Amount of Benefits

The insurance company generally determines the monthly benefit of an individual disability income policy based on stable, earned income at the time of purchase. A typical disability income insurance benefit is 60% of pre-disability income. For example, if you are earning $100,000 per year, your disability income benefit would be $60,000, or $5,000 per month. Since we are talking about individual disability income insurance where you, the insured, pay the entire premium with after-tax dollars, no part of the benefit is taxable. In other words, the benefit is tax free.

Insurance companies are concerned about “over-insurance”. You are considered over-insured if your total income while you are disabled is close to your income before you were disabled. When deciding what size of disability benefit to offer, an insurance company will take into account how your overall disability income may be affected by other sources – which might include Social Security Disability Insurance benefits, workers’ compensation disability benefits and group insurance disability benefits. Insurance companies are concerned that you might receive such a large total benefit that you have no need or incentive to return to work and might stay disabled longer than necessary

Insurance companies worry about over-insurance because experience shows that disability insurance is most effective when people are motivated to return to work once they are healthy. For example, there are fewer disputes over proof of disability because insureds have no compelling desire to stay disabled when they can make more money returning to work. If they can do just as well financially by not working, they may be inclined to exaggerate their disability. This leads to many drawn out disputes with the insurance company when the company suspects the insured is malingering. Such disputes can cost insurance companies a lot of money which ultimately results in higher insurance premiums for everyone. Insurance companies approach over insurance by setting your disability income benefit under the policy at about 60% of your pre-disability income and stipulating that in no event will your income from all sources exceed 80% of pre-disability monthly income. If the total of your other benefits exceed 20% of your pre-disability monthly income, then the benefit from your individual policy will be reduced so that the total from all sources is 80%.

Those percentages are not always the same, for insurance companies use a sliding scale and tend to give lower-paid workers a higher percentage of their pre-disability income than higher paid workers, reasoning that, above a certain point, not all earned income is needed. If you were making $30,000 per year and your disability income benefit is 60% of that, or $18,000, you will be far more motivated to return to work than someone whose pre-disability income is $300,000 and whose disability income benefit at 60%, is $180,000. Therefore, the insurance company may only offer a 40% benefit to the person earning $300,000.

When Payments Begin

Many policies allow you to decide when, after you become disabled, disability payments will begin. You can choose a waiting period (often called an “elimination period”) at the time of application. This period can range from the 31st day to 180 days, or more, after the onset of continuous disability. Depending on your resources, you can reduce your premiums by electing to wait 60 days, 90 days, or even 180 days before you begin receiving benefit payments. The longer the waiting period, the lower your premium will be because the longer waiting period means the insurance company will be liable for fewer payments. You should keep in mind that monthly benefit checks are usually issued only after you have completed a month of disability. Therefore, if you elect a 31-day waiting period, you will probably not get your first check until early in the third month of disability.