Long-Term Disability Insurance: Employer Plans Are Not Enough

By Michael E. Goodman and Salvatore J. Ricco

Although group disability coverage is invaluable, several critical issues are often misunderstood or overlooked. Many view disability insurance like life insurance: Either one is covered or not, and there is generally only one way to qualify for the benefit. Disability insurance policies, however, have many shades of gray regarding qualifications and types of benefits.

The most important element of a disability policy is how it defines disability. Many group contracts provide benefits if the insured is unable to perform the material duties of their "own occupation" for at least the first two to five years of the claim, after which the insured is generally expected to accept any gainful employment based on experience and education or, in some cases, without regard to experience and education. While some group policies provide coverage if one is unable to perform their "own occupation" until normal retirement age of 65 or 67, this and other preferred features are becoming more difficult to find.

When evaluating coverage, an important point to be aware of is that benefits could be reduced or capped based on contractual limitations within the plan. Most group plan benefits are reduced by any Social Security benefits that the employee (or even family members) receives. The policy may place a ceiling on the maximum benefit in aggregate to the entire company or, more frequently, place ceilings that are specific to each employee. Plan caps on highly compensated executives are common, and some employers establish a carve-out plan that allows a certain class of employees to fund additional coverage.

For example, an employer's plan may provide coverage for up to 60% of an employee's gross earnings, with a maximum individual monthly benefit of $5,000. If an employee's annual salary is $200,000, the plan will replace only 30% of income ($5,000 per month times 12, divided by $200,000). An employee with no other resources would need supplemental coverage to maintain an existing lifestyle. Furthermore, many group contracts are written to cover a percentage of salary and do not include bonuses or commissions.

Disability policies often have a waiting or elimination period before one is eligible for benefits, generally 90 to 180 days. Some employers provide a short-term disability policy to provide nominal benefits during this period. The majority of policies pay until age 65, while some have shorter payout periods, which has become a concern because of increased life expectancies. If an employer pays the group insurance for its employees or deducts premiums from pay before taxes, disability benefits are generally taxable to the recipient. Other significant potential limitations of group plans include the lack of inflation protection for benefits and the lack of portability (the ability to continue coverage upon separation from employment).

An additional concern is the mental/nervous disorder limitation. The typical group contract limits benefits for mental/nervous disorder claims to 24 months, which can be a serious problem in high-stress occupations.

Workers who had relied on their employer for disability insurance often find themselves attempting to qualify for a private, and usually more expensive, policy upon separation from employment. Group contracts usually have no underwriting requirement, and an individual can often qualify regardless of the existence of potentially debilitating health problems, whereas that same individual might be denied private coverage. Employees that suffer from a potentially debilitating illness should therefore investigate the portability of their employer's disability insurance.

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