By Dan Miller, WCI Contributor
There are many different kinds of insurance, and each type of insurance can protect you from different expenses. If you have a high net worth or have dependents that count on your income to live, life insurance and disability insurance become very important. Simply put, disability insurance is income replacement insurance. Understanding the different types of disability insurance can help you decide which options make the most sense for you.
Group vs. Individual Disability Insurance
The first thing to understand when comparing various disability insurance options is the differences between group and individual disability insurance policies. Group disability insurance is sometimes provided by your employer as a benefit, or it can be purchased through another group or professional organization. Individual policies are purchased by just one person to cover their specific situation. In general, assuming you qualify, it is recommended everyone own an individual disability policy.
Group Disability Insurance
Residents and fellows (and sometimes even students and attendings) are often provided with a short and/or long-term group disability policy as a benefit. There are three issues to be aware of with group disability policies:
- First, their definition of disability is nearly always much weaker than you get with a good individual policy. The employer knows few doctors (and even fewer residents) know much of anything about disability policies, and the naive physician might look at this as a “free” benefit. So, they want to spend as little on it as possible. If you're in this situation, read the group policy and compare it to a good individual policy. In disability insurance, you generally get what you pay for, and your employer's motivation is to pay as little as possible. In most cases, you'd probably be better off if the employer would just give you the money it is spending on the policy in your salary.
- The second issue with group policies is that they can limit your ability to get an individual policy. An insurance company doesn't want you to make more money disabled than you did working, so they take your current policies into account before deciding how much more to sell you. If you are already covered by a group policy, they may not sell you an individual policy at all, and if they do, it will only be for a small percentage of your income. You could opt out of your “free” disability insurance at work, but your employer is unlikely to add the cost of the premiums to your salary.
- The last problem with group policies is that like other benefits, they are pre-tax. The employer gets a tax deduction for it, so the benefits to you are fully taxable. It doesn't take a rocket scientist to realize that $5,000 pre-tax is not the same as $5,000 post-tax.
Many professional societies like the AMA or ACEP offer perks to their members like the option to purchase disability insurance through their organization. It's important to realize that the insurance you might get from a professional society, like any group insurance, may not give you the best coverage or be the best option for your specific situation.
Individual Disability Insurance
One of the best ways to make sure you have sufficient coverage is to buy your own individual disability insurance policy. When you work with an experienced insurance agent or broker, you can make sure to get an individual disability insurance policy that fits your needs and budget.
While you may be able to get disability insurance from your employer or a professional organization, you're at the mercy of the type of policy that is offered and presented to you. Be sure to compare your potential policy to other policy options to make sure it meets your needs. Imagine the disappointment associated with finding out that your disability policy doesn't cover the disability keeping you from working.
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Types of Disability Insurance
Now, let's dig into the different types of disability insurance, what they cover, and how they work. It's important to note that disability insurance is not a “set it and forget it” part of your financial plan. You will need to re-evaluate your disability insurance coverage regularly as you progress through your career. The disability policy you had straight out of residency may not cover you and your family's needs now that you have a higher salary, own a home, and have a few kids. Disability insurance is most commonly divided into short-term and long-term so let's start there.
Short-Term Disability Insurance
Short-term disability insurance can help protect you in case of a disability that lasts a short amount of time (usually anywhere from 3-6 months). In most cases, short-term disability insurance will provide a percentage of your pre-disability earnings if you're not able to work. A short-term disability is one that temporarily keeps you from being able to work. Short-term disability insurance may be offered through your employer or purchased separately.
Long-Term Disability Insurance
Another type of disability insurance is long-term disability insurance. Long-term disability insurance can protect you against a condition that prevents you from working for a longer period of time. A long-term disability insurance policy may also require an “elimination period” (often 90 days) before your benefits kick in. For this reason, it can sometimes make sense to also have either a short-term policy or a big enough emergency fund to cover expenses during that timeframe.
Mortgage Disability Insurance
Another type of disability insurance is mortgage disability insurance—this can cover your monthly housing payments when you become disabled (or die). This is similar to other types of disability insurances, but the payments are limited to the amount of your housing payments. Policies vary, but in many cases, they go directly to your lender—which may or may not be what you are looking for.
Student Loan Disability Insurance
Insurance companies and their agents are always coming up with new products to sell, and we came across one a few years ago from a firm called InsureSTAT. It was offering disability insurance for your medical school loans. The idea is that if you are disabled, this insurance kicks in and pays off your loans. Except you don't have to use it for your medical school loans. You could use it for anything you want.
Honestly, the whole student loan disability insurance thing is just marketing, and you'd likely be better off increasing your disability benefit or taking the money and investing it.
Social Security Disability Insurance
Social Security Disability Insurance (SSDI) is a government program that will pay you a monthly amount if you become disabled. To qualify for SSDI, you need to have worked long enough and paid Social Security taxes. To submit a claim for SSDI, you will file an application with the Social Security office and will need to provide information about your medical condition and disability.
Key Man Disability Insurance
These are specialized policies sold to businesses (such as a medical practice) that pay the business in the event that a financially valuable employee becomes disabled. The employee ought to be covered by their own policy that will pay for their personal needs during the disability, but this policy covers the business losses as a result of the disability.
Consider a practice of three physicians. What would happen if one of them became disabled? Consider that normally half of the income generated by each physician goes to overhead, paying nurses's salaries, rent, malpractice insurance, billing staff, etc. If one doctor can't work, the overhead, at least in the short term, is the same. Now the other two physicians are paying three-quarters of the income generated in overhead. This, obviously, cuts their take-home pay in half. The alternatives—rapid layoffs and restructuring of the business, or outright failure of the practice—are just as unappetizing.
Key man insurance generally pays either a lump sum or payments for 6-24 months. It is anticipated that, within that time, another “key man” can be trained or hired and the business can continue on without major financial catastrophe. There are limited options out there for these policies, and you'll need an experienced agent to help analyze the value of a particular person and select an appropriate policy. Many doctors don't need a policy like this, but many who do have never even considered what might happen to their business if one of their partners suddenly became disabled.
Disability Buy-Out Insurance
This type of policy is designed to be used in the event of a long-term disability of one of the partners. If one partner becomes disabled, the policy pays out money that is used by the remaining partners to buy out the disabled partner's equity in the business at an agreeable price. This benefits everyone. The disabled owner is guaranteed a willing buyer at a good price. The remaining owners don't have to come up with the cash to do the buyout, and they don't have to relinquish control to an outside investor. These policies generally have a lump sum payment made after an elimination period of 1-2 years to ensure the partner really does have a long-term disability and won't be coming back. Doctors in a single-physician or single-dentist practice or a small partnership would be wise to discuss this with an experienced disability insurance agent.
Retirement Protection Disability Insurance
If you can't buy enough personal disability insurance to pay your living expenses AND to save for retirement, you might be able to increase the amount of coverage you have by buying one of these policies. Basically, if you become disabled, the policy pays a certain amount each month (up to ~ $4,000 a month) into a special trust where you invest the money. At age 65, the money is distributed to you to help supplement your retirement income. In general, steer away from these plans UNLESS you can't purchase enough disability insurance in a typical policy. Mixing insurance and investing is generally a poor idea.
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Alternatives to Disability Insurance
Business Overhead Insurance
This is a similar type of policy bought by a business. Consider a one-physician practice where the doctor has a year-long disability. Without a policy like this, the practice will go out of business, all of the staff will be laid off, and the patients will have to rapidly and unexpectedly find a new physician. If a business overhead disability insurance policy is in place, then the staff can continue to be paid, the utilities and rent can continue to be paid, and even a locums physician can be hired to cover the practice. Again, benefit periods usually don't exceed 24 months, and they are deductible as a business expense (with the benefits being fully taxable, of course.)
Another alternative to disability insurance is to self-insure. When you reach a certain level of income and/or assets, you may feel that you have enough that you could still maintain a certain standard of living even if you become partially or completely disabled. In that case, you might decide that you're willing to take the risk of a temporary or permanent disability. Before you decide to self-insure, make sure that you fully understand the risks and are willing to live with the worst-case scenario.
The Bottom Line
If you have a spouse, children, or others who depend on your income, having the right kind of insurance is crucial to ensure that they can maintain their standard of living if something happens to you. Disability insurance is an important component of a financial plan that can help protect you and your family. Physicians and other business owners have a variety of different types of disability insurance that may be applicable, and it's important to understand each type so you can make sure to choose the right policies for you.
Have more questions about insurance and what kind of policies would be the best for you? Hire a WCI-vetted professional to help you sort it out.
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