What it means
Most people insure property they could replace and leave uninsured the thing they could not, which is their ability to earn. Disability insurance fills that gap by converting a salary into a promise of monthly payments if a medical condition prevents work.
Policies come in two broad shapes. Short-term cover pays quickly and typically runs for three to six months, while long-term cover starts after a longer waiting period, known as the elimination period, and can run to retirement age.
The definition of disability is the single most important clause. An "own occupation" policy pays if you cannot do your specific job, whereas an "any occupation" policy only pays if you cannot do any job you are reasonably suited to, and the second is far harder to claim on.
Benefits are usually capped between 50% and 70% of pre-disability income, deliberately below full pay so there is still an incentive to return to work. Group schemes bought by an employer are cheaper per head but the benefit is often taxable, while an individually bought policy paid from after-tax income normally pays out tax free.
For a small business the exposure runs both ways. A partner or key employee who cannot work still needs an income, and the business itself may need cover for fixed overheads or a buy-out of the disabled owner's stake.
In practice
Real-world examples.
Example
A dental practice owner buys own occupation cover because a hand tremor would end her clinical career even though she could still manage a business. The policy pays $9,000 a month, enough to service the practice loan while an associate is recruited.
Example
A logistics company adds group long-term disability to its benefits package after two warehouse injuries in a year. Staff see a genuine safety net, and the firm no longer keeps paying full salaries informally to injured employees, which had been costing it far more.
Example
A two-partner consultancy pairs disability cover with a buy-sell agreement. If either partner is disabled for more than twelve months, the policy funds the purchase of that partner's 50% stake so the working partner is not left funding an absent owner.
Think of it
“Disability insurance replaces income if you can't work-protection against lost earnings.
Formula
Calculation
Monthly benefit = Replacement percentage x Pre-disability monthly earnings (subject to the policy cap)
Total benefit paid = Monthly benefit x Months of disability after the elimination period
A regional architect earns $120,000 a year, which is $120,000 / 12 = $10,000 a month. Her long-term policy replaces 60% of earnings after a 90-day elimination period, with a maximum benefit period to age 65.
Monthly benefit = 60% x $10,000 = $6,000
She is unable to work for 15 months following a spinal injury. The first three months fall inside the elimination period and are unpaid, so benefits run for 15 - 3 = 12 months.
Total benefit paid = $6,000 x 12 = $72,000
The premium on the policy is $2,400 a year, which is 2% of her salary, so a year of cover costs about one twelfth of a month's benefit.Case study
Seen in the real world.
Harrowfield Surveying is an illustrative, fictional firm of eleven people whose founder generated most of the fee income. He assumed the group life cover on his benefits statement also protected him against illness, and never read the schedule closely.
When a stroke kept him out of the office for eleven months, the family discovered the group policy was life cover only. The firm carried his $11,000 monthly salary for five months out of reserves, cut two junior roles, and lost three retained clients who wanted continuity.
After he returned, the firm put individual long-term disability cover in place for both directors and a key person policy on the founder, at a combined cost of about $7,900 a year. The illustrative point is simple: the premium was less than one week of the disruption the firm had already absorbed.
Watch out
Common mistakes.
- Assuming state or statutory sick pay is enough. Public schemes typically replace a small fraction of a professional salary and often run out within months.
- Buying an "any occupation" policy on price alone. It is cheaper because it pays out far less often, and many claimants discover this only when a claim is declined.
- Forgetting that group cover ends when employment ends. If the illness causes a job to be lost first, the protection may lapse before it is needed.
Questions
People also ask.
Is the benefit taxable?
If the employer pays the premium, the benefit is usually taxable income; if the individual pays from after-tax money, the benefit is usually received tax free.
What is an elimination period?
It is the waiting time between becoming disabled and the first payment, commonly 30, 60, 90 or 180 days, and a longer wait means a lower premium.
Can a business insure its own overheads?
Yes, business overhead expense cover pays fixed costs such as rent, utilities and staff wages while an owner is unable to work.
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