What it means
Most people rely on their ability to earn a salary to pay for their home, family and future. A TPD policy covers the risk that this ability is lost for good, which would otherwise leave the person with large costs and no income.
The policy pays a single lump sum, called the sum insured, when the insurer accepts that the disability is both total and permanent. This is different from income protection, which pays a monthly benefit, usually until recovery or retirement, rather than a one-off amount.
The definition of total and permanent is critical, and it varies between insurers. An "own occupation" definition pays if you cannot return to your usual job, while an "any occupation" definition pays only if you cannot do any work suited to your education, training and experience, which is much harder to meet.
Insurers usually require a waiting period, often several months, and medical evidence that the condition is unlikely to improve. Claims can be refused if the condition was not disclosed when the policy started, so honest and complete answers on the application form are essential.
In business, TPD matters for owners and key people. A company may insure a founder or a critical executive so that a lump sum helps to fund a replacement, repay loans guaranteed by that person or buy out the owner's share under a shareholders' agreement.
Premiums rise with age, occupation and the size of the sum insured, and the tax treatment of benefits and premiums differs between countries and between personal and company-owned policies. A tax adviser should confirm how the benefit would be treated before a policy is bought.
In practice
Real-world examples.
Example
A self-employed electrician falls from a roof and loses the use of his hands. His TPD policy pays a $500,000 lump sum, which clears his mortgage and funds retraining and home adjustments.
Example
A software company buys TPD cover on its two founders. When one founder is permanently disabled by illness, the $1,000,000 payout is used to hire a replacement and to buy the founder's shares from the family.
Example
An employee of a retail group is covered for TPD through the group's pension plan. After a stroke she receives a lump sum through the plan, which the pension trustees assess against the plan's definition of permanent incapacity.
Formula
Calculation
Cover needed = Debts to clear + (Annual living costs x Years of support) - Existing assets and benefits
Suppose a 45-year-old with a family has a $250,000 mortgage and other debts to clear, expects annual living costs of $60,000 for 10 years while the family adjusts, and already has $150,000 of savings and other benefits. Cover needed = 250,000 + (60,000 x 10) - 150,000 = 250,000 + 600,000 - 150,000 = $700,000. A sum insured of about $700,000 would therefore be a reasonable starting point, to be checked with an adviser.Case study
Seen in the real world.
Greenfield Surveyors is an illustrative, fictional partnership of three surveyors who each guaranteed a $400,000 bank loan used to open a new office. The partners realised that if one became permanently disabled, the others would carry the loan alone while also losing that partner's fee income.
Their accountant recommended TPD cover of $400,000 on each partner, owned by the partnership and paid for out of partnership profits. The annual premiums were about $1,800 per partner, and the agreement said that the payout would be used to repay that partner's share of the loan and to buy out the partner's interest at a pre-agreed value.
Two years later one partner was permanently disabled in an accident. The illustrative claim was paid after the waiting period, the loan share was cleared, and the remaining partners kept the business without a funding crisis.
Watch out
Common mistakes.
- Assuming that all TPD policies define disability in the same way, when "own occupation" and "any occupation" tests can lead to very different claim results.
- Not disclosing a past medical condition, which gives the insurer grounds to reduce or refuse a claim.
- Confusing TPD with income protection, and so expecting a monthly income when the policy pays a lump sum.
Questions
People also ask.
Is TPD the same as total and permanent disablement under a pension plan?
They are similar ideas, but the exact definitions and who decides the claim can differ, so check the plan rules and the insurance policy separately.
How long is the waiting period for TPD claims?
It is set by the policy, commonly several months, because the insurer needs time to see whether the condition is permanent.
Does the payout have to be spent on particular things?
No, the lump sum is paid to the policy owner and can be used for any purpose, such as debts, medical care or living costs, subject to any trust or loan arrangements.
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