How to Ensure Your Disability Coverage

One-fifth of all workers under 65 will find themselves unable to work for a year. Here's a guide to public and private disability insurance

An illness or accident will keep one in five employees out of work for at least a year before the age of 65, according to the Life and Health Insurance Foundation for Education. What kind of safety net do you need if you can't work? Personal Business editor Lauren Young asked Tom Klett, a senior consultant at benefits consultant Watson Wyatt Worldwide (WW), for the lowdown on disability insurance.

How does disability insurance work?The short-term disability plan offered by employers provides coverage for a set period of time—typically six months. After that, you transition to long-term disability.

The key thing to remember is that after 24 months, you normally face a change in disabled status: You are no longer just disabled from your own occupation but must be disabled from any occupation you are suited for in order to receive benefits. That is when a disability claim can be denied.

When you are on short-term disability, you may receive your entire salary or as little as 50% of your income, depending on your employer. If you shift to long-term disability, you could get as little as 35% of your gross monthly salary. Buying a supplemental disability policy will narrow the income gap.

Why does disability coverage get short shrift?Most people, especially younger workers, don't see the value. They're paying more for health care every year, so they have less money for other benefits. But for senior managers who own two or three homes and have kids in college, your life savings can evaporate quickly if something happens and you don't have disability coverage. Even so, this area is often overlooked in negotiating compensation packages.

What kinds of coverage are available?Social Security will provide some coverage, but it can take up to two years to get approval. Plus, the average Social Security benefit is just $1,000 per month. Some states also mandate disability coverage. In New York, the maximum benefit from the State Insurance Fund is $170 per week.

The disability policy your employer may offer, meanwhile, is meant to cover the company's entire workforce. On average, companies pay a premium of $238 per employee, according to JHA (BRK.A), a reinsurance company in Portland, Me. But those benefits have a cap. Ten years ago, you could find group plans that capped monthly disability payments at $35,000. Now underwriting standards are tighter. It's tough to find a plan that will pay more than $15,000 a month.

As a result, many companies offer individual policies—on top of basic group coverage—to senior executives. Some employers may fund these, but often they are paid for by the employee. Because they're underwritten specifically for the individual, you can take yours if you leave the company—though you'll likely be on the hook for premiums.

What is the best way to buy a policy?See if your company offers supplemental disability coverage through a major carrier. Those policies tend to be the most reasonable.

You can buy an individual policy on the open market, but it can be cost-prohibitive as you get older. The latest JHA data have the average premium for a new policy at $1,635 in 2007. But for a highly compensated senior executive in his 50s, it can cost $7,000 to $10,000 annually for comprehensive disability coverage.

Although they can be expensive, those policies offer benefits that are much more customized, like a cost-of-living adjustment. Also, if you have a preexisting condition such as diabetes, an employer plan will cover you. But if you try to buy a policy on the open market, it's going to cost you—if you can get coverage at all.

Before it's here, it's on the Bloomberg Terminal.