PRINT - Chapter 3
Principal Disability Rider Benefits
The important points addressed in this lesson are:
Riders available for use on disability income policies can add substantially to insured benefits
Social Insurance Benefit riders enable a policyowner to increase the level of disability coverage without exposing the insurer to the problems of overinsurance
Social Insurance Benefit riders permit the policyowner to have greater levels of disability coverage at generally lower cost
A Purchase Option Rider protects an insured's insurability by making additional disability income coverage available in the future despite any deterioration of the insured's health
Cost of Living riders combat the problem of reduced purchasing power caused by inflation by increasing the monthly disability benefit based on a guaranteed minimum increase, the change in the CPI or both
Return of Premium riders substantially increase the policy premium but provide a return of premium, less the aggregate claims paid, on specified dates, at death or upon surrender
A Hospital Income Rider may be designed to provide a non-disability benefit for each day the insured is in the hospital or may be designed to waive the elimination period in the event of hospitalization so that disability benefits begin immediately
Social Insurance Benefits Rider
One of the sources of disability income available to wage earners is Social Security disability. Although the likelihood of obtaining Social Security disability benefits is generally small because its definition of disability is difficult to meet, Social Security disability payments, nonetheless, could create overinsurance. The Social Insurance Benefit rider is designed to overcome that overinsurance problem.
Social Insurance Benefit riders enable policyholders to purchase disability income benefits that are a high percentage of the insured's current income without the concern about overinsurance that could be caused by the possible payment of Social Security disability benefits. Let's look at how they work.
Despite its name, a Social Insurance Benefit rider pays a monthly disability income benefit only if Social Security does not pay. If and when Social Security disability benefits are payable, some or all of the benefits under these riders cease.
Two approaches have been taken by insurers in the development of Social Insurance Benefit riders. In part, the approach chosen has been influenced by the jurisdiction in which they were to be sold. The two riders emerging from this development are:
Social Insurance Substitute rider
Social Insurance Supplement rider
In the case of the Social Insurance Substitute rider, benefits are payable only if no Social Security disability income benefits are payable. If any Social Security benefits are payable -- no matter how small -- no rider benefit is payable.
For example, suppose an insured purchased a $1,000 monthly benefit to be provided by a Social Insurance Substitute rider. As a result of the insured's disability, he is awarded a $300 monthly Social Security disability benefit. Since the rider benefit is a substitute, the rider benefit would be zero.
Instead of the substitute benefit, a supplement benefit might have been purchased. In that case, the benefit payable is the amount of monthly income purchased less any benefits provided by Social Security; the rider benefit supplements, and is payable in addition to, the Social Security disability benefits.
In the example that we just looked at in which the insured purchased a $1,000 Social Insurance Substitute rider, his result would have been different if the purchased rider had been a Social Insurance Supplement rider. In the case of a supplement rider, the insured's receiving a $300 Social Security disability benefit would simply cause the rider to pay the difference -- $700 in this case.
According to typical Social Insurance Benefit rider provisions, the insured must satisfy two criteria in order to receive a disability benefit under one of these riders:
The insured must file a claim for Social Security disability, and
The Social Security disability claim must be denied
If Social Security disability benefits are initially denied, the insured is usually required to appeal. Often, the cost of the appeal will be borne by the insurer.
The Social Security Administration sometimes reverses its position with respect to benefit awards. As a result, a Social Security disability income claim that was previously denied may be paid and may include back payments. In the case of most SIS riders, no repayment of previously -- received rider benefits is required. Any subsequent rider benefits, however, would be reduced or eliminated depending upon the type of SIS rider if Social Security disability benefits continued to be paid.
Up to this point in our discussion of Social Insurance Benefits riders, we have considered only the impact of Social Security disability benefits. Sometimes, other social insurance benefits may reduce or eliminate rider benefits. In the case of Social Insurance Benefits riders issued to applicants in the higher risk occupations, rider benefits are affected not only by the receipt of Social Security disability benefits but also by the receipt of Workers Compensation benefits. Usually, however, the riders are identical in all other respects.
While the principal benefit of a Social Insurance Benefit rider is the additional coverage it permits, there is another benefit: reduced cost. In cases in which the insured may add coverage under the basic policy or through a Social Insurance Benefit rider, the rider approach may reduce the insured's premium substantially.
Purchase Option Rider
Let's change our focus to an equally important rider that guarantees the policyowner the right to buy additional coverage. It is known as a guaranteed insurability option or purchase option rider.
When an applicant purchases disability income insurance, he or she usually buys the maximum amount that is offered; normally that is about 60% to 70% of his or her gross income. As the applicant's income increases, however, that earlier disability income purchase will probably become insufficient to meet increasing expenses. The insured may have bought a bigger house with a larger monthly mortgage payment and may have children in private schools. At the same time, the insured's health may have deteriorated, resulting in his or her uninsurability. A disability purchase option rider solves that problem.
A disability purchase option rider allows the insured, usually on specific policy anniversary dates, to increase the monthly benefit payable in the event of his or her future disability without regard to his or her current health. In other words, there is no medical underwriting done when a new policy is purchased under the option rider. In most cases, the benefit period may not be longer on the new policy nor may the elimination period be shorter than on the original policy. In addition, the new policy is issued at the same occupation class as the original policy.
The disability purchase rider usually waives only the non-financial aspects of the normal disability income insurance underwriting. The insured must still meet the insurer's limit on the amount of disability income insurance it will issue, based on income.
The increased coverage that is purchased as a result of the insured's exercise of the disability purchase option requires the insured to pay the premium based on his or her attained age. Usually, the policy issued under the option may contain any of the riders, other than the disability purchase option rider, that are attached to the original policy.
Some interesting variations on this approach are also available. Under one approach, the disability purchase option rider is issued for an aggregate option amount rather than a maximum monthly amount that may be purchased on each option date. The aggregate option amount is usually limited to no more than the amount of monthly income that is provided by the original policy.
The aggregate approach to the design of the disability purchase option rider permits the insured, on each policy anniversary, to exercise an option for the entire remaining aggregate amount or some portion of it. Since the underwriting of disability income insurance purchased under a disability purchase option rider is limited only to financial underwriting, exercise of the option is subject only to his or her ability to meet the earned income requirements for the opted amount. Not unexpectedly, the aggregate disability purchase option design is particularly useful when working with a client whose income is likely to increase dramatically over a short period.
Disability purchase option riders are usually issued to a maximum age of 40 or 45.
Cost of Living Rider
Inflation has a devastating effect on buying power. The problem of inflation -- caused erosion of buying power is even greater for your disabled client, however, since the client cannot increase income to compensate for it. The solution to the problem of inflation for disabled individuals lies in the Cost of Living Adjustment riders, also called COLAs.
A COLA rider adjusts the amount of monthly disability benefit received by the insured each year during his or her disability. The first adjustment is on the 13th month of disability. The adjustment that is made in the monthly benefit depends upon the way the rider is designed. There are three approaches taken by COLA designers.
Under the most common COLA approach the amount of the adjustment made each year is based on the CPI-U, the Consumer Price Index for urban consumers. Although we are generally accustomed to thinking of COLAs as increases, a COLA adjustment may be up or down. The monthly disability benefit paid, however, may not be less than the benefit amount shown in the policy.
To see how this COLA design might work for any client, let's consider an example. Suppose that our client purchased a disability income insurance policy with a $1,000 per month total disability benefit and a COLA rider providing an annual adjustment based on the CPI-U up to a maximum of 7% yearly.
Let's further suppose that during the first year of disability, the CPI indicated that inflation grew by 5%. As a result of that inflation growth, our client's monthly benefit will grow by 5%. Therefore, in the second year of disability, the client's monthly benefit is 105% of the amount at which it began, or $1,050. ($1,000 x 1.05 = $1,050)
But, what if, in the next year, the CPI-U is a minus 1% as the economy experienced deflation? The benefit payable in the third year of disability would then reduce under most COLA riders that are based solely on the CPI. The total change in the CPI after the onset of disability is 104% since the change in the CPI was plus 5% in the first year and minus 1% in the second year. As a result, the benefit payable in year 3 is 104% of the initial $1,000 or $1,040.
There have not been many periods in U.S. history when the country experienced deflation. However, the client with a COLA rider should realize that his or her benefit can reduce if the CPI is negative. As we noted earlier, however, the benefit can never fall below the monthly amount that was purchased.
We just looked at the operation of a COLA rider tied solely to the CPI. When we began this discussion of COLAs, we noted that there are three approaches to COLA design. A second approach to COLA design increases benefits each year of disability by a certain percentage -- regardless of the direction of the CPI. The typical percentage increases in the COLA riders are 3% and 5%.
The final COLA design employs a combination of the methods used in the other two. It combines a benefit increase based on the CPI coupled with a minimum guaranteed increase. The minimum guarantee is usually 3%.
When the CPI is greater than the guaranteed minimum, the increase is equal to the CPI; in years in which the CPI is lower than the guaranteed minimum, the guarantee comes into play.
In order to impose an upper limit on claims, the maximum increase is almost always limited to some maximum amount. The total increase in the monthly benefit under any of these approaches is usually limited to 2 or 3 times the initial monthly benefit. Furthermore, in those COLA riders whose adjustments are based on the CPI rather than a guarantee, the maximum increase in any year is usually limited to 7% or 10%, depending on the rider.
Even in successive years of inflation, it's unusual for the inflation rate to remain constant; in some years it may be 3% and 10% in others. Those COLA riders with an annual limit on the COLA increase will often contain a "catch-up" provision. A catch-up provision in a COLA rider allows a monthly disability benefit to increase based on previous CPI increases that were in excess of the permitted annual COLA increase.
Let's consider another example. Suppose that our client's COLA rider was CPI-indexed and contained an annual increase limit of 7%. Our client became disabled, and the CPI increased 10% in the first year of disability, 3% in the second, 8% in the third and 5% in the fourth. What would happen to his benefit?
At the end of the first year of disability, our client's monthly disability benefit would increase by 7%, the maximum that it can increase in any given year. In the second year of disability, the CPI increased by only 3%. However, rather than the benefit increasing by only 3%, it is increased by that year's CPI change plus previous CPI increases since the onset of disability that are not yet reflected in the benefit. As a result, the benefit increases by 6% -- a combination of the current 3% change in the CPI and the previous year's 3% change that was in excess of the COLA maximum.
The actual increases in our client's monthly disability benefit will tend to catch-up to the changes in the CPI as shown in the following table:
We have been looking at the effect of the COLA rider on the total disability benefit payable. However, the COLA rider may affect the residual disability benefit payable as well. The COLA's effect on the residual disability benefit results from the action of the COLA on pre-disability earnings.
When we examined the residual disability benefit, we noted that the amount payable was the percentage of income lost multiplied by the monthly benefit for total disability. So, for example, if the insured had pre-disability earnings of $10,000 per month that were reduced to $4,000 because of sickness or injury, he or she would have suffered a 60% loss of income. If the insured's disability policy provided a $6,000 total disability benefit, the residual disability benefit would be $3,600 -- 60% of that amount.
But, what if the policy contained a COLA rider and the CPI increase by 7%. Let's look at its effect on the residual disability benefit.
Since the change in the CPI affects the pre-disability earnings, the $10,000 of pre-disability earnings are increased to $10,700. ($10,000 x 1.07 = $10,700) To make the illustration clearer, let's assume that the insured's residual earnings remain at $4,000 monthly throughout the period of disability. In the second year of residual disability, the residual disability benefit would increase to $4,020. ($6,700 ÷ $10,000 = .67; .67 X $6,000 = $4,020)
Return of Premium Rider
Riders that provide the policyowner with a return of his or her premium are not without their critics. Some of these critics claim that the return of premium possibility keeps policyowners from submitting legitimate claims. As a result of this controversy, Return of Premium riders are not available in all states.
In the typical Return of Premium rider, the policyowner pays a premium in addition to that required for the disability benefit. That additional premium creates a cash value that is payable to the policyowner, less the total of any claims previously paid, on dates specified in the policy.
The Return of Premium rider is usually designed to make "return of premium" payments according to the following schedule:
Upon surrender of the policy,
At the death of the insured or
At a particular date or dates in the future, for example: every 10 years or at age 65.
Hospital Income Rider
When considered in relation to the importance of the other riders we have examined, the Hospital Income Rider is a minor rider. The rider has two basic designs:
An additional benefit paid ,and
A waiver of the elimination period
Under the first design, a Hospital Income Rider might provide $100 per day for each day the insured is in the hospital. For example, suppose a disability income policy contained a $100 per day hospital income benefit and a $4,500 per month disability income benefit payable after a 60 day elimination period.
If the insured were hospitalized, the hospital income benefit would begin paying a benefit of $100 per day immediately. By the end of 15 hospital days the insured would have received $1,500. However, since the 60 day elimination period had not been satisfied, basic disability income benefits would not have been payable.
A Hospital Income Rider designed in the second way would have paid no specific "hospital" benefit. It simply would have waived the elimination period, and the $150 per day basic disability income benefits would have been payable immediately. The result, assuming the same facts, would have been a payment to the policyowner of $2,250. When designed in this second way, the Hospital Income Rider is referred to as a "first day hospital" benefit.
Riders attached to disability income policies can greatly expand the policy coverage. Social Insurance Benefit riders can be added to increase the overall coverage while still enabling the insurer to avoid the problems associated with overinsurance in the event Social Security benefits are payable. Available as supplements and substitutes, Social Insurance Benefits also permit policyowners to reduce the premiums for needed coverage.
Purchase Option and COLA riders both help to overcome the tendency of benefits to become less significant over time. The Purchase Option Rider enables an insured to purchase additional coverage while COLA riders increase benefits while on disability. Return of Premium riders offer disability income policyowners the opportunity to recover some or all of their disability income policy premiums.