What it means
For most people, their ability to earn is their biggest financial asset. If an accident or illness stops them from working, there is no salary to pay the mortgage or buy groceries.
DI insurance protects against that risk by paying a monthly benefit, usually a percentage of normal income, for a set period or until retirement age. Policies commonly pay somewhere between half and two-thirds of earnings, because insurers want people to have a reason to return to work.
Benefits are often paid after a waiting period, known as an elimination period, which may be 30, 60 or 90 days. A longer waiting period lowers the premium (the regular price of the cover).
Policy definitions matter enormously. Some policies pay if you cannot do your own job, while others pay only if you cannot do any job.
The first type, called own-occupation, is more generous and more expensive, so the wording needs careful reading. Business owners use DI insurance in several ways.
They can buy it personally, or arrange group cover for employees as part of a benefits package. Small firms may also buy key person cover, which protects the business if an important individual cannot work.
Tax treatment varies by country and by who pays the premiums. In some places benefits are tax free when the individual pays the premiums from after-tax income, and taxable when the employer pays.
Because the rules change over time, individuals and finance teams should check the current position locally. Finance teams should also look at exclusions, such as pre-existing conditions, and at whether the policy can be cancelled or its premiums raised by the insurer.
A guaranteed renewable policy offers more certainty than one that can be changed.
In practice
Real-world examples.
Example
A self-employed graphic designer buys a policy paying $3,000 a month with a 60-day waiting period. After breaking her wrist in an accident, she receives payments for four months while she cannot work.
Example
A company with 80 staff arranges group DI insurance as part of its benefits package, so that every employee is covered without individual medical questions. The finance team budgets $48,000 a year for premiums, and the cover helps with hiring and staff loyalty.
Example
A surgeon chooses an own-occupation policy because a hand injury would stop him operating even if he could still teach. The extra premium is worth it to him because his specialist skills drive his income.
Formula
Calculation
Monthly benefit = Annual income / 12 x Benefit percentage
Suppose an employee earns $90,000 a year and has a policy that pays 60% of income. Monthly income is $90,000 / 12 = $7,500, so the monthly benefit is $7,500 x 0.60 = $4,500. Over a 12-month disability the policy would pay $4,500 x 12 = $54,000, but if the policy has a 90-day waiting period, the first three months of the claim would be unpaid, so payments in the first year would total $4,500 x 9 = $40,500.Case study
Seen in the real world.
Lakeside Cafe is a fictional small business used here as an illustrative example. Its owner, a 45-year-old chef, earns $72,000 a year and supports two children.
Concerned about what would happen if she could not cook, she buys a DI policy paying 60% of income, or $3,600 a month, with a 90-day waiting period at a premium of about $180 a month. When a back injury keeps her out of the kitchen for seven months, her emergency fund covers the first three months and the policy pays for the remaining four.
The payments cover her mortgage and household bills while the cafe's manager keeps it running. The story illustrates how a modest premium can protect a household from a very large loss of income. Without the policy, she would have had to borrow or sell business assets to cover the bills.
Watch out
Common mistakes.
- Assuming the sick pay from an employer will last long enough. Many employers pay for a limited period only.
- Choosing the cheapest policy without reading the definition of disability. A narrow definition can mean claims are refused.
- Ignoring the waiting period. You need enough savings to cover the gap before payments start.
Questions
People also ask.
What is the difference between DI insurance and life insurance?
Life insurance pays out on death, while DI insurance pays out while you are alive but unable to work. Many people need both.
Why does DI insurance not pay 100% of income?
Insurers want people to have a financial reason to return to work. A benefit of about 60% is common, though it varies by policy.
Is DI insurance worth it for the self-employed?
Often yes, because there is no employer sick pay or benefits to fall back on. The cost depends on age, occupation and health, and a policy that pays partial benefits during a gradual return to work can be especially valuable.
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