What is Disability Insurance?
Disability insurance is an insurance policy designed to replace your income if you become too sick to injured to work.
It insures your income. To put it simply, I still refer to it as paycheque insurance.
It’s easy to say that but, this is a policy that still causes confusion with most Canadians. That’s why you may not have it.
So why is it a big deal?
In 2015 RBC commissioned IPSOS to conduct a study on the financial security of Canadians. The research concluded that the majority of Canadians are going to fall on hard times is someone in the household became disabled. The 3 main questions were as follows, ask yourself the same questions.
- Are You Financially Prepared to be off work? 48% of Canadians Said No.
- Will Finances be tight if you are not working? 78% of Canadians Said Yes
- Will you be upset or suffer from emotional stress if you are off work? 81% of Canadians said Yes
If your answer resonated with that, keep reading.
How does Disability Insurance Work?
Let’s Play The Lottery
There may be a big percentage of readers who don’t play the lotto, let’s pretend you do.
Imagine, you just won a secondary prize, it gives you a $5,000 monthly income for 10 years.
But If it was reduced to $4800, it would guarantee that income until you retire. Which would you choose?
You may even do some math and think to yourself:
“$5,000 a month is $60,000 per year.
$60,000 a year is $600,000
If I gave up, $200 a month, that is $2,400 per year.
I’d lose $24,000 in the original 10 years.
Is it worth it?”
I hope you said yes.
We’ll it would only take 5 months of income for you to breakeven.
($24,000/4800 = 5)
By the way, before I wrote this article I asked a handful of people the same question and almost unanimously everyone said yes to the reduced option.
Most people didn’t even do the math as you did, they just liked the prospect of having the income for longer.
That’s illustrative of how disability insurance works.
If they understood, most people would choose to receive less to guarantee their income longer.
The sad thing is, most Canadians are still unclear with what the implications are of losing their income due to disability.
Your Biggest Asset
Let me ask you, WHAT IS YOUR BIGGEST ASSET?
Just like the lottery question, I asked a handful of people before asking you. Did you respond like
Most answered with a list and the common responses were
- My Home; My House
- My Car
- My Investments, RRSPs, TFSAs and Stocks
- My Family (P.s Not enough people listed this)
Ok fine, the family one is a sappy response, I’m the one who gave that answer.
But to everyone else, I would say “WRONG! FAKE NEWS!”
To understand why, I want you to summon your inner Mark Cuban or Mr. Wonderful and be a shark!
Most of the time, they ask about multiples for valuation. The most common ones being, revenue(sales) multiple or profit(net earnings) multiple.
This is often explained as the top line or bottom line.
If someone is asking for $1,000,000 valuation and made $100,000 in sales, that would be a 10X on sales. ($1,000,000/$100,000 =10)
While it would be a 20x Net earnings multiple if they were getting $50,000 net profit. ($1,000,000/$50,000 = 20)
So how does that apply to you and disability insurance?
We can use the same income multiplier idea to determine the value of your biggest asset, your ability to earn an income.
It’s what allows you to pay for your home, the car and have money to invest.
Let’s meet Sam, he’s a 30 year-old and earns a gross income of $60,000 a year (Top Line) after-tax, his take-home pay is $46,000 (Bottom Line)
If he is expected to work until 65, he has 35 earning years left, let’s use that as our multiple.
Gross Income: $60,000 X 35 = $2,100,000
Net Income: $46,000 x 35= $1,610,00 (Note that I used Alberta’s provincial rates)
This simple calculation is also known as the human life value(Terrible Name) or personal economic value.
This does not account for Sam’s pay raises, bonuses or inflation.
If Inflation was factored in or he received a 2% yearly increase in earnings, it would be 2,999,668.66 of total gross income.
So are you convinced that your earnings ability is your biggest asset? The correct answer is Yes.
Disability Insurance Basics
How much disability insurance should you have?
The Maximum Limit, Next question.
That may seem like a non-answer but the truth is, you cannot simply buy as much disability insurance you can afford.
Insurance companies will limit the total disability benefits they would provide you.
This is often called participation limits, this caps the amount of insurance you can buy.
The typical limits are 2/3rd of your income prior to disability until a fixed dollar amount for each company. There are two nerdy insurance reasons for this, indemnity and risk management;
- Indemnity or Indemnification is the concept of “making you whole” it attempts to re-establish your financial situation prior to becoming disabled.
- Risk management: This means insurance companies do not want to be responsible for paying massive amounts of monthly benefits to a single insured client, let alone thousands of clients.
So even if you were earning $50,000/mo some companies could limit you to $15,000 or $20,000 of disability benefits because that is the biggest policy they have to offer.
Some clients who are earning this would need multiple policies or a specialized disability insurance contract.(I wrote about disability insurance for high-income earners here. This article is directed mainly to dentists and doctors but is applicable to professionals and small business owners.)
Let’s translate that to common English. The insurance company does not want you to have more income during a disability, otherwise, why would you go back to work, you would probably stay at home and watch NetFlix.
The good news is, this disability insurance payout is tax-free as long is it is set up properly.
So for our example: Sam Earns $5,000/mo.He would be capped around to $3300/mo or (⅔ x $5000).
Considering that his monthly take income is roughly $3800 he would have a monthly reduction of $500 on income.
This deficit should encourage Sam to return to work as soon as his recovery allows him to.
Your advisor or financial planner can help you determine the appropriate amount of disability insurance that would protect you adequately.
What if you already have other disability benefits? (Integration of Benefits)
The disability participation limits also apply to your overall coverages.
This means if you have 2 or 3 disability coverages, they would coordinate or integrate to add to the ⅔ of income total.
This is also referred to as Offsetting benefits.
In Sam’s Example: Even if he had a policy with a $2,300 monthly insurance policy in place with company A and another $2,000 policy with company B. The total coverage would still be $3300 as he cannot be in a position where he is making more money in disability.
In this case, he was essentially paying for $1,000 of Disability Insurance that would never payout.
This would also apply is you were covered under separate insurance policies or government benefits such as:
- Car Insurance Policy if you were disabled because of a car accident.
- Workplace Compensation Benefit (WCB) if you were injured at work.
- Disability Insurance From Work
- Potential Government assistance programs such as EI and CPP Disability.
- Part-time earned income.
This is why it’s a good idea to have your financial advisor or planner to look at the overall picture.
It may be advantageous to consolidate coverages instead of having multiple disability insurance benefits.
When can you claim disability? (Definitions Of Disability)
How do you tell when you are Eligible to Claim? (Who is considered disabled)
The basic eligibility requirement is being totally disabled. You can read more about that below.
First, I want to clarify that, the right disability insurance plan should cover you for BOTH ILLNESS AND ACCIDENT.
It should also cover you regardless of where you were injured, whether it’s your home, while at work, on the way to work or even on vacation.
There are accident and hospitalization policies only which pose as a disability but may not protect you adequately if you were not in a traumatic accident or were not admitted to a hospital.
Stay away from the fringe, pigs-must-fly policies making it impossible to claim.
The eligibility of disability insurance claim is broken down between 3 different definitions; Own-Occupation, Regular-Occupation and Any Occupation.
Make sure you are aware of what the definitions are of your policy. These three definitions help guide if you are considered to be disabled by your policy
Own Occupation is considered to be the Cadillac of disability definitions. You would be considered to be disabled if you cannot work in your CHOSEN profession based on your training and experience. This is suitable for individuals with highly specialized skills and education such as dentists, physicians, surgeons, and other high-income professionals.
For Example:
Dr. Jenny Mackena is An endodontist, because of a snowboarding accident, she broke her wrist and suffered permanent nerve damage in her operating hand. She is no longer able to perform root canals. If she had disability insurance with the Own Occupation definition, she would still be considered disabled even if she worked as a dental operations consultant or taught at a university. There will be no reduction of benefits even is she is already earning a sizable income from her new career.
Regular Occupation:
You would be considered disabled if;
- Unable to perform the regular, substantial and material duties of your job.
- Not engaged in profit or wage-earning activities.
- Under the regular care of a physician appropriate for their injury or sickness
EXAMPLE
In this case, the moment Dr. Mackena starts consulting, her disability insurance will cease paying the benefits because she is no longer considered disabled.
It’s important to understand how long this definition will last, as the typical Canadian policy has a 2-year window for regular occupation and then the definition of disability is bumped down to any occupation.
Any Occupation
I would consider this to be the worst type of disability definition as it puts the most restrictions on you, most policies will use the phrase “gainful employment” as a measure of recovery.
To put it simply, It means that the moment you earn an income you may no longer be eligible for disability benefits.
What makes this confusing is the word “ANY” it’s not literal, Just because you can technically sit on the exit doors of Costo and check receipts does not mean you can work in your field again.
They still consider your training, education, and experience before the disability, but because of the ambiguity and the terms, I would suggest you opt for a long term regular occupation definition.
Some any-occupation policies may force you to go through what “retooling”. Making new training and education mandatory.
Though a work placement assistance is a great perk, your policy could have a retraining clause forcing you to return to school.
Know your own coverage.
As you can see from these 3 tiers, disability insurance can get extremely specific. It’s important that you speak with a professional when it comes to addressing your needs. This doesn’t just save you time, it helps prevent headaches.
Even if you were earning a high income and want to pay for the better policies, some companies may not offer the extended regular occupation option let alone the own occupation plan.This is because of the type of job you have.
For example, some high-earning trucker driver-operators have a hard time getting disability insurance because of their job and the type of cargo they carry and how prone they are to car accidents.
Your job and daily responsibilities will alter how you should approach disability insurance.
What if I Am Not Totally Disabled? (Partial Disability)
Injuries or illnesses can still reduce your ability to earn an income even if you are not totally disabled, so do you have coverage if you were to lose some, but not all of your income?
Most insurance companies will have a provision for being partially disabled. These may be included in the base of the policy, or you may need to add them as extra features. There are 2 types of partial disability:
Partial Disability:
- You are not considered fully or totally disabled
- You are working at your regular employment but cannot perform a key task (main role) or you are losing more than 50% of your hours.
- In the care of a doctor
Residual Disability
- You are not considered fully or totally disabled
- You are working at your regular employment but have lost more than 20% of your income due to an illness or injury.
- In the care of a regular doctor.
It is important to understand what your policy covers because partial disability gives you coverage based on lost time, where residual is income tested. Residual also has a lower threshold for being able to claim. Losing 20% of income is more likely compared to losing 50% of your hours. Some policies include both of these definitions allowing the insured the choice to claim based on time or lost income. However, speak with your financial advisor to verify what would work best for you.
When Do the Monthly Benefits Start? (Waiting Period)
The disability policies have a waiting period, usually 60-90 days.
The waiting period works similarly to the deductible on your home or auto policy. The first portion of your coverage is “out-of-pocket”. This means during the elimination period, you are responsible for your lost income. You may have an emergency fund that accounts for this period or maybe you don’t.
If you don’t have sufficient reserves, it may be a good idea to buy down the waiting period from 90 down to 30 days. The shorter the waiting period the more expensive the policy is.
When Do the Monthly Benefits End? (Coverage Duration)
Benefits stop when you are no longer considered disabled based on the definitions above or if you’ve reached the maximum period you signed up for.
Benefit Periods often default to:
- 2 years,
- 5 years,
- or until you are 65.
My first instinct is to always check the coverage until 65 years old before anything else unless your budget is extremely tight.
This is because if you become disabled, you may or may not recover and even if you do, you are unsure how long the disability would last for.
The longer the period the more expensive the policy is due to the amount at risk for the insurance company.
Example:
Think about Sam, if he was disabled today, replacing his income for 2 years is only $79,000(3300×24) while it would be $198,000 for 5 years and $1,188,000 until he turns 65. If he purchased a policy that covers him until 65, he is essentially buying nearly 1.2 Million dollars of insurance.
How does my work impact disability insurance? (Occupational Classes)
Disability insurance is designed to replace income. So it makes sense that the source of income plays a part in qualifying for a disability insurance policy and also it’s premiums.
The best way to understand this is by thinking about the following comparison.
A roughneck who works in the rigs will have a higher risk of being disabled at work through compared to a financial planner like me. The physical nature of the work will also make it less likely for the rig-hand to go back to work. Compared to a financial planner, where I could do some of my work even if I was unable to walk due to an injury. (knock on wood).
Because of the diversity of jobs available, insurance companies have their own occupational classes or grouping tiers. They publish a list of common occupations and duties required by the job descriptions. That list is then occupational groups, It usually follows a 5 level tier system. The Higher numbers show lower risks for insurance companies, therefore lower premiums, and more features.
- Class 4A: Specific professional careers and business executives. Example: Surgeons and Dentists(Note: Some companies only offer 3A rating for dentists)
- Class 3A: Office workers with high job stability and no manual duties. Most Professionals and members of the clergy fall under this occupation class.
- Class 2A: Skilled Specialized Trades for workers. Typically supervisory or foremen positions of a skilled trade.
Reduced manual work compared to Class A
- Class A: Skilled labors and lighter trades with little to no unusual hazards like extreme heat or chemicals.
- Class B: Extremely physical efforts required for the job. Unskilled labor
- UnInsurable: (highly risk or unstable work). Someone who handles explosives, like an avalanche prevention specialist who throws explosives from a helicopter to set off controlled avalanches, will have a hard time getting disability insurance- yes, that is a real job. Freelancers, actors, writers will also have a hard time getting insurance due to the instability of work unless they have a long documented history of projects and stable income. Part-time workers with minimal hours may also be uninsurable. Factors that would make someone uninsurable:
- Accident Prone Work
- Exposed to Extreme Temperatures
- Exposed to hazardous Materials and Chemicals
- You may also be considered uninsurable based on preexisting health conditions or dangerous hobbies, always consult with an insurance expert.
Occupational Class Upgrades:
Aside from the dangers in your daily work routine, companies also reward you for higher work stability. They do this by allowing occupational class upgrades.
This means you can get a bump up from 2A to 3A and from 3A to 4A. This is typically determined by your length of employment and stability of income.
Check if the insurance company is giving you the right the best class.
While there is really no such thing as “right” occupational class. Make sure your insurance provider is offering you a favorable class rating. This is because every carrier has a slightly different categorization.
For example, General Dentist used to be classified as 4A by RBC and Canadalife, however, due to high claims cost, the whole occupation has been ranked down to 3A. I cannot comment if other carriers will follow yet.
Disability Insurance From Work Is not Enough!
First I have to say, AWESOME! It’s good that you do. With increasing pressures from minimum wage increases and additional taxes on small businesses, I have seen more and more companies remove benefits, consider yourself lucky!
Let’s compare individually owned long term care insurance to group disability plans, also known as employer-sponsored disability insurance plans.
Affordability: You may be paying very little or some cases no premiums at all for your group disability benefit but this comes at the cost of reduced benefits.
Tax Consequences: If you are not paying for your disability policy at work, this may be deemed as a taxable benefit. If the premiums are not reported as a benefit, this may become a huge pitfall in your coverage.
We already discussed the tax-free nature of disability insurance benefits, therefore even though it is limited to ⅔ of your income, it gives you a benefit very close to your net take-home pay, you know, the money you actually get to spend when you work.
Let’s go back to Sam’s case.
Sam Earns $5,000/mo and would be capped around to $3300/mo or (⅔ x $5000).
Considering that his monthly take income is roughly $3800 he would have a monthly reduction of $500 on income, this deficit should encourage Sam to return to work as soon as his recovery allows him to.
However, if that $3,300 is taxable at 25%. His net disability income is $2,475. This means he lost a total of $1,325 ($3,800-$2,475) in monthly income.
You can find out if this is the case for your benefits simply by asking your HR representative or looking at your payroll deductions, if it looks like there are premiums for disability taken from your pay, you do not have to worry about this.
Partial Disability: Verify that your work disability policy actually has partial benefits because if you are injured but are not totally disabled, you may lose a substantial amount of your income. With your own disability policy, you may be able to add these, or it might have it built-in, depending on the insurance company.
Will You Keep Your Policy?: Because group sponsored disability policies are owned by your employer, it does not move with you. There is a very strong likelihood that you may change jobs throughout your career. If you do, the benefits will not come with you and there is no guarantee that you will have this covered in your new place of employment.
Will Your Employer Keep your policy? Remembering the last point, YOU DO NOT OWN YOUR POLICY. THE COMPANY DOES. This means they can change the benefits any given year. There was a time when these benefits would extend even to your retirement, but as Sears and 3M have recently proven, these benefits can go away at any time.
How Can You Make The Most Out of Your Employer-Sponsored Disability Policy?
I’ve already discussed the concept of integration. Which follows the maximum participation rule. This means, your total monthly disability benefit cannot exceed ⅔ of your regular income, even if it was coming from multiple policies. This includes your insurance benefits from work.
Make sure you are disclosing all existing benefits to your financial advisor so they can craft a plan where your personal policy may simply act as top-up saving you money, on premiums.
Improving Your Disability Insurance Policy (Riders)
Additional Policy Benefits or Enhancements.
Disability insurance can be customized to fit the needs of each and every client. Some may need or qualify only for the most basic form; while others may need additional enhancements to their plans. These enhancements are called “riders” I remember the term by imagining that they ride on top of the main policy. Most riders can only be purchased as additional benefits and not as individual products.
Below are some of the most common enhancements that I would often bring forward with my clients. Ask your advisor about the following:
Own Occupation Rider
The own occupation definition can come standard, but, most carriers have this as an enhancement if you qualify. It is worth the extra premium if you’ve got a highly specialized job such as a surgeon dentist or an executive.
Cost of Living Adjustments Or Inflation Adjustment.
Things become more expensive over time. So even if you have the right amount of insurance in place, if it stays the same, while costs go up, you will experience a downgrade in your lifestyle. Just look back 5 years, and you’ll clearly see that everything has gone up in price. From your daily necessities to your luxuries. The cost of living rider allows for the benefits to increase during the time of claim. It is designed to keep pace with inflation.
Future Increase Option.
If you are a young, a recent graduate or if your career does not follow a regular increase in earnings. It may be worth looking into getting the ability to add insurance later on without medical qualification. That is that the future increase option provides. This is also known as guaranteed insurability option as you will not be turned down regardless of your health condition.
Automatic Increase Riders.
This is similar to the Guaranteed Insurability or Future Increase options because it allows you to get additional insurance as your income goes up. The key difference is this is typically set to increase at certain periods without needing a request. Some policies increase the total coverage over time to account for regular raises
Partial Or Residual Disability are riders that will allow you to get benefits even if you are not completely disabled. I’ve explained this in detail above. I would say this is a must.
Return of Premium Rider.
If your policy expires without you filing a claim, the insurance company keeps the premiums. This causes discontent with a lot of people.
I have to be honest with you. I am still on the fence with the return of premium riders. And it has to work on very specific cases, the math just has to make sense. Essentially you pay more upfront so you get some money back. I’ve seen agents sell it as a ”forced savings” But when you look at what the extra premiums could have earned if invested elsewhere. However, this is commonly demanded by clients.
Health Care Professional Rider is very specific to Dentists, Doctors and Health Practitioners.
If you deal with a patient’s bodily fluids, you are at risk of coming into contact with HIV or Hepatitis, as you know, this would need to be disclosed and could cost you your career since you would not be able to perform some of your duties. you would legally have to disclose this impairment resulting in patients refusing to work with you, you may even lose your license. So In my opinion, If you are a Doctor, Dentist, Nurse, Lab Specialist, You should add this to your disability policy.
Additional Built-in Perks ("Freebies")
In order to compete, insurance carriers throw on additional perks that should make their policies more appealing. However, I would consider these as “nice to have” rather than musts.
This is because getting the right insurance coverage comes first. Think about it, you would look at the passenger capacity of a car when buying for a family before you check the sunroof options.
However, there are really powerful services that come with some of the top insurance companies in Canada:
RETURN TO WORK SUPPORT: There are physical and psychological challenges regarding disability which may be a contributing factor to addressing your recovery.
There are services which will equip you with support. Here are some of what may be included in these programs:
- Co-ordination and payment for physical and/or psychological rehabilitation services
- Financial and business planning
- Transferrable skills analysis, which includes identifying other occupations you could perform Job
- training and education Job search assistance and placement
- We may also provide a job or work-site modifications to accommodate your needs, such as Ergonomic furniture and/or equipment.
- Working with you and your employer to change your job duties Assistive devices such as mobility-enhancing equipment or visual/audio devices. (RBC’s Return to Work Assitance Benefits)
CATASTROPHIC DISABILITY: You would be considered totally disabled if you needed support in 2 of the six activities of daily living listed below.
- Bathing: Being unable to wash in a tub, shower or by sponge without assistance.
- Dressing: Being unable to put on, remove fasten, or unfasten essential clothing and artificial limbs.
- Toileting: Being unable to go to the washroom and complete personal hygiene without support.
- Transferring: as measured by the ability to get in and out of bed, and get into and out of a chair.
- Self-feeding: The Ability to consume food which has already been prepared.
A qualified physician and a physical assessment by an occupational therapist are needed. If qualified, most carriers will:
- waive the waiting period
- and premiums are waived during the disability.
- monthly payments are increased
- an additional lump sum is received.
Presumptive Disability Clauses: If you suffer an irreversible loss to:
- Speech
- Hearing from both ears
- The sight from both eyes
- use of 2 limbs combined.
A qualified physician and a physical assessment by an occupational therapist are needed. If qualified, most carriers will:
- waive the waiting period
- and premiums are waived during the disability.
- monthly payments are increased
- an additional lump sum is received.
Survivors Benefit: Some carriers provide a lumpsum benefit to your survivors if you pass away while disabled. This is often a multiple of the monthly benefits received.
How Do You Buy Disability Insurance?
Ask an ADVISOR. Seriously.
Make sure that they are licensed and can give you professional advice. If you don’t have one, feel free to contact me.
I understand that some of my readers are pro at DIY. I would still urge you to have a conversation. If not please go through the following steps.
- Check For Insurable Income: You may be receiving income from other sources such as rental income or investments. Those are not considered insurable.
- Ask yourself: “Will this income keep coming if I am not working” if the answer is yes, it is not insurable.
- Likely, this will simply be your paycheck
- Check For Maximum Coverage: Take that income amount from the previous step and multiply it by 2/3 or 67% this will give you a rough idea of the maximum integrated benefit you would qualify for.
- Do a reserve check: How long can you go without your income before you get into a financial mess.
- Do you have cash reserves? you will likely tap into this prior to receiving disability insurance benefits.
- How many months of expenses will the reserves last for? 1,2,3 maybe even 6?
- If you have sufficient emergency reserves, you may be ok with a longer waiting period.
- If you can sustain 3 months, check for a 90 day waiting period
- If you can sustain 2 months, check for a 60 day waiting period
- If you have no reserves, check for a 30 day waiting period.
- Do you have specialized training: If your field is highly skilled and specialized own occupation is a must. Do not skimp on this.
- Summarize Your Need: Put your answers in steps 2-4 in this formula:
- I need (Answer in step 2) of disability insurance, with a (Answer in Step 3) waiting period. With/Without the own occupation definition. ( Based on step 4)
- Shop Around: Sadly, you, my friend are back to my first recommendation. Disability insurance is not like term insurance where there are tonnes of online quotes available.
this is because you may not be giving yourself the right occupational class as explained above. However, if you do steps 1-4 on your own, you will have a way to verify if the person you are talking to is looking after your best interest.
Conclusion
This has been a comprehensive guide on what you need to know to be an informed buyer of disability insurance.
There are a lot of services and policies which technology has commoditized through online points of sale or DIY platforms.
Unfortunately, disability insurance is not one.
This is a financial tool that requires professional handholding, more so than others.
I hope that this guide has equipped you enough to have the confidence in talking to an advisor and use it as a hiring tool if you must. Verify the advisor’s responses to your questions through this guide.
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