The Disability Insurance Trap

One out of every four Americans will miss at least 90 consecutive days of work because of an injury or sickness between the ages of 35 and 65. Disability insurance can help prevent such medical disasters from becoming financial disasters.

However, disability insurance is usually obtained through deeply flawed group policies offered by employers. Employees with such group coverage often aren't adequately protected.

Here's what to watch out for and how to get the best coverage...

PROBLEMS WITH EMPLOYER PLANS

The employer-sponsored disability policies in which all or part of the premiums are paid by the employer, generally claim to replace 60% or 70% of an employee's income when he/she is disabled beyond the typical 90 or 180 day elimination (or waiting) period. However, these promises are empty and deceptive. Insurers are allowed to reduce the benefits they pay dollar for dollar for any benefits the disabled employee receives from his state workers' compensation program ... Social Security disability program... the state's disability program ... and even cash settlements received for pain and suffering if the employee was injured in an accident that caused his disability.

Even worse: Any money these insurers pay out to group disability policy holders is taxed. Beneficiaries end up with only a small fraction of what they thought they were insured for.

Other drawbacks...

- An employer might eliminate its disability plan at any time.

- An employee may not be able to take this disability policy with him if he quits or is fired.

- If a claim is ultimately denied, an employee in the group plan must appeal the denial in a timely manner, then sue in federal court to recover only his past-due benefits, some interest and attorney fees if the court allows. The horror of group disability litigation is that there is no trial by jury, no recovery for emotional distress and no opportunity to seek punitive damages under the Employee Retirement Income Security Act (ERISA). The carrier is required to pay only what it owed - this is like robbing a bank and returning the money years later without any penalty or jail time.

ADVANTAGES OF INDIVIDUAL COVERAGE

It is best to purchase your own individual disability coverage through an insurance agent, whether or not you are covered through your employer's group plan. You will be given the maximum benefit you're owed, tax free, even if you get other forms of compensation for your injury ... you, not your employer, have control over the coverage ... and if necessary, you can take the insurer to court, get a trial by jury and seek not only the benefits owed but also punitive damages if your state allows.

The downside is cost. A 55-year-old man in good health might spend $280 per month for a well-designed disability policy that replaces 60% of wages up to $4,000 a month after a 90 day waiting period. A 55-year-old woman might spend around $325 (women are more likely to become disabled, thus their coverage will cost more). For a 45-year-old man, the cost might be $199 a month. For a woman, it might be $281 a month.

Two ways to cut the cost of your coverage...

*Increase your waiting period from 90 to 180 days. This should reduce premiums by about 20% compared with a 90-day wait, but this strategy makes sense only if you can afford to live half a year without income. With a six month waiting period, you begin to accrue payable benefits in the seventh month and would get a check at the 225th-day (seven-and-a-half month) mark.

- Women should ask their agents to check whether unisex policies are available. These might cost 10% to 20% less.

MUST-HAVE FEATURES

Expect an insurer to offer coverage for up to two-thirds of your current wages, not to exceed $15,000 per month.

Three provisions that you also should insist on having...

- "Own occupation" protection. Without this provision, your insurer could reduce benefits by the amount you're capable of earnmig, even in a line of work that doesn't appeal to you.

Example: A stroke makes it impossible for a woman to continue her career as a surgeon. Without "own occupation" protection, her disability insurer might argue that she still could work as a janitor and then reduce her benefits by the $2,000 a month she could earn in that job. With "own occupation" protection, the woman receives her full benefit for as long as she can't perform surgery.

- Noncancelable and guaranteed renewable to age 65. With this clause in the contract, your insurance company cannot terminate your coverage until you turn 65, even if your health deteriorates. Guaranteed renewable policies also have fixed premiums.

- Total disability and partial disability coverage. Some individual policies provide for both total and partial disability benefits.

Example: A woman has a heart attack but still can work 20 hours per week. If her policy covers only total disability, her insurer will not owe her a dime. With total and partial coverage, she will be compensated based on the percentage of her income that she has lost.

RECOMMENDED FEATURES

- Cost-of-living adjustments. This feature increases your monthly benefits after disability strikes to keep pace with inflation. It's highly recommended for those younger than 40 but not vital for those over 50 - inflation won't have as much time to deplete the value of their benefits. Expect a policy that provides an annual 3% to 6% increase in benefits to cost 8% to 12% more than the disability policy that doesn't provide such an increase.

- Future increase option. It makes sense to add on more disability coverage over the course of your career to keep up with your increasing wages. A future increase option gives you the right to buy more coverage at the initial contract rate, even if your health declines. This provision typically isn't available past age 50.

WHAT TO AVOID

- "Except fraud" provision. If an "except fraud" clause is written into your contract, your insurance company can attempt to take away your policy at any time by claiming that you materially misstated your medical, financial or occupational status when you applied for coverage. Insurance companies sometimes use this clause to deny benefits to honest policyholders when they find the slightest hint of an error on the application.

Better: Ask for a "two-year contestability policy" instead. After your contract has been in force for two years, the insurance company cannot contest any statements in your application.