Cost & Coverage
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During the underwriting process, the disability insurance carrier takes a look at your employment and income to help it decide how much coverage they can offer you.
Disability insurance, like other types of insurance, is a hedge against financial risk; in the case of disability insurance, that risk is the loss of your income should you become so ill or injured that you need to leave work and lose your income. Your policy is kept in force by premiums, monthly or annual payments to the insurance carrier that are calculated with a formula that includes such factors as your medical history, coverage needs, and age.
A major component of your premiums is your personal financial situation. Your coverage needs are roughly equivalent to the amount of income you’ll be forgoing if you become disabled, so your salary is the first thing you need to look at when taking out a disability insurance policy. Think of disability insurance benefits like replacing your income in that they come out to around 60%-80% of your pre-tax pay.
During the underwriting process, which is when your actual premium will be determined, the disability insurance company will also look at your finances. They’ll collect information that paints a picture of your employment and income that will not only help them decide your eligibility for coverage but also how much coverage they can offer you.
In underwriting, the disability insurance company assesses the risk you pose that you’ll become disabled and it’ll have to pay benefits. The financial component of underwriting helps the carrier understand whether you’ll be able to continue paying premiums.
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When you first apply for disability insurance, you’ll be quoted a premium rate. This rate is an estimate based on the information you provided at the time you applied, but by the end of the application process you’ll be quoted a different rate that could be higher or lower than your initial rate. The latter premium is the one you’ll pay for insurance.
The process of underwriting is what determines your final cost. Underwriting is when the insurance carrier pores over your medical records and health history, occupation, financials, lifestyle choices, and coverage needs to estimate how much risk you pose. The riskier you are – meaning the less healthy you are, the more likely you’ll become disabled, or the more likely you are to stop paying premiums due to financial concerns – the higher your premiums will be.
During underwriting, you’ll have to take a medical exam and a drug test. One of your doctors will have to provide an attending physician’s statement attesting to the health information in your application, including the types of medications you take and severity of your disability.
On the financial side, you’ll be asked to furnish the disability insurance company with tax documents that prove your income. What documents you’ll need depends on the type of work you do and your employment status. (The full list is outlined below.) Your actual coverage amounts may vary if the disability insurance company determines during underwriting that you can’t afford premiums, but the more income you need to replace, the higher your rates will be.
Underwriters will be thorough, making sure they don’t miss anything that could cause the disability insurance carrier to have to pay out. They want to make sure you’re not underinsured, meaning you don’t have enough coverage, and not overinsured, meaning you pay too much for too much coverage.
For that reason, the entire process could take as long as eight weeks.
The list of documents that you may be requested to give the underwriter will depend on the type of income you receive and whether you own the business from which that income derives or if you’re an employee of someone else’s business. Every carrier also has individual rules for what documents it needs. The list is below. In addition, some insurance carriers may accept signed contracts as financial proof or up to two years of tax returns.
|Non-owner W-2 employee||Most recent Form 1040 including schedules and W-2s; or paystub showing a minimum of six months' income.|
|Non-owner 1099 employee||Form 1040, including Schedule C.|
|Owner of sole proprietorship||Form 1040, including Schedule C.|
|C corporation owner||Form 1120, U.S. Corporation Income Tax Return, if you own more than a 20% stake; otherwise W-2s.|
|S corporation owner||Form 1040, with W-2s and relevant schedules; or Form 1120S, U.S. Income Tax Return for an S Corporation, with Schedule K-1 and W-2s.|
|Partnership||Form 1040; or Form 1065, U.S. Return of Partnership Income, with Schedule K-1.|
|Limited Liability Corporation (LLC), single member, individual||Form 1040, including Schedule C, E, F.|
|Limited Liability Corporation (LLC), single member, Corporation||Form 1120 or 1120S.|
|Limited Liability Corporation (LLC), multiple members||Form 1065.|
|Students, residents, new professionals||Underwriter's decision.|
An important reason for financial underwriting is to avoid the two problems of overinsurance and underinsurance.
Overinsurance is where your policy has benefits that exceed your actual coverage needs. Ideally, you should look to replace between 60% and 80% of your pre-tax income. Theoretically, if it were possible to take out a policy that pays out more than that, it would be prohibitively expensive; disability insurance premiums already cost between 1% and 3% of your income for normal benefit amounts.
But disability insurance companies use the financial underwriting component of the application process to make sure you aren’t overinsured. (It’s still possible to exceed 80% of your pre-tax income if you also qualify for and receive Social Security disability insurance benefits.) This not only protects the consumer from paying really high premiums, and potentially lapsing, but also provides an incentive to return to work.
Underinsurance is the opposite problem. With your financial records in hand, disability insurance companies make sure you’re getting enough benefits. The benefit amount roughly replaces your income – that 60% to 80% of your pre-tax income nicely aligns with your after-tax income. Your disability benefits should be high enough to continue your standard of living as well as to pay medical costs, which could be considerable in light of treatment for your disability, and other bills like mortgage payments and credit cards.
Some disability insurance companies may offer simplified-issue underwriting, which lets you skip most of the usual underwriting process, making the whole application process much quicker. You won’t have to take a medical exam or provide your medical records, and you won’t have to provide your financial information.
However, your eligibility for simplified-issue disability insurance is dependent on your age and coverage needs. The benefit amount may be smaller than that of traditional disability insurance; it generally ranges between $4,000 and $6,000 per month.