What to Look For in an Income Replacement Insurance Policy


Understanding disability insurance (otherwise known as income replacement insurance) can be a frustrating and overwhelming task without a knowledgeable advisor by your side. Plan pricing and coverage shift dramatically depending on health history, age, occupation, and income.

Robert Clark is a disability insurance expert who enjoys a comprehensive understanding of disability insurance plans. He partners with individuals, financial advisers, and employee benefit brokers to solve clients’ financial and disability insurance concerns.

Below are four questions Robert advises his clients to ask when researching a disability insurance policy.

  1. How much does disability insurance pay?

Ideally, an income replacement plan should provide you with funds equivalent to your after-tax monthly income. You’ve built a lifestyle to which you and your family are accustomed. If you experience a situation where you can no longer earn (because of injury or illness) your lifestyle shouldn’t suffer. You shouldn’t have to consider drastic compensatory measures like selling your car or taking your children out of your school of choice. Income replacement plans allow people to not only survive and maintain, but rather to continue to thrive financially with minimal life changes.

Your regular earnings contribute to more than just lifestyle, however. It’s also important to continue meeting longer financial goals, like contributing to savings and staying on track with retirement. The cost of missing just one year of retirement contributions can be monumental. If you’re unable to work, disability insurance allows you to continue contributing and ensures that retirement plans don’t get derailed.

A sudden disability invariably comes with additional expenses. Deductibles, copays, transportation to medical visits, and prescriptions add up quickly. Also, if a spouse is an income earner, then assuming the role of caretaker will put stress on their earnings as well. Knowing how much a plan pays can help offset such costs.

  1. When do disability insurance benefits start?

The time between when a person becomes unable to earn and when they receive their first insurance payment varies depending on a number of factors. Typical income replacement plans start after 90 days or 180 days of missed work. In other plans, a person has to be out of work for one year before they receive their first income replacement check.

It’s important to choose a plan that fits your ideal waiting period, or how long you’re able and willing to wait for benefits. Consider that while you wait for insurance payments, expenses are coming from your own pocket. Robert advises clients to look at their emergency savings. Have you saved enough to cover three months of expenses? Six months? These funds will be depleted as you wait for coverage to begin.

Robert points out a trade off: The sooner benefits begin, the higher the plan premium, which can translate to financial stress while the plan is active but unused. However, if you choose a plan with longer wait times, you’ll put greater stress on your immediate financial situation, i.e., out-of-pocket expenses incurred before benefits begin.

According to Robert, the sweet spot is 90 days. A plan with a 90-day wait period has the most advantageous balance between benefits and pricing. Most insignificant illnesses (broken bones, for example) will not engage a DI plan because a person will be back to work after healing. The plans on which Robert advises are designed for bigger, catastrophic illnesses. Plans are built to protect against insurmountable life experience and long-term loss of income. Applicable situations include cancer, depression, heart attack, stroke, and musculo-skeletal conditions like arthritis and joint pain, which prevent sitting or standing for long periods of time, among others.

  1. How long do disability insurance benefits last?

Robert says an ideal income replacement plan should be focused on the long term. In fact, the greatest cost-benefit ratio is realized when plans provide to the age 65 or retirement.

The average claim time is just 32.4 months, but Robert says that can be misleading. Illness and injury often continue to affect a person’s ability to earn for decades. “We always want to plan for the worst, and hope for the best,” Robert says. “The purpose of this exercise is, worst case scenario, something terrible happens to us and it doesn’t kill us. We want a plan that’s robust enough to continue to replace all of our career earnings should we never be able to return to work.”

  1. How much does disability insurance cost?

A disability insurance policy typically costs 1-2 percent of a person’s gross income, with other factors coming into play. Age is one factor. Older individuals will pay higher premiums for their plans. Another factor is gender. Because women have a higher likelihood of suffering illness that leaves them unable to work for 90 days or longer, their costs are higher. Finally, there’s occupation. An executive will have cheaper premiums when compared to someone in a specialty occupation, like a cardiovascular surgeon, for example.

These external pieces are largely unchangeable. To adjust the cost of a plan, then, a person must look to other, more flexible elements of that plan. Cost fluctuates based on the chosen benefit amount, when the benefits begin, and how long the benefits last.

Case Study Examining Cost-Benefit Ratio   Of course, a plan with a shorter benefit window may be attractive to some because the plan is initially more affordable. However, the risks far outweigh the potential rewards. Below we examine how an attempt at up-front cost savings can lead to long term losses.   A 40-year-old male making $200,000 a year is considering two plans: One provides benefits until age 65 and the other provides benefits for just five years.   The plan that pays until age 65 is $3,000 a year (remember, a typical DI plan costs 1-2 percent of an individual’s gross income). In the event he can no longer earn, he will receive $10,000 a month (60 percent of his earnings) for the next 25 years, totalling $3 million if he never returns to work.   To save money, he chooses a five-year plan that costs just $2,400 a year, saving him 20 percent up front. The plan will also pay $10,000 a month in the event he is unable to earn. However, the total payout amount will only be $600,000 after five years.   An initial savings of 20 percent led to a loss of 80 percent of the potential benefits, which could be catastrophic if he is never able to work again.

Whether you’re an individual looking to purchase a disability insurance plan, or you already have a plan but you want to better understand it, Robert Clark can help. He works closely with his clients to ensure they’re protecting themselves and their financial wellbeing by thoroughly understanding all income replacement options.

To learn more, Contact Robert today.