LONG TERM DISABILITY INSURANCE

LONG TERM DISABILITY INSURANCE In Canada there are about 2 million disabled people of working age who reside in households. About 48% of them are severely or moderately disabled. Only about 40% of disabled adults are employed and more than half of those are limited in the kind of work they can do. Less than 10% of disabled adults of working age receive benefits from Canada or Quebec Pension Plans and only about 13% of them receive Workers Compensation benefits. There are a lot of people out there who are having a rough time of it due to a disability. Actuarial statistics show that any of us is five times more likely to suffer a disability than to die during our working lives. That s you and me: one in seven. About 80% of disabilities are resolved by the end of two years either by recovery or by death; about 90% by the end of five years on claim. Modern medicine has developed to the extent that many accidents or illnesses that used to be fatal are not, or are not so right away, and the patient can live on for some time, but as a disabled person. Indeed, some disabilities prolong life since the disabled person may be removed from a stressful business career. As an aside the author s grandfather had to withdraw from the workplace in his 30 s on account of a disability; he lived into his 90 s and the author played golf with him on his 92 nd birthday. Quite probably he would have died much earlier had his budding career panned out and had he had to cope with the stresses of a lifetime in senior management. Planning for death is somewhat simpler than planning for disability: you are either dead or alive. With disability there are degrees: some disabilities will affect one occupation more than another. The dead person is not consuming and requiring care; the disabled person is consuming, is an object of sympathy, and may require care and specially adapted equipment. In short, it costs money to be disabled. Governmental agencies have developed disability plans for specific purposes, such as Workers Compensation, the Canada / Quebec Pension Plans, and automobile accident insurance benefits. However, not many people who are disabled get to collect them since their definitions of what constitutes a disability are rather stringent: the surgeon who cannot operate on account of losing a thumb may be able to earn his living as a labourer or as a teacher and so is not disabled for purposes of such definitions. Many employers have brought in group disability benefits for their employees. This is good since large sectors of the population do have some benefits as a result. Even if the benefits are less than perfect, they are better than no benefits. Many professional and trade associations have developed their own voluntary group benefits to which members can subscribe and this, too, is good, for the same reason. Quite probably a large measure of the population who are covered this way are reasonably well covered. Certainly much better-covered than they would be if dependent purely on the statutory plans. However, the upwardly-mobile semi-affluent to affluent members of society are not protected very well by these schemes, at least not in proportion to their pre-disability income levels. These folks should take such group schemes into consideration when planning, but they should not count upon them as their sole source of support during a period of disability. 1

Employer group long term disability insurance is designed for a group of people, not for one person. It usually provides a portion of one s pre-disability income to the disabled person for a period of time, such as two years, five years, or to age 65. Usually it is not indexed to inflation. The benefit when received is taxable if the employer pays any portion of the premium; non-taxable if entirely paid for by the employee. From the benefits to be received, usually, is deducted the amounts that would be payable by the Canada / Quebec Pension Plan, Workers Compensation, and other statutory benefits. Medical evidence of continuing disability has to be provided more or less constantly to keep the benefits coming. Almost always, with group insurance, there is a cap on the benefits, such as $3,000 or $5,000 per month, sometimes more. Often the definition of what constitutes a disability will be reasonable for the first couple of years but, after that, may become more stringent. Often it is a condition of employment that all employees of the company subscribe. If so, employer group long term disability insurance is in place and usually it cannot be dropped by a member of the group, even the boss. The contract is between the insurance company and the employer; this means that: the insurer may decide not to renew it the employer may transfer the plan to another carrier who could be offering a reduced premium but who may not accept all the employees, especially those who are older or who have a claims history the employer might not be able to make premium payments in a poor economy and so the coverage lapses the employer, or the insurance company, may go out of business the employed person may lose his job and the disability insurance is therefore discontinued Any of these circumstances could mean cancellation of the coverage. There are no rights of continuation and whoever gets cancelled is on their own. Association group long term disability insurance is also a contract that excludes the individual as a party to it. It is made between the association (ie Chamber of Commerce, professional association, union, etc) and the insurance company. For the same types of reasons that an employer group contract can terminate, an Association can be dropped by an insurance company or can face huge premium increases. It does happen. However association group coverage is voluntary and, from a planning standpoint, it is less of a stumbling block since it can be replaced more easily with a more advantageous privately-owned plan. A privately-owned non-cancellable disability insurance policy is a contract between the policyowner and the insurance company. So long as the premiums are paid the policy cannot be cancelled or altered in any way without the policy-owner s consent. It is not dependent upon the insured person being in any particular occupation or belonging to any group. It stands alone. It is more expensive than the other two types and it provides better coverage with much more flexibility than the other two, obviously, since it is designed for one person and not for all classes of employees above the rank of foreman or some such. 2

How do we construct the best value income replacement program for our clients, using these three types of coverage? A needs analysis almost always will indicate the need for at least as much income replacement insurance as can be bought. Please understand that disability insurers have no wish to provide as much or more income during a claim period than the individual was earning prior to the disability: there needs to be some incentive to get back to work and off claim. Unlike life insurance, where one can purchase more or less any amount they might want, disability insurance is strictly underwritten on the basis of how much you really need in the eyes of the underwriter, and not a penny more. Underwriters generally are not overly well-paid themselves and usually do not understand why anybody else should be well-paid or heavily insured. A common problem for financial planners is dealing with an executive who is trapped in his or her own employee group plan which caps out at, say, $5,000 per month, non-indexed, with a to age 65 benefit period. If the definition of disability is decent (meaning own occupation to age 65) this may not be too bad. However from this would be deducted the statutory benefits referred to above. Probably the benefit is not indexed to inflation. Would the $5,000 of monthly benefit be enough to replace an earned income of $250,000? How would it feel ten years later with no increases? How would it seem if the own occupation definition changes after, say, two years to any occupation and the claimant is no longer deemed disabled according to the definition of disability, and the benefit stops? Think about it. After being a neurosurgeon or a chief financial officer of a large company, would you be happy as a letter carrier, supposing you could even get a job as a letter carrier? Also, there is no stipulation that a job you are deemed fit for has to be available. The underwriting limits for a private carrier might permit you to top up existing group insurance with a smaller private disability insurance plan. Limits vary from company to company but most insurers would permit a top-up from $5,000 against an earned income of $250,000. Generally speaking, as the income level rises, the proportionate amount of income replacement insurance a company will issue declines. It could be 70% of a $50,000 income, going down to, say, 30% of a $500,000 annual income. Proper financial planning requires us to remember you may not always be who you think you are. Downsizing may take its toll; you may wish to become a free-lance consultant; you may get another job offer from a company that doesn t offer a benefits package. Your group disability insurance is not portable; your privately-owned disability insurance policy is completely portable. There are options you can build into your privately-owned disability insurance plan that can act like a self-inflatable raft: it becomes expandable when you need it. Let s look at these options and see what they do. The cost of living adjustment (COLA) rider indexes the benefit received, while on claim, to inflation or to some other scale of increase such as a set percentage of the original face amount of the policy. Thus it increases the benefit amount each year, during a long period of disability, to prevent the insured person being caught in a fixed income squeeze. The face amount update indexes the face amount of the policy while the insured is not on claim, thus keeping the policy in line with inflationary trends without having to apply for more insurance simply on account of inflation. 3

A lifetime benefit period is just what it says it is. The benefit lasts as long as the insured is alive and still disabled. While on a prolonged claim, you would have trouble finding the funds for retirement savings. This helps offset the fact that you might not have enough money set aside for retirement by keeping the payments coming, hopefully indexed, as long as you live. Lifetime presumptive total disability defines certain types of major losses (such as hearing, sight, limbs) and de-hassles future claims by eliminating the need to provide continuing evidence that you are disabled. While on claim the retirement protector benefit pays an agreed-upon amount each month to a trust fund established for the insured. Usually an individual on claim has little or no taxable earned income and, therefore, cannot contribute to an RRSP. This develops a non-registered offset to assist in providing a retirement income. It is useful instead of a lifetime benefit period and/or for the protection of the insured s spouse. The future income option allows the individual to purchase additional disability insurance without having to provide medical evidence of insurability, just financial evidence. This is particularly useful for individuals whose income potential has not yet been realized. It is also useful for individuals who have been terminated, particularly if the wording of the option permits the use of historic rather than current income for underwriting purposes. Your own or regular occupation definition of total disability is extremely important, if available, since it is your occupation which provides your income. Private plans should have this available for the duration of the contract, less likely for group plans. Residual definition of disability is essential since some disabilities are not total and you can sustain an income loss without being totally disabled. This definition provides for a proportionate amount of the benefit to be paid to correspond to the degree to which your income has declined on account of a disability. Both own occ and residual definitions should be included in your policy if available. The zero day qualification period allows you to claim a partial disability benefit without having to be totally disabled first. Without it, you might never collect since many partial disabilities are not preceded by a period of total disability. Indexing of pre-disability earnings is essential for the client who is on a partial or residual claim. Without it, working part-time at his own occupation, he could be done out of his claim simply on the basis of inflationary increases in his earned income. The group offset rider is essential for those who are topping up an existing group insurance policy. It causes the private plan to treat the group plan as a first payor and then it builds on top of and around the group plan, extending the private plan s definitions and strengths to supplement the group plan s benefits. Should the group plan stop paying, perhaps due to a time-weighted definition of disability, the private plan would pick up the slack. Meanwhile all the benefits of the private plan would be extended to the first payor group benefit. 4

How do we put all this together? Disability insurance is extremely complicated due to the large number of variables. There are a few cardinal rules to follow in planning your disability insurance program. You need as much as you can get You need most of the available riders You need the highest quality plan available to you A quotation for disability insurance often bears little apparent relationship to the final policy that is issued. This is particularly true of self-employed individuals who typically do not have a high income for tax purposes but who nonetheless enjoy significant earnings. In applying for disability insurance your motivation should be the opposite to your motives in compiling your tax return. Individuals who work mostly at home are apt to have difficulty in obtaining disability coverage since it is a problem for the insurer to know if they actually are disabled during a period of claim. The need to go out and about frequently is helpful in obtaining the coverage. Individuals who are thinking of leaving their steady jobs should review their disability coverage well ahead of departure. Just because they were paid a large salary as an executive does not mean they can make it successfully on their own. Insurers want to be certain that they will not be paying a disability claim that is really the result of a business failure. However once a private plan is in place, there is nothing to stop an insured person from starting their own new business or changing jobs, provided the coverage was not taken with that in mind in the first place. Individuals who are terminated from their jobs almost always will have their group disability insurance terminated on their last day of work. Even if the other benefits are continued for a period of time. This is why a privately-owned plan of disability insurance is so much better as it continues so long as the premiums are paid. A private plan is underwritten at the time of application rather than at the time of claim. If you are terminated from employment, there are a small number of bridging disability plans available to provide a modicum of coverage during the period between jobs. They all require your prompt application, usually within 90 days of termination, or you may not qualify. If you are terminated from your job we invite your prompt call so we can work on replacing your benefits. Please see separate article about disability insurance in job termination. How much does it cost? Privately-owned disability insurance is perceived to be expensive and, sometimes, difficult to obtain. However, compare the difference in present value between an indexed benefit with a lifetime payout period to a flat benefit that stops in, say, five years. Which would you rather have and which would you pay more for? In summary, you want to know you have the coverage now, and that you will continue to have it when you need it. The only way to do that is to deal directly with the insurance company and not interpose an employer or professional association between you and the insurer. The cost is more for a privately-owned, non-cancellable, guaranteed renewable policy. These are serious guarantees and guarantees cost money. The benefits are more too. 5

The author invites your call for a quote and a discussion..... Provided as a courtesy for the clients and associates of.... e&oe STEPHEN B H SMITH, CEB, CFP, PRP YORKMINSTER INSURANCE BROKERS LIMITED 105 Dorset Street West Port Hope, Ontario, L1A 1G4 Telephone: (905) 885-4977 Facsimile: (905) 885-2556 Tollfree: 1-800-668-1751 Mobile: (905-373-5670 sbhs@yorkminster.ca www.yorkminster.ca 6