Group Short-Term Disability Plans

The first step in short-term disability coverage is sick leave plans (also called salary continuation plans). With sick leave plansAllow employees to accumulate leave time that can be used in the event of injury or illness at 100 percent income replacement, typically at a rate of one day per month of work up to a maximum of twenty-six weeks., employees accumulate leave, typically at a rate of one day per month of work up to a maximum of twenty-six weeks. In the event of illness or disability, the employee uses sick leave and receives 100 percent income replacement beginning on the first day of illness or disability. Today, many employers do not offer sick leave separately from vacation. The combined time off is called paid time off (PTO)Consolidates sick leave, personal leave, and vacation leave into a total number of personal days off each year to reduce employee incentive to abuse sick leave and reward those who never use sick leave.. Under PTO, there is less incentive to abuse sick leave and more reward to employees who never use sick leave. PTO consolidates sick leave, personal leave, and vacation leave into a total number of personal days off each year.

Short-term disability (STD) income replacementPays employees between 65-75 percent of salary from three months to two years in the event of nonoccupational injury or illness that interrupts employment. through insured plans generally includes all full-time employees after meeting some probationary period, such as three months. Unlike sick leave, these plans do not pay benefits until after an elimination periodThe one- to seven-day absence from work often required before employees qualify for benefits from short-term disability; in the case of long-term disability, may be the benefit period under short-term disability., typically from one to seven days of absence from work due to disability. The employee may be required periodically to provide medical evidence of continuing disability. These plans pay for the duration stipulated in the employer’s policy, usually ranging from three months to two years (although the majority pays for one year at most). Group short-term disability insurance plans do not provide full income replacement but instead pay 65 to 75 percent of salary. This provision reduces moral hazard and encourages employees to return to work.

The definition of disabilityDetermines when an employee is eligible for short-term disability insurance benefits, generally stated as the inability of the employee to perform any and every duty of the job; long-term disability definitions are more restrictive. determines when the employee is eligible for benefits. Short-term disability insurance policies generally define disability as the inability of the employee to perform any and every duty of the job. This liberal definition allows disabled workers to qualify for benefits relatively easily when compared with the definition of disability used by most group long-term disability insurance policies. Some STD policies require a more stringent definition of disability, especially those that provide coverage for a year or more. Under this definition, the employee will receive benefits only if unable to perform a job for which he or she is qualified by education and training. Generally, group short-term disability policies pay only for nonoccupational disability, and workers’ compensation benefits cover employees for short-term occupational income loss.

Group Long-Term Disability Plans

The eligibility criteria for group long-term disability (LTD) insuranceAfter satisfying an elimination (generally equivalent to the benefit period in short-term disability), pays employees between 60 and 70 percent of salary for a five to ten years or longer in the event of nonoccupational injury or illness that interrupts employment. are often different from those for short-term insured plans. Unlike short-term insured plans, which generally cover all full-time workers, long-term disability plans usually cover mostly salaried workers after they meet a probationary period lasting from three months to one year. Long-term disability plans also have an elimination period prior to payment of benefits, ranging from three to six months. The elimination period is often equivalent to the benefit period for the short-term disability plan. If the elimination period is longer than the period covered by short-term income replacement, the employee may have a gap in coverage.

The definition of disability used for long-term plans is generally more restrictive than for short-term plans. Most contracts pay only if the employee is unable to engage in the material duties of the job. Under this definition, the employee receives benefits only if he or she cannot perform a job for which he or she is qualified by education, experience, and training. For example, a surgeon who can no longer perform surgery because of a hand injury may be able to manage the surgery room. This employee will not be eligible for LTD.

Some group STD and LTD policies use a dual definition of disability. For example, benefits are payable while the own-occupation definition applies for a relatively short period of time, perhaps two or three years. After that, long-term benefits are paid only if the employee is unable to engage in any reasonable occupation for which he or she is or can become qualified. Use of both definitions provides economic security to the employee and an economic incentive to find reasonable, gainful employment.

The benefit period for LTD policies can vary greatly. Employees may be covered only for five or ten years, or they may be covered until retirement age or for life. Typically, group LTD plans pay no more than 60 to 70 percent of salary to disabled employees. In addition, a maximum dollar benefit amount may apply. Group disability benefits are usually coordinated with other disability income from Social Security or workers’ compensation to ensure that the overall benefits are still below the level earned prior to disability. Employees may be able to obtain additional nongroup disability insurance in the individual market to increase their total amount of protection, although seldom to the level of full income replacement. This ensures that the disabled person has an economic incentive to return to work.

Most group LTD contracts include a rehabilitation provision. This allows insureds to return to work on a trial basis for one or two years while partial long-term disability benefits continue. If disabled employees are unable to perform in the new job, long-term disability benefits are fully restored. By providing this safety net, insurers encourage disabled workers to attempt to return to work through rehabilitative employment. Insurers may also assist with training and rehabilitation costs because these can be far less than continuing benefit payments for those who do not return to work.

LTD benefit amounts may also be affected by supplemental benefits made available to employees through payroll deductions. Cost-of-living adjustments can be added to prevent the erosion of purchasing power of the disability income benefit. Survivors’ benefits can protect an employee’s dependents after the death of the disabled employee.

Group LTD contracts contain several important exclusions. Benefits are not paid unless the employee is under a physician’s care. Benefits are not paid for self-inflicted injuries, and preexisting condition clausesRestrict coverage of named preexisting conditions in the case of disability benefits. may restrict coverage. Generally, benefits are not paid if the employee is gainfully employed elsewhere.

In the past, long-term disability claims experience (both frequency and duration) for hourly workers has been especially unfavorable (relative to salaried employees). This may be because hourly workers are more likely to be in jobs that are monotonous and produce lower satisfaction, factors that do not help keep employees at work or encourage them to return quickly. Disability claim frequency among hourly workers has risen, especially during periods of economic recession, when job security is threatened. Hourly employees may choose to make a disability claim rather than to be laid off with temporary and minimal unemployment benefits. Because of unfavorable claims experience, employers and insurers are reluctant to provide hourly workers with long-term disability insurance.

For salaried workers, too, there has been a shift in long-term disability claims experience in the last few years. The frequency and duration of claims by salaried employees and highly paid professionals, particularly physicians, have increased significantly. The rise in claims among physicians may be due in part to an increasingly litigious environment for practicing medicine and to health care financing reform initiatives that threaten the traditional practice of medicine, factors that can negatively affect physician job satisfaction. Among nonmedical professionals, the increased incidence may be due to a more stressful business environment characterized by firm downsizing, especially among mid- and upper-management employees. Employers and insurers are paying attention to the increased incidence of claims among salaried employees and in some cases are limiting the amount of benefits payable for long-term disability to reduce any potential moral hazard problems.

Whether group disability benefits are taxable income to the employee depends on who pays the premiums. If the employer pays the premiums, the employee is taxed on the benefits. If the employee pays with after-tax income, the employee does not have to pay taxes on the benefits. If the employee pays with before-tax income, the employee pays taxes on the benefits in case of disability. Thus, many employers advise their employees to pay for this coverage themselves with after-tax income through payroll deductions.

Traditionally, disability insurance has never been easy to sell. However, the need for such a product is always clearer during hard times. It is known that financial planners look at the lack of disability coverage as a gap in the complete coverage for a person. A downturn in the economy is actually helpful in pushing the sales of disability income policies.Sadler, Jeff. “Down Economy Can Push DI Sales Up,” National Underwriter, Life & Health/Financial Services Edition, February 25, 2002.

Definition and Cause of Disability

Definitions of disability vary more among individual policies than among group policies. Total disabilityDefinitions vary across different disability policies, but generally: the complete inability to perform “any and every duty” of the individual’s own job; alternatively, the inability to engage in any “reasonable and gainful occupation” for which the individual is (or could become) qualified by education, training, or experience. may be defined as the complete inability to perform “any and every duty” of the individual’s own job. Alternatively, it may be defined as the inability to engage in any “reasonable and gainful occupation” for which the individual is (or could become) qualified by education, training, or experience. Some policies combine these two definitions, with the more liberal (from the insured’s point of view) “own occupation” definition satisfying the requirement for total disability during an initial short-term period (e.g., two years) and the more stringent definition being used thereafter. Partial disability is even more difficult to define than total disability. Partial disabilityUsually measured in terms of the inability to perform some of the important duties of one’s job; paid in some disability policies only if partial disability follows total disability or only if a loss of income results. is usually measured in terms of the inability to perform some of the important duties of the job. Some policies pay partial disability only if partial disability follows total disability, or only if a loss of income results.

Some contracts provide income benefits for disability caused by accident only, others for both accident and sickness. It is necessary to distinguish between losses caused by accident and those caused by sickness because the benefits can differ. Some policies provide that income losses resulting from injuries due to accident must start within ninety days after the injury. Losses resulting from injuries that begin after the ninety-day period are deemed to have resulted from sickness. A loss is not considered caused by accident unless it results “directly and independently of all other causes.” This provision is designed to eliminate from the definition of accidental bodily injury those income losses actually caused by illness. For example, a person who suffers a heart attack and is injured when falling to the ground would not qualify for accident benefits but would qualify for sickness benefits.

The debate about the definition of disability is an old one. It is not always clear which definition best serves the individual policyholder. In reality, it is desirable to have a true needs assessment of the individual in this market.

Benefits

As with group insurance, both short-term disability and long-term disability policies are available for individuals. Short-term disability (STD) policies are those with benefits payable up to two years. Short-term plans may restrict benefits to periods as short as thirteen or twenty-six weeks. Individual STD plans may limit benefit duration to six months for the same cause of disability, sometimes requiring the insured to return to work for up to ninety days before establishing a new maximum benefit period for disability from the same cause.

Long-term disability (LTD) policies are those that pay benefits for longer periods, such as five years, ten years, until a set retirement age, or for life. Long-term disability policies often assume that the insured will become eligible for retirement benefits from Social Security or private retirement plans at age sixty-five. To coordinate benefits, the disability policy defines the maximum duration as age sixty-five. LTD benefits for any shorter period would expose the insured to a potentially devastating income loss because neither disability nor retirement income would be provided for this period.

Long-term benefits do not cost proportionately more than short-term coverage. From the consumer’s point of view, the longer term policy is a better buy. It protects against an unbearable risk: the long-term loss of income. This is a good example of the large loss principle, where an insurance purchase should be governed by the potential severity of loss rather than the frequency of loss. The large loss principle should govern disability income insurance purchases even though most disabilities are of relatively short duration.

Policies pay benefits after an elimination or waiting period. The elimination period, like a deductible in medical insurance, reduces moral hazard. For STD policies, the elimination period typically extends from a few days to two weeks; for LTD policies, the period extends from one month to one year. Here, as in group coverage, the insured may be covered during the LTD waiting period by benefits from the STD policy or a salary continuation plan (such as sick leave).

Individual contracts generally state the amount of the benefit in terms of dollars per week or month, unlike group policies that state benefits as a percentage of the insured’s basic earnings. In either case, the insurer is wary of having the benefit equal to anything approaching full earnings. Typically, the amount is limited to about two-thirds of earned income because benefits under individual disability policies are typically not taxable. The benefits are not taxable because the premiums are paid from after-tax income. As with group disability, the purpose of this limitation is to reduce moral hazard by providing an economic incentive for employees to return to work.

Benefits may differ for disabilities resulting from accident rather than sickness. Benefits for sickness are not as generous as those for accidents. For example, a policy may provide benefit payments for five years if disability is caused by accident but only two years if caused by sickness. Some long-term policies pay to age sixty-five for sickness but for life when the cause of disability is accidental. Benefits for partial disability, which are more likely to be provided by individual contracts rather than group contracts, are often only for disability caused by accident. Some policies pay no benefits if the sickness or accident is work-related and the employee receives workers’ compensation benefits. Such policies are called nonoccupational. Others supplement workers’ compensation benefits up to the point at which the insured gets the same payment for occupational and nonoccupational disabilities. Some individual policies specify a maximum combined benefit for Social Security and the private policy. The insured can purchase a plan with a social insurance substituteDisability policy provision that replaces Social Security benefits if the individual does not qualify under the strict definition of disability in Social Security., which replaces Social Security benefits if the individual does not qualify under their strict definition of disability.

Often, individual policies are not coordinated with other disability income benefits. The relatively few individual policies that coordinate disability benefits use the average earnings provisionCoordinates benefits under different disability policies by providing for a reduction in benefit payments if the total amount of income payments under all insurance policies covering the loss exceeds earnings at the time disability commences or exceeds the average earnings for two years preceding disability, whichever is greater.. This provision addresses the problem of overinsurance, which may occur when a person has more than one policy. (In group insurance, coordination of benefits provisions addresses the problem of overinsurance.) For example, a person whose salary is $2,000 per month may have two disability income policies, each of which provides $1,200 of income benefits per month. In the event of total disability, assuming no coordination provision, the insured loses $2,000 per month in salary and receives $2,400 in benefits. This reduces the incentive to return to work and may lead to benefit payment for a longer time than anticipated when the premium rate was established.

The average earnings clause provides for a reduction in benefit payments if the total amount of income payments under all insurance policies covering the loss exceeds earnings at the time disability commences, or exceeds the average earnings for two years preceding disability, whichever is greater. The amount of the reduction is the proportion by which all benefits would have to be reduced to prevent total benefits from exceeding average earned income. In the example above about the worker whose salary is $2,000 per month, total insurance payments exceeded income by one-fifth, in which case the benefits of each policy containing an average earnings clause would be reduced so that disability benefits do not exceed predisability earnings. A reduction of the payment provided by each policy from $1,200 to $1,000 per month eliminates the excess.

The insured may have policies in place that do not have an average earnings clause, and he or she could receive benefits in excess of predisability earnings. This provides an income advantage during a period of disability. As noted above, a further advantage to the insured is the absence of federal income taxes on disability benefits from individual policies (as well as employee-paid group policies). In addition, the disabled insured has few, if any, work expenses, such as clothing and transportation costs. Insurance underwriters recognize these advantages, as well as the potential for moral hazard, and may be unwilling to issue a large policy when benefits are otherwise available.

LTC Annuities

In the world of insurance, change and new products are constants. There is a new interest in LTC annuityLife insurance rider that covers the costs of nursing home stays, home health care treatment, and other long-term care services typically covered by stand-alone long-term care insurance policies. products.Chelsea K. Bachrach and Craig R. Springfield, “LTC-Annuities: Two Birds, One Stone,” National Underwriter Life & Health/Financial Services Edition, September 2, 2002. The product is similar to life insurance with an LTC rider. This rider covers the costs of nursing home stays, home health care treatment, and other LTC services typically covered by stand-alone LTC policies.Cary Lakenbach, “Traditional Life: A Chassis for LTC Riders,” National Underwriter Life & Health/Financial Services Edition, September 13, 1999. The tax implications of the portion of the premiums attributed to LTC are not yet determined. The LTC risk and living too long risk are inversely related because those needing LTC are expected to have a shorter life span. This provides the insurer a type of hedge.

LTC Acceleration Life Rider

Like living benefits, accelerated LTC benefits fit well with life insurance. LTC benefits are provided to the needy insureds while still living, like living benefits. Traditional life insurance policies are considered best suited for LTC riders because of the guarantees.

Insurers such as National Life and Interstate entered this market with various universal and variable life insurance products. The development activity is more pronounced in the variable universal life. These integrated VUL/LTC products pose many challenges because LTC requires more guarantees than those provided by universal variable life products. To overcome some of the challenges, the LTC benefits are designed as a percentage of the death benefit or other specified amount.Cary Lakenbach, “Integrated VL/LTCs Pose Some Challenges,” National Underwriter Life & Health/Financial Services Edition, February 21, 2000. Some products provide a minimum death benefit guarantee, and the LTC monthly maximum benefit reflects the death benefit guarantee.