Demistifying disability insurance

10/3/2007 3:52:00 PM

A while ago we started looking at life insurance. One very important aspect of long term insurance is disability insurance. Very often people only look at insuring the financial implications of death. Truth is that daily there are people who suffer some or other form of trauma but are not able to continue working and therefore have no income.

Death cover only pays out at death. So what happens if a doctor loses his/her arm, or a teacher becomes deaf. How can one protect one self from these kind of events and what options do you have?

Lets first define disability insurance. In the event of a person getting injured or fall ill and cannot continue to earn an income, disability insurance will pay out a monthly income for a period or a lump sum of some sort. If it is a monthly payment it can be for a period of two years up to the remainder of the persons working life, at which stage the monthly payments will seize and the person will have to rely on some sort of retirement saving. This is very important because it means that while the disabled person lives from the insurance payments he/she has to save for retirement. Make sure you know what the term of the insurance is.

So the first point is to answer the question: do you insure for a lump sum or monthly payments. If it is a lump sum make sure the amount is sufficient to produce an income that will provide for your needs. A lump sum disability benefit is a once-off payment based on a multiple of your annual income. A good financial advisor will be able to do a calculation to determine what cover you will need. The advantage of a lump sum payment is that the funds come under your control and it is an asset in your estate which you can bequeath to heirs.

When buying disability cover it is also important to know that in the case of monthly payments these payment seize at death. They also seize if the insured recovers sufficiently to be able to work again. The insurance company will revisit the insured after a period to see if the condition still satisfies their criteria for payment. If the insurance company assesses that the insured person is able to work again they will stop the payments and encourage the person to go back to work. The advantage of monthly payments is however that you know what the monthly amount will be if you qualify for the payment. You do not have to carry the risk of market returns to insure that you receive sufficient income and to ensure that the funds last for as long as you need it.

Furthermore it is important to understand the definitions of disability. These differs widely from company to company. One company may for instance insure you for own occupation whilst another may insure you for own or similar occupation. In the former the insured will be paid out if he/she cannot perform their specific job any longer for instance a teacher cannot teach any longer because he/she lost his/her hearing. If this person however had insurance covering own or similar occupation the insurance company may argue that the teacher can still work in the library or mark papers for which hearing is not a prerequisite.

Another distinction is functional impairment or physical impairment. Functional impairment is when a person lose a limb or the function of their hand whereas physical impairment is when a person becomes a quadroplegic or a paraplegic.

It is imperative that one understands the different definitions used by the insurance companies. This is critical when comparing different insurance quotes. Familiarise yourself with the definitions and understand what you are buying. Ask your advisor to explain to you with examples under what circumstances the product he or she is selling will pay out and under what circumstances will it not pay out. How much will pay out? Is it a lump sum pay-out or is it monthly? If it is monthly for how long will it pay out? These are critical questions that you need answers for when buying disability insurance.