Most people fail to recognize the need for disability insurance, although the chances of becoming unable to work are relatively high. Car and home insurance are bought out of necessity, and life insurance is common, yet your clients could very quickly be prevented from earning an income to fulfil financial commitments.

The probability of becoming disabled is actually far greater than premature death, making such insurance an important risk-management tool for your clients — whether they are self-employed or belong to a group plan that provides limited disability coverage.

“It’s human nature not to think about the prospect of being disabled in our prime years,” says Philip Kung, president, Markham, Ont.-based RGI Financial Inc. “We tend to believe that we are invincible. However, disability can be a major setback as people without disability insurance would have to use up their savings if they cannot work. And if they do not have sufficient savings they and their families can face severe hardship — especially if they are disabled for a long period of time.”

A 20-year-old man is about three times more likely to be disabled for at least 90 days than he is to die before age 65, statistics from the Canadian Life and Health Insurance Association show. A 35-year-old woman is about seven times more likely to face disability than death before age 65. In addition, if disability lasts for at least 90 days, it is likely to last, on average, three years or more for a 35-year-old man or woman, and four years or more for a 45-year-old man or woman.

Evidently, the probability of disability is high during years when your clients may least expect it to occur. The consequent financial disruption can derail their best-laid plans. For instance, CLHIA statistics show that almost half of all mortgage foreclosures are because of disability.

Disability insurance is income-replacement insurance that provides a tax-free income in the event the policyholder cannot work because of injury or illness. It provides money when someone needs it most.

There are five types of individual disability policies: guaranteed non-cancelable, guaranteed renewable, renewable, non-renewable and cancelable. Here’s a look at each:

> Guaranteed non-cancelable policies are fully guaranteed to age 65 and cannot be terminated by the insurer during the term of the policy, excepting for the non-payment of premiums. In addition, the insurer cannot change any of the policy provisions, definitions, coverage or premiums during the term. The policy holder can cancel the policy at any time.

> Guaranteed renewable policies have the same provisions as guaranteed non-cancelable policies, except the insurer can change the premiums upon renewal to whatever level it deems fit.

> Renewable policies allow the insurer to change the terms of coverage on any anniversary date during the term of the policy and request new evidence of insurability prior to renewal.

> Non-renewable policies are generally not renewed under any circumstances at the end of the policy term. If coverage is still required a new application for insurance must be made.

> Cancelable policies can be terminated by the insurer at any time upon providing written notice to the policy owner.

Clearly, guaranteed non-cancelable and guaranteed renewable policies would provide the most favourable terms for your clients, with guaranteed non-cancelable policies being the better option.

With guaranteed non-cancelable coverage “the insurer accepts the full risk” says Lawrence Geller, president, L.I. Geller Insurance Agencies Ltd. of Campbellville, Ont. While a guaranteed renewable policy has largely similar provisions “much of the risk is transferred to the policy owner,” adds Geller. “All the insurer has to do is charge a high enough premium to get the policy owner to cancel the policy.”

Benefits are guaranteed to age 65, but some policies offer a rider to extend benefits to the lifetime of the policy owner. Other policies may extend benefits for a specified period if the policy owner continues to work full-time after age 65.

When it comes to renewable, non-renewable and cancelable policies, the policy owner is left at the mercy of the insurer, which can either change the terms and conditions, raise the premiums, refuse to renew or cancel the policy.

Income replacement provided by disability insurance is not based on gross income but on earned income from employment before deductions, such as taxes and Canada Pension Plan contributions. Unearned income, such as rents and interest, investment income and pension income — which are part of gross income for tax purposes — are normally excluded when calculating insurable income. Even if your client only has employment income, disability insurance does not replace 100% but is based on a schedule of benefits developed by the insurer.

@page_break@“Disability insurance isn’t purchased according a formula but instead from a table of maximum benefits determined by the insurer,” says Geller. “The higher the income, the lower the indemnity.” What this means is that, as income rises, the amount of benefits paid as a percentage of income declines.

For example, someone with an earned income of $40,000 may receive a benefit equivalent to 67% of income and only 59% on an income of $80,000. In effect, the dollar amount of benefits increases but the percentage of income being replaced by disability benefits decreases.

It is important for your clients to understand that the terms and conditions of disability insurance policies vary widely. Policies may have: exclusions on coverage based on pre-existing conditions; limitations on length of coverage; maximum benefits payable; conditions under which benefits will be paid; or other restrictions. Some may have benefits that are indexed to inflation, while most may have a waiver of premiums payable during the period of a claim. For example, there may be limitations on benefits payable for a specified medical condition or no benefits may be payable because of disability resulting from a pre-existing condition.

Typically, disability policies can have an elimination period ranging from 30 days to 180 days, or, in some cases, as long as one year before benefits are paid. Usually, the longer the elimination period, the lower the premium.

Premiums are generally lowest for those with the least risky occupations, such as office workers, and highest for those who work in industries such as construction. Some jobs may even be uninsurable, for example if your client works in an explosives factory.

Your client’s income will be generally replaced on four conditions: being disabled to do his or her own job; unable to work at his or her own occupation and choosing not to take an alternative job; unable to perform any suitable occupation based on education, training and/or experience; and becoming totally or permanently disabled.

While some clients may be covered by group insurance, you should still assess whether they need supplemental disability insurance coverage, as many group policies provide only limited benefits.

“Most people do not know that their group insurance may not provide them with adequate disability benefits, says Tim Landry, director, living benefits, MSA Financial Services in Montreal.

Disability benefits under a group plan may have ceilings, may not be based on total income, or may be subject to qualifying periods — leaving employees at risk of an income shortfall in the event that they become disabled.

If your client purchases individual disability coverage, says Landry, he or she can retain a policy, subject to certain conditions, even if he/she is no longer a member of the group plan or does not have an earned income. Coverage will be based on the individual’s income at the time the policy is purchased and not on a possibly lower income or no income when there is a change or loss of job, he adds. As well, coverage is based on an individual’s state of health at the time the policy is purchased, not on a possibly worsened state at a later date.

Wendy Hope, CLHIA vice president, external relations, advises that although this option is available, one should ensure that their policy provides disability coverage when the individual does not have earned income. “All policies do not offer this option,” she says.

Disability insurance can be expensive, but it may be worthwhile to recommend it to your clients and add a return of premium rider, says RGI’s Kung. With an ROP rider, your client will receive a refund of between 50% and 70% of premiums at various periods — on average every 10 years a renewable policy is in force — or at specified ages, such as 55 or 65, if a claim is not made. The level of ROP varies by insurance contract.

Disability can strike at any time, regardless of age. “People have an incredible belief that nothing can happen to them,” says Landry. Advisors should ensure their clients can meet financial obligations if they do become unable to work. IE