The Ultimate Guide to Long Term Disability (LTD) Insurance

Who is this for?

For anyone actively engaged in the workforce, this article is for you.

Here we will explore Disability Insurance and explain why it is one of the most important insurance benefits you should be aware of during your working years, and highlight some deficiencies in your insurance planning that you may not be aware of.

I’ll warn you in advance, as with any insurance discussion some parts of this may be a bit dry (such as definitions of disability - yikes), but bear with us, as understanding this stuff can be critical to your assessing the quality of disability benefits (that you may or may not yet have), and ensuring that if ever you find yourself diagnosed with a disability that you are in the best financial position possible.

What is Disability Insurance, and Why is it Important?

If you were to walk down the street and ask ten people what their most-valuable financial asset is, there’s a good chance that all ten would point to assets such as a house, cottage, or investment portfolio. That’s understandable, but if you think about it, your most-valuable asset is your ability to earn an income. Why? Because the ability to earn an income is what makes everything else possible.

While healthy and working, your income allows for payment of expenses, paying off liabilities, contribution to retirement savings and child education, as well as leisure and the occasional luxury. However, when you become disabled, income will go down, while expenses and liabilities will remain the same (or increase).

What’s more is that you’ll incur additional expenses when paying for cost of medical treatment, transportation to/from appointments, perhaps even retrofitting your home etc. Therefore, total expenses increase during periods of disability. Sadly, this can lead to a loss of assets (i.e. selling to pay expenses/liabilities), and a build-up of debt to cover the shortfall – the exact opposite of what you are trying to achieve during your working years.

We’re quick to insure our ‘assets’ such as our homes and our cars, but if we’re being logical, we’d all take equal (if not greater) care in insuring our incomes as well.

Drumroll, this is where Disability Insurance comes in.

Disability Insurance is primarily designed to protect (and replace) a percentage of your income, should you become disabled and find yourself unable to work. Upon being diagnosed as disabled by your physician, and after a pre-determined waiting period elapses, the insurance company will begin to issue a monthly payment to replace a percentage of income lost while you’re unable to work – enabling you to maintain some semblance of your former standard of living and quality of life.

Life Insurance Versus Disability Insurance

Life insurance is widely understood (comparatively). Most people understand how Life Insurance works; when you die a tax-free lump-sum is paid to the beneficiary of your choosing. Life Insurance is designed to offer protection in case of premature death and is used to ensure a minimum standard of living for your family/dependents as well as for Estate preservation and maximization. By contrast, living benefits such as Disability Insurance offer protection while you are still alive.

It may come as a surprise then, that despite all the attention that Life Insurance gets, the odds of experiencing a disability are substantially greater during your working years than the odds of passing away prematurely.

According to the Canadian Institute of Actuaries, your risk of a disability is 3x-4x greater than your risk of a premature death at all ages during your prime working years (prior to age 70), and the risk increases with age. Furthermore, according to the Commissioner’s Standard Ordinary (CSO) tables, the average risk (regardless of age) of experiencing a disability of 90-days or longer is over 40%.

Accidents and Illness can happen to anyone at any time, and chances are that you know someone who suffered an injury or illness and was unable to work for a period.

Still Unconvinced?

It’s perfectly normal to begrudge the idea of needing disability insurance. It feels like yet another insurance we’re told we need, and after all buying insurance isn’t nearly as much fun as a new flatscreen TV.

People will naturally come up with reasons why it isn’t necessary for them, but often haven’t thought it entirely through. Here are some of the most common reasons people offer for why they feel they don’t need disability coverage, and why that thinking may be flawed.

“I will live off my savings”:

Most people are only able to self-insure for a short period of time. How many months of total disability would it take to wipe out your savings? To calculate this, take your current savings and divide by your monthly burn rate. Further, your savings are more typically earmarked for retiree lifestyle and family, as opposed to funding a period of disability.

“I will liquidate assets. I could sell our home if I needed to.”:

Can you get a fair price when you need it most? Being forced to sell an asset when you’re in a desperate situation puts you at a disadvantage when attempting to negotiate on price. Do you want to face moving from your home while you are disabled? What impact will selling your home, or other assets have on your family?

“I get disability coverage through work”:

If you’re an employee, there’s a good chance your employer offers you some Long-Term Disability (LTD) coverage as part of your employee group benefits plan. However, the benefits and options on these plans can vary significantly and may not be as comprehensive as you would think. We explore this in detail in this article.

“Government benefits will suffice”:

There are three main government benefits:

  • Employment Insurance: Only covers employees, and is limited to 15 weeks.
  • CPP/QPP: Has a restrictive definition of disability that can be difficult to qualify for known as any occupation (more on this later). In short, one must be unable to perform the duties of any job in order to qualify.
  • Workers’ Compensation: Is limited to accidents only, and more specifically those that occur on-the-job in the workplace. Workers’ compensation therefore will not cover for accidents which occur outside the workplace.

“I will simply borrow the money”:

Who is going to lend money to a recently disabled person who has no means of repaying the loan?

“We could live off my spouse’s income”:

Can one person be a spouse, parent, private nurse, and employee all at once? What if your spouse needs to take time off to take care of you? Will your spouse’s income be enough to meet the needs of your family? How secure is your spouse’s job?

What is Long-Term Disability (LTD)?

Employers will often have an employee group benefits plan, which they offer to their employees as part of their overall compensation, which they offer employees as a way to attract and retain talent, and to help ensure that the workforce within the organization remains healthy, happy, and productive.

An employee group benefits plan will typically be comprised of several insurance benefits, such as life insurance, accidental death and dismemberment, health/dental, disability, and perhaps some critical illness coverage. While all of these are important to have for their own respective reasons, one of the most important insurance benefits one can have – and the focus of this article - is Long-Term Disability coverage (LTD).

LTD coverage is designed to replace lost income in the event that you become disabled and are unable to perform the duties of your occupation.

At this point the self-employed readers of this article may be saying “hey, but I’m not an employee, what about me?”. Don’t worry, we’ll get to you later, for now read on.

How an Employee Group Benefits Plan Is Typically Structured for LTD

When establishing an employee group benefits plan, your employer works with a benefits consultant who assists in designing a plan that (ideally) delivers on the goals of attracting/retaining talent, ensuring a sufficiently high baseline for employee health, all while being cost-effective, affordable, and sustainable over the long-term.

Depending on how your employer’s plan has been designed, employees may receive either a flat amount of disability coverage (i.e. everyone receives the same amount of coverage), or a graded amount (i.e. coverage amounts differ from person to person depending on their respective income level).

Your employer likely takes great care to try to ensure that everyone is treated equally with respect to the benefits they receive, however this can result in some reverse discrimination towards some of the high-earning employees.

Huh? Discrimination towards high-earners? Yes.

The Reverse Discrimination Problem

When we think of discrimination in terms of benefits, we are likely to assume it means some form of unfair treatment towards those employees on the lower end of the wage spectrum. Few would think the word “discrimination” would be applicable to higher wage earners, however that is exactly what occurs when attempting to create an employee group benefits plan that serves everyone equally.

How does this happen you ask? Let’s illustrate by way of example.

Example

Say your employer’s plan includes LTD (Long Term Disability) coverage which is graded at 85% of the employee’s monthly earnings, to a maximum of $5,000 per month. For employees earning $70,000, this $5,000 cap perfectly represents the 85% benchmark. Everyone earning less than $70,000 will also receive 85% of their pre-disability wages in the event of a disability claim.

What happens to those who earn more? An employee making $75,000 may not notice, but they’re not receiving 85% of their wages. For employees earning $120,000, the $5,000 cap represents around 50% of their gross earnings. An employee earning $150,000 or more would receive even less as a percentage of their pre-disability earnings in the event of a disability claim. i.e. The higher your insurable earnings goes, the lower the percentage the insurance carrier(s) will take at risk.

Is This, Okay?

When viewed through this lens, it becomes evident that the plan design is problematic for those employees at the higher end of the wage spectrum. Often, those earning higher wages are long-time employees, with many years of accumulated experience, are instrumental to the success of the organization, serve as mentors for others, and may even hold management positions.

In other words, these are the members of the team that keep the organization running, and are also the ones that the organization wants to ensure are back on their feet as quickly as possible if they ever find themselves disabled.

It goes without saying that an employer offering these benefits to employees cares and wants to ensure everyone is taken care of, nonetheless due to the design of the plan the highest earners are being discriminated against, which effectively punishes those who are often the most senior and valuable employees.

What Can You Do About It?

If you think you may be one of these people that isn’t properly served by your employee group benefits plan, you have options to consider and learn about. You can either do nothing and risk being under-insured in the event of a disability claim, or you can take steps to ensure your income is properly protected. Depending on your personality, your sleep quotient may vary.

Best practices are to always insure for the maximum amount of coverage you are eligible for based on your income. There are two alternative approaches you can take to ensure your income is sufficiently covered.

  1. Top-Up
  2. Offset/Replace
  3. Do nothing

Top-Up:

As the name implies, a top-up involves obtaining additional individual disability coverage over and above that which you are receiving from your employee group benefits plan.

E.g. To continue with the earlier example; as someone who has insurable earnings of $150,000 per year you would be eligible for approximately $7,000/month of disability coverage if you went shopping for an individual disability policy in the Canadian marketplace. Under your employee group benefits plan however you’re currently entitled to $5,000/month of disability coverage. Therefore, your shortfall is $2,000. To make up the shortfall, you would ‘top-up’ using an individual disability policy. In the event of a disability claim, you would receive benefits from both your employee group benefits plan (up to $5,000), as well as from your individual disability policy ($2,000).

By topping-up your disability coverage in this fashion, you have effectively increased your total coverage from 40% of your pre-disability earnings, to 56%, which is a much healthier ratio. Here is the math:

Before Top-up:

$5,000/month disability benefit * 12 months = $60,000/year of disability benefit.

$60,000/year of /$150,000 = 0.40 (i.e. 40%)

After Top-up:

$7,000/month of disability benefit * 12 months = $84,000/year of disability benefit

$84,000 / $150,000 of pre-disability income = 0.56 (i.e. 56%)

You’ll note that even in this scenario, you are still only receiving 56% of your pre-disability income of $150,000. In other words, even after you’ve purchased a top-up, in the event that you’re disabled your income will still be far below the standard of living you may be accustomed to.

Insurance companies do this intentionally because they want to disincentivize malingering (i.e. behavior that encourages you to sit at home and collect disability cheques) while at the same time incentivize behavior that will get you back on your feet, working towards recovery, and back to actively working again.

This means that even if you are fully insured, you are at best in a deficit position relative to your pre-disability earnings. For this reason, you should always obtain the maximum amount of coverage you are eligible for based on your income.

Offset/Replace:

The approach known as ‘offsetting’ (aka Replacing) involves obtaining your own individual disability policy for the full amount that you would be eligible for based on your income – irrespective of what you are eligible to receive from your employee group benefits LTD. The individual disability policy would operate in lieu of your employee group benefits LTD coverage.

In the event of a claim, your employee group benefits plan will take into account any other disability insurance you may have elsewhere – such as an individual disability plan, and will ‘offset’ against that amount. In other words, any disability benefit payable under your LTD coverage with your group benefits plan will be reduced by the coverage amounts you own elsewhere.

Why would anyone do this?

There are a couple of reasons why this approach may appeal to some people. An individual disability insurance policy will generally have more favorable policy provisions than your LTD coverage will. Further, you can take your individual disability policy with you throughout your career(s), whereas if/when your employment terminates with your current employer, you will lose your LTD benefits. Later in this article we examine more thoroughly the ways in which an individual disability policy and LTD benefits compare.

When using the offset approach, there is certainly some redundancy created (i.e. you’re paying for your own individual policy when your employer may be offering you coverage at no cost), and for that reason most people tend to go with the top-up approach.

Definitions of Disability

The essence of any disability policy is the definition of disability that it uses, which generally define the circumstances which must be experienced before a disability benefit is payable by the policy. As such, the definitions of disability have a significant influence on the premium charged for the policy. It’s helpful to read the different definitions together and in context to best understand them.

The following definitions are the three most common in descending order from the most liberal, to the least liberal namely Own Occupation, Regular Occupation, and Any Occupation.

Own Occupation (own occ):

Is the most liberal definition of disability, the most expensive and is usually made available only to individuals in the top occupational classes. A typical own occupation definition would read as follows:

Total Disability means that:

  1. Due directly to injury or sickness, the insured is unable to perform the important duties of his or her occupation; and
  2. The insured is receiving the appropriate care and attendance of a physician who is licensed to practice in Canada.

Own occupation protection measures the insured’s ability to perform his/her particular occupation(s). If the insured does not have any capacity to work in their occupation(s) due to their injuries or sickness, then work that is being performed or could be performed in another occupation would not disqualify them for benefits. As such, this definition has the potential to result in over-insurance in some cases, which is why its access is usually limited to occupations where the individuals are highly motivated to work, or to return to work after an illness or injury, or where highly specialized skills are required (e.g. a brain surgeon).

Regular Occupation (regular occ):

Is the most popular definition of disability and arguably offers the best value for money. A typical regular occupation definition would read as follows:

Total Disability means that:

  1. Due directly to injury or sickness, the insured is unable to perform the important duties of his or her occupation;
  2. The insured is not working an any other gainful occupation; and
  3. The insured is receiving the appropriate care and attendance of a physician who is licensed to practice in Canada.

Like own occupation, regular occupation provides a measure of occupational protection, but it reduces the over-insurance risk by introducing point b) above. The insured is not considered totally disabled if he/she is working in another gainful occupation. Points a) and c) are the same as own occupation. The regular occupation definition is sometimes described as “own occupation, provided not working.”

Any Occupation (any occ):

Is the least liberal and is generally less expensive than the own occupation or regular occupation definitions of disability. A typical any occupation definition might read as follows:

Total Disability means that:

  1. Due directly to injury or sickness, the insured is unable to perform the important duties of any gainful occupation for which he/she is reasonably qualified, based on his/her education, training, or experience; and
  2. The insured is receiving the appropriate care and attendance of a physician who is licensed to practice in Canada.

An any occupation definition of disability asks the question, “Could the insured work in his/her own occupation or another gainful occupation for which you have education, training, experience?” If the answer is “no”, the insured is considered totally disabled.

Comparing Group Benefits LTD with Individual Disability Policies:

 Group LTD Individual Disability
Coverage Often, only base income is covered. Bonus and commission income may not be covered. Full protection to include not just salary alone but also bonus, commission, and business earnings
Disability Definition It may have a regular occupation definition for perhaps two years, then any occupation definition thereafter. Consequently, this could result in the benefits being cut off after two years. Regular occupation definition every year through to expiry.
Benefit Period Benefits may be payable for a limited period. E.g. two years or five years. In some cases, it may be to age 65. Most individual disability contracts offer the option to expire at age 65/70 (two and five year benefit period options are available if premiums need to be reduced due to budget constraints).
Premiums Employer often pays some/all the premiums on behalf of the employee – which has tax implications (see below). Individual disability policies can have guaranteed premiums through to expiry of the policy.
Taxability Benefits are often taxable.
(Whenever an employer pays some/all of the premiums on the employee’s behalf, then 100% of benefits paid at claim time would be taxable.)
Benefits are often tax-free.
(Whenever an individual pays premiums personally using after-tax dollars, then 100% of benefits paid at claim time would be non-taxable.)
Reduced Disability (Residual / Partial Disability) Often, benefits are paid only if an individual is totally disabled. Which means that benefits may not be paid if a person is only partially or residually disabled. i.e. if a person can only work in limited capacity or reduced hours. Insured person's do not have to be totally disabled to receive benefits. If their work hours or income are scaled back due to disability, they may be able to receive reduced disability benefits.
Portability LTD coverage is not usually portable, meaning that if/when your employment terminates you will also lose the coverage. Individual disability contracts cannot be cancelled by the insurer - even if the insured person changes their job, retires, or is unemployed etc. Individual disability policies can be taken with you throughout your career(s).
Control Traditional true group Long Term Disability (LTD) can be cancelled by your employer, or the insurance company. Individual Disability policies are owned/controlled by you, and cannot be cancelled, or reduced, other than for non-payment of premium, or your signed authorization.
Optional Benefits There are often no optional add-ons, like guaranteed insurability. Individual disability contracts offer optional (or built-in) add-ons such as a guaranteed insurability benefit which allows you to increase coverage as your income grows, or premium refunds if few (or no) claims are made.
Inflation Protection Often there is typically no inflation protection – unless your employer has opted to include that feature for LTD benefits. Cost of Living Adjustment (C.O.L.A.) rider is an optional (or built-in) add-on available for most individual disability policies designed to adjust for inflation.

I’m Self-Employed, What About Me?

As a self-employed person you’re probably well aware by now that it’s up to you to figure things out. You are on your own with respect to seeking out appropriate insurance solutions and creating your own safety nets. There is no HR team that is assessing insurance plans on your behalf and providing them as a benefit of your employment.

On one hand you can enjoy the freedom to shop around and construct an insurance plan that is best suited to your needs and budget, on the other hand it means you need to be cognizant of what insurances are important to have and when, and you also need to be better educated so you can make informed decisions – hopefully this article has aided in this endeavor somewhat.

As a self-employed individual you’re going to want to seek out an individual disability policy from a qualified advisor that covers you to the maximum amount you’d be eligible for based on your income.

Conclusion and Next Steps:

Authorized Advisors and Representatives from Garrett Agencies are available to support you and provide professional advice in reviewing your disability insurance planning and can address any potential questions or concerns you may have at no additional cost.