How does disability insurance work?

What is disability insurance?

Your most important asset is your ability to earn a living, but can you support a family and pay bills if you can’t work? The possibility of becoming disabled or ill may seem unlikely, but the statistics paint a different picture. According to the Social Security Administration, at least one in four 20-year-old men can expect to be disabled before reaching normal retirement age.

Find out how disability insurance works, what types of policies are available, and how you can get coverage.

Definition of disability insurance

Disability insurance or disability income insurance provides partial income reimbursement for eligible employees who are unable to work due to a non-work-related injury or illness or, in some cases, pregnancy. Employees can get this type of insurance through their employer, the policy they buy, a government agency, or the Social Security Administration.

Disability insurance does not provide job protection, only cash benefits. However, you can protect your job through state and federal laws such as the Family and Medical Leave Act (FMLA).

  • Alternative name: Disability Income Insurance

How does disability insurance work?

Disability insurance provides compensation for loss of income if you are unable to work due to injury, illness, both, or pregnancy. To be eligible for benefits, you must meet the definition of disability in the policy.

Disability benefits will not replace more than 100% of your pre-disability income, but will often replace less. The methods for calculating your disability benefit differ depending on what kind of benefit you have and whether the benefits are provided by a government program, a private insurance company, or the Social Security Administration. However, there are two methods:

  • Income Benefit Formula: The income benefit formula expresses your total benefit payment as a percentage of your pre-disability wages, and may also take into account the income you receive from workers’ compensation or Social Security benefits. This percentage varies from policy to policy but can range from 50-75%.
  • Fixed Amount: Your benefit payment may be a predetermined dollar amount shown on the policy, usually determined when you purchase the policy. You will receive this amount regardless of whether you receive other disability benefits.

Benefits will not start immediately after you become disabled. Disability insurance contracts have a liquidation period – a certain period of time after your disability begins, during which no benefits are paid. The waiting period varies from contract to contract, from a few days to a year or longer. You can choose a waiting period when purchasing a policy; a longer liquidation period reduces your insurance costs.

Disability insurance benefits are often based on the insured person’s earnings. Your disability benefits may decrease after you purchase coverage if your salary decreases.

Review the fine print of your policy to understand your rights and responsibilities and what is and is not covered. Typical exclusions from disability insurance:

  • Claims due to pre-existing conditions
  • Injury or illness resulting from war
  • Self-inflicted injuries
  • Injury or illness as a result of alcoholism, intoxication, or drug addiction.
  • Industrial injuries

Types of disability insurance

If you are unable to work due to injury or illness, these types of disability insurance will pay a portion of your income.

Short term disability insurance

Short-term disability insurance replaces a certain percentage of your pre-disability income after a short exclusion period, such as two weeks. The duration of benefits varies from policy to policy, but the maximum duration is usually limited to six months.

Short-term disability insurance can be expensive to purchase individually, but group insurance is generally cheaper. Companies may offer short-term insurance to their employees as a company-paid benefit. A short-term disability policy may cause the elimination period to break before your long-term disability benefits begin if you have both.

Long term disability insurance

With a typical withdrawal period of at least 90 days, long-term disability insurance is generally considered protection against catastrophic illness or injury. Benefits can last up to five years until you retire or until the end of your life, depending on your policy. You may be eligible for a higher premium if your policy has a longer benefit period.

Short-term and long-term disability insurance policies may have the following protective functions:

  • Non-cancellable: Your disability insurance policy will remain in effect as long as you pay your premiums, which are guaranteed not to increase. Benefits also cannot be changed.
  • Guaranteed Renewable: This type of policy is similar to a non-cancellable policy, except that premiums can be increased for an entire class of policyholders.

How to get disability insurance

Employer-sponsored coverage

Employer-sponsored insurance is the main source of disability income protection in the United States, often in the form of short or long-term group plans. Coverage may be automatic, meaning no underwriting or a medical examination. Employees also often have the opportunity to increase the basic coverage provided by the employer.

Some companies do not provide disability coverage but allow their employees to purchase insurance coverage on a voluntary basis. It is easier to qualify for employer-sponsored insurance coverage, but you should check with your Human Resources department to find out what coverage and acquisition options are available.

Insurance Company

Private insurance companies provide a range of options for individual disability insurance. A medical examination may be required to qualify for coverage, and policies may cost more than the coverage provided by your employer. But these policies are portable, so you don’t have to worry about losing coverage when you change jobs.

State disability insurance programs

The states of California, Hawaii, New York, New Jersey, Rhode Island, and the Territory of Puerto Rico provide a partial payroll replacement insurance plan—typically for up to six months—that all eligible workers must pay through payroll withholding. This can be an important source of short-term income replacement for residents of these states.

Social protection

The federal government’s insurance program automatically covers most workers, but not everyone is eligible for benefits—about 64% of applicants are initially denied. Disability benefits are considered long-term, they are not for short-term disability and may be paid if you have an illness that will last at least a year or cause death. The amount of the benefit usually depends on your work experience, your income, and your age. In 2019, the average monthly allowance was $1,257.65.

Key Findings

  • Disability insurance protects your earned income from the risk that a disability could make it impossible to work and therefore earn an income.
  • Disability insurance is available on the basis of short-term and/or long-term disability.
  • Both long-term and short-term disability policies include waiting periods after an illness or injury before receiving benefits.
  • Your disability insurance policy will tell you how long you will receive monthly benefits.
  • Alternative sources of income, such as workers’ compensation and Social Security benefits, may reduce the amount you receive as income reimbursement.