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Good to Know: 4 Dangerous Gaps in Long-Term Disability Coverage

Saying “I have a long-term disability policy” is very much like saying “I have a car.”  There’s a big difference between a new Mercedes S-Class and a 40-year old AMC Concord (for any Millennials reading this, the Concord was manufactured just after the extinction of the dinosaurs by a now-defunct automaker). Here’s my point – LTD policies are not created equal. To make that point, I’ve illuminated 4 of the most dangerous gaps in LTD coverage:

  1. The Ostrich Syndrome
  2. The wrong definition of “disability”
  3. The wrong definition of “long-term”
  4. Not enough coverage

#1 – The Ostrich Syndrome

Life insurance is just as important as LTD insurance, yet too many of us buy a life insurance policy and then ignore the even higher and more costly risk of LTD.  This may be especially true when we have a group LTD plan at work. The temptation is to go “ostrich” and just ignore LTD risk.  Yet, there is a school of thought that says LTD risk is at least as dangerous as premature death risk.

Here are just a few considerations to support that school of thought:

  • The cost of LTD can be higher than the cost of death. Dead people do not need living expenses or medical care costs.
  • The risk of LTD is greater than death for most working-age clients. For individuals in their early  30’s for example, there are 7 LTD occurrences for every 1 premature death.
  • For every 100 home foreclosures, only about 3 are caused by premature death.  Yet almost 50 of every 100 foreclosures are caused by LTD.

Financial Tip: Get moving! Nothing good can happen from the Ostrich position.

#2 – The Wrong Definition of Disability  

This disaster in the making is best illustrated by example.  Let’s assume that your client, Dr. Amy Corazon, is a heart surgeon.  She’s an adventure junkie and just returned from a grueling two-week trek through the Amazon (the rain forest, not the internet giant).  Regrettably, she brought more than just pictures back from her adventure; she picked up an unheard-of virus that causes her hands to shake moderately to violently most of the time. Since she’s a surgeon, she’s disabled right?  Well, maybe yes and maybe no. The chart below summarizes when she’s disabled and when she’s not:

Definition of Disability in the LTD Policy Is Dr. Corazon Disabled? Pros and Cons
Own Occ
Inability to perform one’s own occupation
She’s disabled!
She cannot perform her own occupation.
The best coverage and highest premium cost
Reasonable Occ
Inability to perform an occupation for which one is reasonably suited by training, education or experience
She’s NOT disabled
She can teach at a medical school, work for an insurance company or similar job.
 
Less expensive premium cost than “Own Occ” and better coverage than “Any Occ.”
Any Occ
Inability to perform any gainful employment
She’s NOT disabled
Even if she cannot work in a “Reasonable Occ” job, she is not disabled if she can greet retail customers with a cheerful rendition of “Welcome to Mega-Mart.”
Lowest premium cost and the worst level of coverage.
BTW, this is the Social Security definition of disability.

Financial Tip: Be sure you have “Reasonable Occ” at a minimum, “Own Occ” is ideal.

#3 – The Wrong Definition of “Long-Term”

Assume that the average age of your clients is about 45.  A 45-year-old client needs a benefit period until retirement yet may actually have only 5 years. Benefit periods can range from under 5 years to about age 65.  Review any existing policy provisions, especially group LTD policies, to be sure the benefit period lasts as long as possible – ideally until your client’s retirement age. The longer the benefit period, the higher the premium.

Financial Tip: At what age do you plan to retire? Coverage should generally last that long.

#4 – Not Enough Coverage

We could have put this gap even higher on this list.  A group or individual LTD policy provides a benefit to the insured… but is it enough?

  • Remember that the benefit will be fully included in income for income tax purposes if your employer pays all of the premium costs.
  • None of the benefit will be included in total income if you pay for all of the premiums.

At a bare minimum, the monthly after-tax benefit should be enough to pay a family’s required monthly living expenses.  Yes, you’ll need to do a budget if you don’t have one, but that’s a small price to pay to make sure the peanut butter and the bread comes out even at the end of every month.

Financial Tip: Even if you’ve addressed all of the risks so far, picking the right benefit amount is a vital part of managing disability risk!

I promised you 4 dangerous mistakes.  As an extra, no charge, bonus, also take a look at the following opportunities when analyzing your LTD coverage:

  • If you need additional or supplemental coverage, apply for it now. Every year that goes by without your addressing these risks will increase your premium cost and, if you become ill or injured, you may not qualify for LTC coverage at all.
  • Automatic inflation protection– today’s purchasing power is cut in half in 24 years with a 3% inflation rate. The benefit amount should increase with inflation at a minimum.
  • Protect yourself, at least to some degree, from premium increases by purchasing “non-cancelable” coverage.  Your premiums cannot increase beyond any increases specified in the policy.
  • Keep saving for retirement with a retirement protection  This rider will continue making your existing retirement savings contributions in addition to paying the stated benefit amount.

As I prepare to close, let’s discuss one last thing. What if your ideal LTD policy costs more in premiums than your budget affords?  Here are just a few quick ideas:

  • If you cannot afford “Own Occ” until your age 65
    • Consider changing the policy to cover “Own Occ” for 5 years, then to “Reasonable Occ” until the end of the benefit period.
    • This gives you a financial soft landing to sort out the next stage of your working life.
  • Take a longer elimination period (the period between your disability and when you start receiving benefits).
    • A 30-day elimination period costs much more in premiums than a 180-day elimination period.
    • Just make sure you have enough in cash reserves to eat for those 180 days.
  • Analyze your discretionary spending
    • Can you cut back on a few of life’s extras to fund life’s necessities?

Bottom line – facing these dangerous LTD gaps could very well mean the difference between at least a modest lifestyle or severe hardship for your family.