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The basics of long-term disability insurance

By Insure.com

Last updated Jan. 29, 2010

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 (CDA). That's a long time to survive without a steady income.

Musculoskeletal and connective tissue disorders—including neck and back pain, joint, muscle and tendon disorders and foot, ankle, and hand disorders—were the leading cause of new long-term disability claims in 2008, according to CDA claims data. Cancer ranked second among the primary causes.

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. Most people who have LTD insurance get it through their employers, although you can buy individual LTD insurance on your own, says Drew King, president of JHA, a disability and group life reinsurance division of General Re LifeHealth.

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 to 60 percent, depending on your policy. You will then receive benefits for two to five years or until you turn 65.

The average annual premium for a new group LTD policy in mid-2009 was $238 per person based on a 158-person group, according to King.

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.

You'll most likely find your disability insurer "managing the claim" if you are "partially disabled" — meaning you can still work but only in a job that pays substantially less. In cases where you’re only able to earn less than 20 percent of what you previously made, you’ll likely get full disability benefits that are based on your pre-disability income. For example, if you worked in a warehouse and earned $40,000 annually, then hurt your back and had to take a part-time desk job that paid less than $8,000 a year, your LTD policy likely would pay you full benefits based on your pre-disability wages of $40,000. If the full benefit per your policy was 60 percent, you would get 60 percent of $40,000, or $24,000.

If, however, you were able to earn between 20 and 80 percent of your pre-disability income, you’d get a proportionate amount of income based on the percent you could earn. If you are able to earn more than 80 percent of your pre-disability income, most insurers will consider you not disabled.

Some insurers, though few, offer a dependant care reimbursement benefit, meaning they 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, King says.

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. You can buy this through financial planners or the same agents who sell you life insurance or annuities, or sometimes through your mortgage company.

Most policies are sold on a "non-cancellable" or a "guaranteed renewable" basis, according to the Insurance Information Institute (III). With a non-cancellable 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, says King, but it can raise rates on a class or group of insured people who have the same policy, work at the same place or share another, non-risk-associated characteristic.

According to the III, 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 benefit each year.

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