statistics Canada says that we will have 3 careers and 8 employers on average over our working lifetime. Given that statement, there is at least a solid possibility that the benefits you may have at one point in your working life may not be there when you need them most.

In addition to that, we are seeing a major move to hire under contract, rather than as true employees. There is a solid financial reason why companies are doing this and it is unlikely to change. Canada and the United States are two of the most expensive economies in the world. One of the largest reasons for that is the generosity of employee benefits offered in North America especially as compared to the developing world and China and India in particular. If we wish to be competitive in this changing world, we need to find a way to lower those costs. My sources tell me that employee benefits increase payroll costs by 30%. One of the ways we have chosen to reduce these costs is by reducing or even eliminating employee benefits and leaving it up to the individual worker to protect himself. A modern approach (sometimes referred to as the “cafeteria approach”) consists of the employer advising its employees that $X is available to spend on benefits. They give the employees a list of benefits to choose from and let them choose the ones they want most. For example, the employer may give each employee a budget of $1,500 and list Medical, Dental, Vision, Life Insurance, Dependent Life Insurance, Short and Long Term Disability, etc – each of these with their individual cost indicated. The problem is that many of us tend to think short term without taking the time to truly understand what can impact us most severely.

I am wearing a fairly expensive ($1,500) pair of glasses but if I break or lose them, the financial impact on me is tiny compared to losing my income for 3 to 6 months. On average, a disability that lasts 3 months will most likely extend to 5 years.

Certainly I might break my glasses, but which hurts more? Losing my $1,500 glasses or losing the $250,000 (5 years at $50,000 annually) income that pays for them?

Let’s illustrate what you gain from having even a small personal policy. You are working at a job you like (or do not like). One morning, you find out (or decide) that you no longer work there. Let’s create an ideal scenario:

You are offered your dream job. A job that will allow you to work in a location convenient to home with a group of people you know, like, and respect. A job that matches your abilities, meets your desires, and offers a 50% salary increase. Would you accept it? What would happen if there were no employee benefits available? Would your decision change if you were a Type 1 Diabetic (or had some other significant condition)? This is where you would immediately see the benefit of the personal coverage. It gives you flexibility.

For several reasons, you should have individual disability insurance rather than group disability insurance. The protection offered is superior and you can count on it being there. Why then, do we not all buy individual insurance? There is the minor issue of BUDGET. Group insurance may be mandatory and is always less expensive (you get what you pay for). Recognizing this, what are your options?

First, establish the amount that you can afford to purchase individual insurance and guarantee your right to buy more should your situation change. The higher that amount, the more you can do RIGHT NOW – but any amount will buy you some flexibility and control. In this situation, there are 4 suggestions:

1. ALWAYS buy a 90-day Waiting Period for your individual policy. It costs about 50% of what a 30-day Waiting Period costs (waiting longer than 90 days has very little real impact on the cost; a 120 day Waiting Period saves you about 2.5% - even a 730 Day (2 YEAR waiting period only reduces the cost by about 21% - and you lose potentially 21 months of benefits) 
2. Buy a “Guaranteed Insurability” feature (I might even put this as #1) as this is what gives you the flexibility should you lose your group insurance for any reason;
3. Make sure that you are protected in your “Regular Occupation” for the duration of any claim. You do not want the insurer to be able to say “You are now able to do something else – so we cease all benefits”
4. Purchase some protection against “non total” disabilities.

The “Guaranteed Insurability” feature does two things: it allows you to purchase disability insurance with no proof of health and it guarantees your original occupational classification. Disability policies are priced (and the wording may differ) based on the occupational group the insurer considers your job to fall into. Two things which tend to improve your classification are (1) how long you have been with a given employer and (2) your established level of income. Two things are certain, if you change jobs you lose all of the benefits of #1 and if your income reduces or if you go “on contract”, you most likely lose #2. A properly designed, and priced, individual plan will solve all of these issues.

Click these for more information on the respective topics :
Long Term Care Insurance
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DO NOT TOTALLY DEPEND ON YOUR GROUP LONG TERM DISABILITY INSURANCE!

It is bizarre that very few financial advisors would suggest relying solely on Group LIFE; however, these same advisors have no problem allowing their clients to depend entirely on their Group Long Term Disability insurance. I will certainly not dispute that the amount of the Group Life insurance may well be inadequate, but other than needing more insurance, there is absolutely nothing wrong with the underlying protection.

On the other hand, there are significant holes in Group Long Term Disability insurance. Even if the group life insurance is all that a client has, the insurance can be converted on leaving the company, regardless of the insured’s state of health. This is rarely true of LTD and, even when it is, there may be requirements that the client be employed; requests for proof of income, or limitations on the policy wording. To my knowledge, one carrier actually seems to use group terminology for their converted individual policies. (This is not a good thing for clients) More on that in the next paragraph.

Group LTD generally protects only against total disabilities – or requires that partial disabilities be preceded by a period of total disability, which may work in the case of a heart attack, but has significant issues in the case of cancer or anything progressive or degenerative. Further, if you are someone who would continue to work, though not at full capacity, or if your job is consultative or communication-based, a total disability is not easy to imagine. I earn my living with my brains and my mouth; as long as I can think and talk, I am able to work.

Many group plans protect you for only 2 years if you cannot do your own job. Thereafter, they will probably require that you be unable to do any reasonable job. Yes, there is jurisprudence that states that new job must give you at least half of what you were previously earning, but how many of us could handle our obligations at half our current pay? Also the job does not have to be available, you just must be deemed capable of doing it. Insurers tend to get very theoretical here. I remember the father of a former co-worker who was deemed capable of returning to work as a file clerk. Even if we accept that the job would probably meet the income requirement (he had been a handyman at a school) there was one problem. He had a significant back problem. He would have very little problem working in the top drawers but would have a HUGE problem accessing the bottom ones. Also, when faced with a choice between hiring a healthy employee versus hiring one returning from 2 years of disability, which one would the new employer be more likely to hire? Yes I know discrimination against the disabled is illegal, but employers can always find an excuse.

Exclusions: Individual plans generally exclude pre-existing conditions (e.g. I have had a back problem since I was 5 – due to polio – and they will not cover that); any disability due to a war; any disability incurred while you are in prison; and any disability due to normal pregnancy (complications are generally covered). Group Disability will generally exclude many more conditions and some of those exclusions (self-inflicted injuries and criminal acts) are NOT as innocent as they may sound.

“Not portable” – if you lose – or leave – your job, almost no group insurance will follow you (and if it does, the coverage may be restricted. What happens if you get laid off? Fired? Just decide to leave? Based on Statistics Canada numbers, we have 3 careers and 8 employers over our working lifetimes.

“Only what you personally declare to the tax man” is covered. If you are self-employed (particularly if you are incorporated) – or if you “split income” with family members – or if you have “perks” which do not show up on your tax slip – group will not protect it. Individual policies will.

“What happens if my income drops?” With Group – so does your coverage. Individual? Stays the same

“What happens if I change occupations? Leave the country?” You lose your group in most cases. Individual coverage? Follows you – and prices and conditions do not change.

“What happens if my disability is intermittent?” The vast majority (over 90%) of group plans will not pay until the disability becomes permanent. Individual plans are MUCH more flexible.

“What happens if I choose to continue working beyond the “normal” retirement age of 65?” Your group terminates – individual continues

Individual offers a better definition of what constitutes disability, it offers coverage for both “total” and “partial” disabilities - Group only covers “total;” Individual also offers fewer exclusions.

Up next: The most important reason to buy Individual versus Group still to come…

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