The basics of long-term
disability insurance

You may not realize the potential danger of becoming disabled. The U.S. Census Bureau estimates that you have a one in five chance of becoming disabled. Also, the average long-term disability (LTD) absence from work lasts 2.5 years, according to the Council for Disability Awareness. That's a long time to survive without a steady income.

Cancer continues to be the No. 1 cause of long term disability, according to Unum Group. In 2007, cancer led to more than 12 percent of LTD claims, followed closely by pregnancy complications and back injuries.

Becoming disabled can have devastating financial implications by stripping you of your ability to make a living. While some people can get by without working for a few months by tapping into their savings, few people can afford to stop working altogether for an extended period of time.

That's where LTD insurance can help you. LTD policies provide you with income for a long period of time, such as two years, five years or until you retire. Most people who have LTD insurance get it through their employers, although you can buy individual LTD insurance on your own.

LTD in a nutshell

LTD picks up where short-term disability (STD) leaves off. (For more, read The basics of short-term disability insurance.) Once your STD benefits expire (generally after three to six months), the LTD policy pays you a percentage of your salary (usually 50, 60, or 66 2/3 percent). Depending on your policy, you will then receive benefits for two years, five years or until you turn 65.

The average annual premium for a new group LTD policy in 2007 was $234 per person, according Drew King, president of JHA, a subsidiary of General Re Life Corp.

If you pay your own premiums with after-tax dollars, your disability benefits will be tax-free. If your employer pays for the policy, most likely with pre-tax dollars, your disability benefits will be taxable.

Most disability insurers will work with employers to help you return to work as quickly and safely as possible. While disability insurers want to see people healthy, rehabilitated and back to work, they also save significant dollars if a claimant quickly returns to work.

"Disability insurance should be a part of everyone's financial plan, but when faced with a disability, the ideal situation for people is really to get well and return to work so they can continue earning the salary they were getting before they became ill or injured and maintain their standard of living," says Diane Russell, assistant vice president of marketing and product development at CIGNA Group Insurance.

You'll most likely find your disability insurer "managing the claim" if you are "partially disabled" — meaning you can still work, but in a job that pays substantially less. LTD will pay you additional money if you decide to take a lower-paying salary, as outlined in the following example.

Let's say you worked in a warehouse lifting crates making $40,000 annually. You then hurt your back at home and are forced to take a desk job that pays $20,000 annually. If your LTD policy was paying you 60 percent of your original $40,000 salary, it will now pay you 60 percent of what you are making in the lesser job. So now instead of staying at home and collecting $24,000 from your LTD policy only, you work at the lower paying job and make $32,000 (in addition to the $20,000 salary, you also get $12,000 in disability benefits, which is 60 percent of $20,000).

Monica Burnett, an account executive for MetLife, says that some insurers will also reimburse the employee for child care expenses if the employee's spouse must go back to work as a result of the disability. "A lot of times, that's a huge factor in whether or not a person can return to work," she says.

King says that some disability insurers give employers an incentive to have workers return to work on a part-time basis. He says it's common for insurers to give employers a premium reduction on the group policy if they allow a partially disabled person to come back to work on a part-time basis.

"In the old days, they never used to do that," he adds.

If you become disabled and begin receiving benefits, you will no longer have to pay premiums. Most policies contain a "waiver of premium" provision that states you can stop paying premiums if you are disabled for 90 days or longer.

Buying individual disability insurance

If your employer does not offer group disability insurance, or if you feel your existing group policy does not provide adequate coverage, you may want to consider buying an individual LTD policy. According to the Council for Disability Awareness, one in seven people can expect to be disabled for five years or more before retirement. If you do not have individual LTD, going five years without working could be financially devastating.

You can buy this through financial planners or the same agents who sell you life insurance or annuities, or sometimes through your mortgage company. If you choose to buy it individually, King estimates that the average premium could cost more than five to 10 times as much as a group policy, depending on your age, occupation and annual income.

"It could cost up to $2,000 a year, depending on how much you buy," King says.

You must take a medical exam to prove your insurability.

Individual disability pays you a flat amount each month, and most often you will not be paid more than 80 percent of your current salary. Your occupation, income and other sources of insurance will help the insurance company determine if it wants to insure you and helps set your premium. After it sets your rate, the insurance company places you in a rating class with people who have similar characteristics such as age, occupation, medical condition and income.

Most policies are sold on a "non-cancelable" or a "guaranteed renewable" basis. With a non-cancelable policy (which requires an initial medical exam), the insurer cannot cancel the coverage or raise your premiums. If you buy a policy on a guaranteed renewable basis, the insurer cannot cancel the coverage as long as you pay premiums, but it can raise rates. However, the insurer cannot raise rates on an individual basis. Rather, it will raise rates for the whole group if you are part of an insured group that has experienced a very high number of claims.

Most individual policies also have features that allow benefits to keep pace with inflation or gradual salary increases, such as a cost of living adjustment (COLA), which adds a percentage to your coverage each year.

Though disability insurance can be costly if you buy it on your own, King says it is an essential part of a person's financial plan. "Everybody should have some kind of disability insurance protection," King says. "Since you're much more likely to become disabled than you are to die, you can make a coherent argument that you need disability insurance more than you need life insurance."