How much do you know about disability insurance?

Most Canadians don’t protect themselves against the loss of their earning power. This year one in eight working Canadians will become disabled for more than three months, and half of these individuals will be disabled for more than three years.

When people are asked “what is your most valuable asset?” the usual responses are their homes, cars or investment portfolios. Usually, most people don’t think of what allows them to buy and maintain these material things and pay for food, utilities, the mortgage and other living expenses.

The answer is simple; it is our ability to earn an income. Our personal income allows us to repay debts, accumulate wealth and develop a lifestyle for our families and ourselves. Unless we are independently wealthy and we do not need to work, disability insurance is an essential part of risk management while implementing a comprehensive financial plan for ourselves.

Consider a 35-year-old lawyer earning $120,000 today, who plans to work to age 65. Using the historical average rate of inflation of four per cent for the 20th century, this lawyer will earn $5.7 million over the next 30 years.

A disability insurance policy is a contract between the insured (you) and an insurance company. The monthly income benefits that you buy will only be paid to you based upon the definitions and wording in your contract.

The most important definition in the disability contract is the definition of “disability.” This definition is the heart of your plan. If, as a reasonable person, you cannot easily understand the definition of disability and how/when your disability income will be paid out, then you should not purchase that plan or deal with your current insurance agent. If the definition appears unclear, be aware that an insurance company at the time of claim has the power to define what constitutes a disability through its own interpretation.

Own occupation

“Own occupation” is the most clearly defined coverage and the most expensive to buy. It is usually sold as a rider to the regular coverage of a disability policy. Owning a policy with the ownoccupation definition pays you an income when you are disabled and not able to perform the duties of your chosen occupation. You would be eligible to collect full disability benefits, for example, when you are no longer able to work as a lawyer, even if you decided to work in another occupation, such as a cashier at a fast food restaurant, earning less, the same or more money than you did when you were a practising lawyer.

Regular occupation

Regular occupation is the most common coverage found in privately purchased disability policies today in Canada. You will be paid a benefit when you can no longer work in your chosen profession because of disability or sickness and do not have employment at all. If you choose to work in another profession, the definition of your occupation then changes to that of your new work situation. So if you were a lawyer and can no longer do this type of work but choose to be employed as a cashier at a fast food restaurant, the definition of your regular occupation changes to that of cashier and the insurance policy will no longer pay you a disability income.

Any occupation

This definition is found in most group and employer-sponsored disability policies and is the most misunderstood. This definition gives the insurance company the most leeway to interpret what constitutes a disability and to determine what the insured can or cannot do to earn a living. With the any occupation definition you will only receive a disability income from an insurance company provided you could not work at all in a job that you are “reasonably suited to do by your education, training or experience.

So if you were a lawyer and can no longer perform this type of work, the insurance company will have the power to make the determination if you are qualified to be a cashier at a fast food restaurant.

Even if you choose not to be a cashier, just because it determines that you are qualified to do so, the insurance company can legally deny you your disability income.

Benefit term

Many people have a difficult time deciding how long a benefit period they should buy. The average length of disability is about three years and your options for a disability policy benefit period range from two years to five years, or to age 65.

If you are a young professional and do not have considerable financial assets, a benefit period to age 65 is highly recommended.

Consumer Price Indexing

It is very important to consider purchasing a Consumer Price Indexing rider/coverage when buying a disability policy. An inflation rate of four per cent per year means that $1 today will have the buying power of $0.50 within 18 years. A cost-ofliving adjustment rider is designed to help you keep pace with inflation after your disability has lasted for more than a year.

Future Insurability

This optional rider is designed to protect your future income. This rider is a must for young professionals. It offers the ability to increase your disability coverage, regardless of your health, as your income rises. With the earlier example of our 35-yearold lawyer earning $120,000 today, if his income only increased with inflation, he would have an annual income of $177,000 ten years from now.

By purchasing this option with his original disability policy this lawyer would be able to buy additional coverage without any additional medical underwriting requirements. In essence, if he was diagnosed with a heart condition, as long as he had future insurability on his policy he could buy more coverage and have no fear of being declined by the insurance company.

Written by Peter Merrick

Peter Merrick, FMA, CFP, FCSI, Instructor at George Brown and Seneca Colleges, President of Merrick Wealth Management, a boutique financial planning, employee and executive benefit consulting firm.

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