United States
Hong KongDisability income insurance
Disability income replaces earnings while the insured cannot work. Four variables define any policy: the definition of disability, the elimination period before benefits start, the benefit period they run for, and the monthly amount, which is capped below full earnings so returning to work stays worthwhile.
Life insurance handles a risk everyone can picture. Disability income handles the one that is statistically more likely during a working life and that almost nobody plans for, and it opens the largest section on the paper with five sub-items.
The four variables
| Variable | What it decides | Effect on premium |
|---|---|---|
| Definition of disability | How hard it is to qualify as disabled | Own occupation costs more than any occupation |
| Elimination period | How long the insured waits before benefits start | A longer wait costs less |
| Benefit period | How long benefits run once they start | A longer period costs more |
| Benefit amount | The monthly payment | Higher costs more, and it is capped |
Change any one of them and you have a different policy at a different price. A stem describing a client who wants to reduce the premium is telling you to lengthen the elimination period, which is the lever with the least effect on the protection that matters.
Why the benefit is capped below earnings
Insurers will not replace the whole of an income. If disability paid as much as working, some claimants would have no financial reason to go back, which is moral hazard in its purest form. So policies replace a share of earnings, and the relation of earnings to insurance provision, which the outline lists in section VI, exists to enforce that as circumstances change.
The cap also interacts with tax. Where the insured paid the premiums personally with money already taxed, benefits are received tax free, so a partial replacement of gross earnings can be close to full replacement of what was actually being taken home.
The five sub-items the outline lists
- Individual disability income: the personal policy, medically underwritten, portable.
- Business overhead expense: pays the fixed costs of running a business while the owner is disabled, not the owner's income.
- Business disability buyout: funds the purchase of a disabled owner's interest in the business.
- Group disability income: employer-sponsored, less underwriting, usually short and long term forms.
- Key employee policy: owned by the business on someone whose disability would cost it money.
Three of those five are business policies, which mirrors the life half of the paper: the products that look alike are separated by who owns the contract and who receives the money.
Individual and group compared
| Individual | Group | |
|---|---|---|
| Underwriting | Full medical and financial | Of the group |
| Definition of disability | Often own occupation | Often own occupation then any occupation |
| Portability | Goes with the insured | Ends with employment |
| Who pays | The insured, with after-tax money | Usually the employer |
| Tax on benefits | Not taxable | Taxable where the employer paid the premium |
The bottom row is the most examinable fact in disability income and it runs the opposite way to intuition. Employer pays, benefits taxed. Insured pays, benefits tax free. The rule is that somebody pays tax once, and the exam wants to know whether you can say when.
An employee is covered under a group disability plan for which her employer pays the entire premium. She becomes disabled and begins receiving benefits. How are the benefits treated for income tax?
- Not taxable, because disability benefits are never income
- Taxable, because the premium was paid with employer money that was never taxed to her
- Taxable only to the extent they exceed her former salary
- Not taxable, because she did not choose the coverage
Where it sits
- Section
- V, types of accident and health policies, 16 questions
- Listed as
- A. Disability income, five sub-items
- Provisions in section VI
- Elimination period, probationary period, relation of earnings to insurance
- Section VIII
- Total, partial, recurrent and residual disability, plus tax treatment
Three sections carry disability content. That spread is the reason it is worth more time than the sub-item count suggests, and it is the same pattern annuities show on the life side: a topic that reaches you from several directions is worth more than its own heading implies.
The opinion, and the concession
Learn the definition of disability first and the products second. Own occupation against any occupation decides whether a claim is paid at all, it separates individual from group policies, and it reappears in the waiver of premium rider on the life side. It is the most reused idea in the health half and it has its own page here.
The concession: benefit percentages, elimination period lengths and maximum benefit periods are all product terms that vary by carrier, and the tax rules are federal. We publish no figures for any of them, because the sources we hold do not set them. What the exam asks is the direction of each relationship, and direction is what this page gives you.
Common questions
Are disability income benefits taxable?
It depends who paid the premium. Where the insured paid personally with money already taxed, benefits are received tax free. Where an employer paid and deducted the premium, benefits are taxable. Tax is paid once, and the question is only when.
Why does a disability policy replace only part of earnings?
To keep a financial reason to return to work. Full replacement would create moral hazard, so insurers cap the benefit at a share of earnings. The relation of earnings to insurance provision in section VI exists to adjust the benefit if the insured's income later falls.
What is business overhead expense insurance?
A policy that pays the fixed costs of running a business while the owner is disabled: rent, utilities, staff wages and similar. It does not replace the owner's own income, which needs a separate individual disability policy. Confusing the two is the standard distractor in this heading.
How can a client reduce the cost of disability cover?
Lengthen the elimination period. It is the variable with the largest effect on premium and the least effect on the protection that matters, because a client with savings can usually absorb a short gap. Shortening the benefit period saves money too and gives up more.