book by wulinqing

VIEWS: 65 PAGES: 196

									                 DISABILITY INSURANCE

                   TABLE OF CONTENTS
CHAPTER ONE
Getting Acquainted with Disability Income Insurance
Racing through History…………………………………………...…………….………1
Early Approaches to DI Coverage………………..………………………………….….1
The Industrial Revolution and DI………………...………………………………….….1
Social Security, WW II and DI…………………………………………...…………..…2
The 1970’s Recession to New Markets of the '90s………………………………..……3
The DI Playing Field Today…………………………………………………….………3
Income Replacement, the Ongoing Need………….………………………………...….3
What's the Risk of Disability?……………………………………………...……..…….4
Disability or Death?………………………………………………………………….....5
Who Needs DI Insurance?…………………………………………………………........5
What's the Game? Who's Playing?………………………………………………..…….6
TheGame………………………………………………………………..…………….6
DI and Life Insurance-Contrasts……………………………………………………..….7
The Greater Risks in DI Insurance…………………………………………...……...….7
The Players………………………………………….………………………………..…8
Policy Types………………………………………………………………...……..……8
Review…………………………………………………………………………………9

CHAPTER TWO
The Language of Disability Income Insurance
Defining the Key Words…………...…………………………………...………...……11
Know Your Policies………………………..……………………………...………..…11
Accidental Injury and Sickness………………….…………………………….………11
Definition of Accidental Injury………………………………………...…………...…12
Accidental Means………………………………………………………………...……12
Definition of Sickness………………...………………………………………..…...…12
Elimination Period……………………………………………………………...……..13
Selecting the Right Elimination Period…………………………………….………….13
Benefit Period……………………………….……………………………….…...……13
Selecting the Right Benefit Period………..………………………………….…….….15
Total Disability…………………………………..…………………………….………16
Own Occupation Definition………………………………………………………...16
Own Occupation-Not Working…….…………………………………………….…17
Any Occupation Definition………………………...…………………………….…17
Dual Definitions……………………………………..……………………………...18
Physician's Care………………………..……………………………………………19
Presumptive Total Disability……………….……………………………………….19

                               i
Residual Disability Benefits………………………………………………………...19
Eligibility……………………………………………………………………………20
The Percentage of Income Loss…………………………………………….……….20
Method No.1………………………………………………………………………...21
Determining the Residual Benefit Amount……………….…….…………………..21
Method No.2………………………………………………………………………...22
Monthly Adjustments……………………………………………………………….22
Inflation Adjustments……………………………………………………………….22
Increased Residual Benefit Provision……………………………………………….23
Residual Benefit Period……………………………………………………………..23
Qualification Period………………………….……………………………………..23
Differentiating Residual from Total Disability……………………………………..23
Partial Disability…………………………………………………………………….25
Benefit Period……………………………………………………………………….26
Eligibility…………………………………….……………………………………...26
Recurrent Disability………………………….……………………………………..27
Before You Continue……………………………………………………………….29
Review……………………………………...……………………………………....29

CHAPTER THREE
Provisions and Riders
Health Insurance Policy Provisions……………………………………….………...31
Uniform Policy Provisions…………………………………………………….……31
Mandatory Provisions……………………………………………………………….31
Entire Contract and Changes………………………………………………………..31
Incontestability……………………………………………………………………...31
Grace Period………………………………………………………………………...32
Reinstatement……………………………………………………………………….32
Notice of Claim……………………………………………………………………..32
Claim Forms………………………………………………………………………...32
Proofs of Loss……………………………………………………………………….32
Time Payment of Claims…………………….……………………………………...33
Physical Exam and Autopsy…….………...………………………………………...33
Legal Actions……………………………………………………………………….33
Change of Beneficiary……………………….……………………………………...33
Optional Provisions………………………….……………………………………...33
Change of Occupation……………………….……………………………………...33
Misstatement of Age………………………………………………………………..33
Other Insurance in This Insurer……………………………………………………..34
Insurance with Other Insurers………………………………………………………34
Relation of Earnings to Insurance…………………………………………………..34
Unpaid Premiums…………………………………………………………………...34
Cancellation………………………………………………………………………….34

                               ii
Conformity with State Statutes……………………………………………………..35
Illegal Occupation and Intoxicants or Narcotics…………………...……………….35
Renewability Provisions…………………………………………………………….35
Guaranteed Renewable……………………………………………………………...35
Guaranteed Renewable by Class………...………………………………………….36
Noncancelable……………………………...……………………………………….36
Optionally Renewable……………………….……………………………………...36
Conditionally Renewable…………………………………………………………...36
Cancelable…………………………………………………………………………..36
Miscellaneous Provisions…………………………………………………………...37
Nonoccupational Clause…………………………………………………………….37
Premium Waiver…………………………….……………………………………...38
Rehabilitation Benefit……………………….……………………………………...38
Transplant Benefit…………………………………………………………………..39
Nondisabling Injury Benefit………………………………………………………...39
Transition Benefit…………………………………………………………………...39
Automatic Indexing/Increasing……………………………………………………..39
Exclusions and Pre-Existing Conditions……………………………………………40
Pre-Existing Conditions…………………………………………………………….40
Rider Options……………………………………………………………………….42
Guaranteed Insurability Rider………………………………………………………42
How It Works……………………………………………………………………….42
Disability on an Option Date………………………………………………………..42
Increase Restrictions………………………………………………………………...43
The Cost Question…………………………………………………………………..43
Cost of Living Adjustment (COLA) Rider………………………………………….45
The COLA Percentage……………………………………………………………...45
How It Works……………………………………………………………………….45
Buy-Back Option……………………………………………………………………46
COLA and Residual Benefits……………………………………………………….47
And Now, the Cost………………………………………………………………….48
Accidental Death & Dismemberment (AD &D) Rider……………………………..49
Hospital Confinement Rider………………………………………………………...50
Social Insurance Offset Rider……………………………………………………….50
Why It's Needed…………………………………………………………………….51
How It Works……………………………………………………………………….51
Supplemental Social Security Rider………………………………………………...52
Cutting Edge Benefits………………………………………………………………52
Cash Value/Return of Premium Benefit…………………………………………….53
The Cash Value Approach………………………………………………………….53
The Return of Premium Approach………………………………………………….54
Objections to the Cost………………………………………………………………54
HIV Benefit…………………………………………………………………………55

                                iii
Assault Benefit……………………………………………………………………...55
Future Benefits……………………………………………………………………...55
Review………………………………………………………………………………56

CHAPTER FOUR
Other Disability Income Sources
Who Else Is Paying?………………………………………………………………...59
Social Security-The Pride of Uncle Sam……………………………………………59
General Eligibility Requirements…………………………………………………...60
Uncle Sarn's Definition of Disability……………………………………………….60
Five-Month Waiting Period………………………………………………………...62
Workers Compensation……………………………………………………………..63
State Differences……………………………………………………………………63
Waiting and Retroactive Periods……………………………………………………63
Benefits……………………………………………………………………………...63
Disability Definitions……………………………………………………………….65
Uncle Sam and Workers Comp……………………………………………………..66
DI Policies and Workers Comp……………………………………………………..66
Social Security and Workers Comp………………………………………………...66
Temporary Disability Benefits……………………………………………………...67
Definition of Disability……………………………………………………………..67
Miscellaneous Government Sources………………………………………………..67
Miscellaneous Non-Government Sources…………………………………………..68
Life Insurance Policy Rider…………………………………………………………68
How Do They Stack Up Against Individual Policies?……………………………...69
Review………………………………………………………………………………69

CHAPTER FIVE
Exploring Business Needs for Disability Insurance
Where We're Headed………………………………………………………………..72
Professional DI Insurance…………………………………………………………...72
What It Is……………………………………………………………………………73
The Key to the Professional's Livelihood…………………………………………...73
What Competes with Professional DI Insurance……………………………………74
Protecting Income that Protects the Business……………………………………….74
Review of Business Types………………………………………………………….75
Business Overhead Expense (BOE) Policy…………………………………………75
Reimbursement of Covered Expenses………………………………………………75
Excluded Expense…………………………………………………………………..76
When BOE Is and Is Not Needed…………………………………………………...77
Maximum Monthly Benefit…………………………………………………………77
Elimination and Benefit Periods……………………………………………………78
Monthly Benefit Applications………………………………………………………78

                               iv
Immediate Reimbursement of Excess Expenses……………………………………78
Reimbursement when Benefit Period Expires……………………………………...79
Elimination Period “Credit”………………………………………………………...80
Other BOE Policy Features…………………………………………………………80
Partial or Residual Disability……………………………………………………….81
Riders……………………………………………………………………………….82
Substitute Salary Rider……………………………………………………………...82
Claims-Made Malpractice Liability Rider…………………………………………..83
When BOE 15 Not the Answer……………………………………………………..85
Disability Buyout or Buy-Sell Insurance……………………………………………85
Cross-Purchase Plan………………………………………………………………...86
Entity Purchase Plan………………………………………………………………...87
The Buyout Policy Benefit………………………………………………………….88
Indemnity vs. Reimbursement………………………………………………………89
Elimination Period………………………………………………………………….89
Definition of Total Disability……………………………………………………….90
Other Features………………………………………………………………………90
Other Business Applications………………………………………………………..90
Key Person Disability Insurance……………………………………………………91
How It Works……………………………………………………………………….91
Who Is a Key Person………………………………………………………………..91
Common Features…………………………………………………………………..93
Benefits……………………………………………………………………………...93
Personnel Replacement Rider………………………………………………………94
Executive Bonus DI Insurance……………………………………………………...95
Section 162 Plans…………………………………………………………………...95
Premium Payment and Taxes……………………………………………………….95
Other Advantages…………………………………………………………………...96
Salary Continuation…………………………………………………………………96
Paying the Premiums………………………………………………………………..98
Plan Features………………………………………………………………………..98
Business Disability Coverages and the Agent………………………………………99
Review………………………………………………………………………………99

CHAPTER SIX
Group Disability Income Insurance
A Review of Group Insurance Principles………………………………………….104
Eligible Groups…………………………………………………………………….104
Single Employer Groups……………………………………………………………..104
Multiple Employer Trusts…………………………………………………………..104
Organized Unions………………………………………………………………….105
Associations and Miscellaneous Groups…………………………………………..105
Creditor-Debtor Groups……………………………………………………………105

                             v
Group Underwriting……………………………………………………………….105
Advantages of Group Coverage…………………………………………………...106
Group DI Compared to Individual DI……………………………………………..107
Employee Benefit Regulations…………………………………………………….107
Eligibility…………………………………………………………………………..107
Policies and Premiums…………………………………………………………….107
Provisions for STD and LTD……………………………………………………...107
Other Group Provisions……………………………………………………………108
Short-Term Disability (STD) Plans………………………………………………..109
Probationary Period………………………………………………………………..109
Elimination and Benefit Periods…………………………………………………...110
STD Benefits………………………………………………………………………110
Definition of Disability…………………………………………………………….112
STD and Major Medical Plans…………………………………………………….112
Long-Term Disability (LTD) Plans………………………………………………..112
Probationary Period………………………………………………………………..112
Elimination Period…………………………………………………………………113
Benefit Period……………………………………………………………………...113
Lifetime Restrictions………………………………………………………………113
Age Discrimination in Employment Act…………………………………………..114
Benefit Amount……………………………………………………………………114
Rehabilitation Benefit……………………………………………………………...115
Residual Disability Benefit………………………………………………………...116
Definition of Disability…………………………………………………………….117
Benefit Coordination………………………………………………………………117
Survivor Benefits…………………………………………………………………..117
Exclusions in Group DI Plans……………………………………………………..118
Opportunities in the Group Market………………………………………………..118
Review……………………………………………………………………………..119

CHAPTER SEVEN
Determining the Monthly Benefit
Introduction………………………………………………………………………..122
What Income is Replaceable?……………………………………………………..122
Fluctuating Incomes……………………………………………………………….123
Special Needs of Self-Employed……………………………………………………..123
Minimum and Maximum Income Levels………………………………………….123
The Replacement Percentage………………………………………………………124
Integration with Other DI Benefits………………………………………………...125
Social Insurance Benefits………………………………………………………….125
Using the Social Insurance Offset Rider…………………………………………..126
Dollar for Dollar Offset……………………………………………………………126
Percentage Offset…………………………………………………………………..126

                             vi
Total Offset………………………………………………………………………...127
Social Security Supplement………………………………………………………..128
Other Benefits……………………………………………………………………...128
Salary Continuation………………………………………………………………..128
Another Individual DI Policy……………………………………………………...129
Group Dl Coverage………………………………………………………………...130
Unearned Income and the Monthly Benefit………….…………………………….130
A Final Application………………………………………………………………..132
Review……………………………………………………………………………..134

CHAPTER EIGHT
Underwriting
Why Underwriting Is Important to You…………………………………………...136
Field Underwriting………………………………………………………………...136
Pre-Qualifying the Applicant………………………………………………………136
The Application for Insurance……………………………………………………..137
General Information……………………………………………………………….138
Occupation Information……………………………………………………………138
Financial Information……………………………………………………………...140
Medical Information……………………………………………………………….140
Miscellany…………………………………………………………………………141
Agent's Statement………………………………………………………………….142
Home Office Underwriting………………………………………………………...142
Medical Examination……………………………………………………………...142
Attending Physician Statement (APS)……………………………………………..143
Medical Information Bureau (MIB)……………………………………………….143
Disability Income Record System (DIRS)…………………………………………144
Financial Information……………………………………………………………...144
Investigation/Inspection……………………………………………………………144
Fair Credit Reporting Act………………………………………………………….145
Summary of Consumer Rights…………………………………………………….145
Occupational Classification………………………………………………………..146
Classification Systems……………………………………………………………..146
Classification Example…………………………………………………………….147
Importance of Classification……………………………………………………….148
The Underwriting Decision………………………………………………………..149
Standard Risks……………………………………………………………………..150
Uninsurable Risks………………………………………………………………….150
Substandard Risks…………………………………………………………………150
Increase the Premium……………………………………………………………...151
Add an Exclusion Rider…………………………………………………………...151
Other Modifications………………………………………………………………..152
Group Underwriting……………………………………………………………….152

                            vii
The Group Sponsor………………………………………………………………...153
History of the Group……………………………………………………………….153
Establishing the Plan………………………………………………………………154
Review……………………………………………………………………………..155

CHAPTER NINE
Taxes
General Tax Rules…………………………………………………………………158
Policies Purchased by Individuals…………………………………………………158
Group Policies……………………………………………………………………..158
Salary Continuation Funded by Insurance…………………………………………159
Key Person DI……………………………………………………………………...160
Executive Bonus DI………………………………………………………………..160
Business Overhead Expense……………………………………………………….160
Disability Buyout…………………………………………………………………..161
Close Corporation………………………………………………………………….161
Partnership Entity………………………………………………………………….161
Individual Partners…………………………………………………………………162
Other Tax Rules……………………………………………………………………162
Constructive Receipt………………………………………………………………162
Installment Sale……………………………………………………………………162
Cash Value/Return of Premium Benefit…………………………………………...162
Tax Credit for Totally Disabled Individuals……………………………………….163
Caution…………………………………………………………………………….163
Review……………………………………………………………………………..164

CHAPTER TEN
Looking to the Future
Directing Your Marketing Efforts…………………………………………………166
Professional and Business Policies………………………………………………...166
Small Business Opportunities……………………………………………………..166
Know What's Hot, What's Not and What's New…………………………………..167
Annually Renewable "Term” DI Insurance………………………………………..168
Step-Rate DI Insurance…………………………………………………………….169
Life/Disability Insurance Combination Policy…………………………………….169
Long-Term Care Conversion………………………………………………………170
Lifetime Benefit Extension………………………………………………………...170
The Evolving Future……………………………………………………………….170
Profitable Underwriting……………………………………………………………170
Agent Opportunity…………………………………………………………………171
Review………………………………………………………………………………171



                             viii
CHAPTER ELEVEN
Ethical Issues
Professionalism……………………………………………………………………173
Knowledge and Skills……………………………………………………………...173
Professional Designations…………………………………………………………173
Chartered Life Underwriter (CLU)………………………………………………...173
Chartered Financial Consultant (ChFC)…………………………………………...174
Certified Financial Planner (CFP)…………………………………………………174
Registered Health Underwriter (RHU)…………………………………………….174
Client-Focused……………………………………………………………………..174
An Industry Representative………………………………………………………..175
In the Business of Service…………………………………………………………175
Fiduciary Responsibilities…………………………………………………………176
Agency Authority………………………………………………………………….177
Actual or Express Authority……………………………………………………….177
Implied Authority………………………………………………………………….178
Apparent Authority………………………………………………………………...178
Consumer Protection and Ethics…………………………………………………..178
Unfair Trade Practices……………………………………………………………..179
Unfair Discrimination……………………………………………………………...179
Rebating……………………………………………………………………………179
Illegal Policy Replacement………………………………………………………...178
Misrepresentation and Fraud………………………………………………………180
Defamation………………………………………………………………………...180
Boycott, Coercion and Intimidation……………………………………………….181
Advertising………………………………………………………………………...181
Misuse of Funds…………………………………………………………………...181
Unfair Claim Practices…………………………………………………………….181
Delivering the Policy………………………………………………………………183
Policy Summary…………………………………………………………………...183
Protection for the Insurance Professional………………………………………….184
Errors and Omissions (E&O) Insurance…………………………………………...184
A Final Word………………………………………………………………………185
Review……………………………………………………………………………..185




                             viiii
                                  Chapter One
                               Getting Acquainted

Racing through History

Since any chronicle of disability income (DI) insurance quite naturally intersects with the
history of all insurance, the intent of this introduction is to meld disability income insurance
into the long record of insuring principles. As a result, the next several paragraphs race
through the history of disability income insurance, rather than taking the lengthy tour that
probably characterized your early study of insurance.

Early Approaches to DI Coverage

Students of insurance will detect in its origins an approach to the risks and hazards of daily
living that is both compassionate and practical. Early communities of independent artisans,
mariners and others gave willingly to funds that would support them and their families when
injury or sickness left them unable to work. They were motivated not only by compassion for
the devastated lives of their neighbors, but also by the practical matter of safeguarding their
own vulnerability to fate's caprice. Protection against the capricious "loss of work" or "loss of
income" is, of course, the basis for disability income insurance.

From the informality of small community groups grew the commercial ventures of
independent under-writers who came to be known as Lloyd's of London and the earliest
insurance companies. Each of these steps moved the concept of transferring risk from the
individual to the many out of the circle of small communities and into the larger domain of
commerce.

The Industrial Revolution and DI

The business of providing disability income protection surged when the Industrial Revolution
produced an environment of increased production and increased risk to workers from the
hazards of machinery in contact with human flesh. Taking into consideration the likelihood
of disability arising from the factory environment, early DI policies were restrictive, covering
only disability that resulted from accidental injury, not from sickness. Most policies could be
canceled and premiums could be raised at the insurer's will. Better than no insurance, these
policies were, nevertheless, often unavailable to those who needed them most urgently-
people employed in hazardous occupations.

As state workers compensation laws, which included disability benefits, appeared in response
to work place hazards, commercial disability insurance became more liberal and insurers
introduced group DI plans for employed workers. The earliest liberalization’s added
disability coverage for sickness and disease, following the lead of workers compensation
laws. Other
                                             1
improvements included coverages for accidental death and dismemberment, better renewal
options, and longer benefit periods. Unfortunately, these vastly improved benefits led too
many workers to remain "disabled" for long periods, causing profitability problems for
insurance companies. Insurers began to drop out of the DI insurance market and coverage
became more difficult to obtain.

Social Security, WW II and DI

Shortly before World War II, the Social Security Act provided another avenue to obtain
disability benefits, although eligibility was (and is today) extremely restrictive. The Social
Security approach demanded a strict inability to perform any type of work, without regard to
an individual's aptitude or training for a particular occupation. This narrow definition of total
disability is the earliest form of what is today known as the "any occupation" definition,
which is discussed at length in the next chapter. Few people could qualify for Social Security
disability benefits under this restrictive definition.

After World War II, insurers began to show a renewed interest in offering a DI product,
tempered by the narrow definition of total disability, short benefit periods and aggregate
limits on the number of days for which insureds could receive DI benefits. As was true with
earlier policies, liberalizations were gradually introduced. Including the first versions of the
"own occupation" definition of total disability. This definition took into account the
individual's actual occupation and the inability to perform it, rather than requiring the
inability to do any type of work.

Other improvements included the elimination of aggregate benefit days, with the introduction
of longer benefit periods extending to age 65 or later as long as the individual was employed,
and greater availability of policies that were guaranteed to be renewable. During this time
period, most DI policies covered disabilities resulting from accidents only, rather than from
both accidents and sickness. In an attempt to avoid some of the malingering problems that
resulted from earlier liberalization’s, insurers began including a provision that required
potential DI benefit payments to bear a greater relationship to the insureds actual earnings.
You will review this "relation of earnings to insurance" provision in a later chapter.

The entry of reinsurers into the DI insurance field allowed insurers to offer higher monthly
DI benefits, generating significant growth in the sale of DI insurance policies. This growth
was soon stunted, however, by the proliferation of generous government sponsored disability
benefits. The lower income markets for commercial DI insurance gradually eroded as the
potential for over insurance became a reality and contributed to a renewed disincentive to
return to work. Insurers began to introduce so-called social insurance offset riders that
allowed commercial DI policies to coordinate with government programs in order to avoid
paying DI benefits greater than the worker's former income. The current versions of these
riders are discussed later. Riders that adjusted benefits to increased costs of living made their
appearance at about the same time.

                                               2
The 1970s Recession to New Markets of the '905

During the recession in the 1970s, insurers began to experience significant losses on DI
policies, and policy provisions were once again tightened. More restrictive policies and fewer
insurers in the game were the result of what had become an ongoing cycle in the DI insurance
market-liberalization’s followed by increased sales, followed by large losses, followed by
restrictions and insurer withdrawals, followed by liberal innovations and through the cycle
again. One attempt to thwart the cycle was the introduction of a smaller, "residual" monthly
benefit to be paid when a disabled person returned to work, where formerly all benefits
stopped at this point. This incentive to return to work sparked availability and attendant
liberalization’s, but instead of stemming the cycle, provoked it to occur once again.

During the 1980s, professional white-collar workers were wooed, while lower income
workers who were increasingly well served by the government were abandoned. Substantial
growth occurred in tandem with more liberal policies and underwriting. This led inevitably to
adjustments to control the now-familiar cycles of the disability insurance field as the end of
the decade saw heavy losses.

The 1990s have so far brought a resurgence of interest in DI products from both buyers and
insurers. The insurers' latest approach is to woo the higher-income markets, especially self-
employed professionals such as doctors and lawyers, and to develop products for the unique
needs of two-income families, single parents and other family lifestyles that have become
commonplace. Insurers have attempted to become more attuned to factors such as other
sources of disability income, controls to prevent over insurance problems, and cautious
underwriting both in the field and at the home office level.

The DI Playing Field Today

Today the need for disability income insurance is as pressing as it has been throughout
history. While the glut of social insurance programs providing disability benefits has eroded
the DI insurance market for certain income segments, the need is greater than ever for higher
income groups. This is especially true for self-employed whose personal services and ability
to remain actively at work are the very foundation of their incomes. The self-employed
business person or professional is often the sole generator of the income that funds both
business and personal activities. The absence of such a person from the work place can result
in the business faltering, which in turn causes loss of the source of income. People who are
employed by others at relatively high wages do not face the loss of earned income.

Income Replacement, the Ongoing Need

Disability income insurance is the unique solution to loss of income that can be generated in
no other way than by working. Replacement of that income, at least in part, is crucial to


                                              3
most people if they are to avoid financial disaster while unable to work. Consider a typical
example-Richard, a self-employed small businessman who operates an accounting firm and
employs two other people, both clerical employees. He pays himself an annual salary of
$85,000 from earnings that pay all other business expenses as well. You can see that the
accounting services Richard personally performs are the key to his business.

If Richard is disabled, everything that produces income stops. It's true that a smart
businessman like Richard probably has some money available to see him through a short
disability-but is it enough 10 keep his business going? If no business is being generated,
where will the money come from to pay the clerical staff, to pay rent, utilities and other
ongoing expenses at his business office? Will Richard want to hire a temporary replacement
for himself to retain the accounts he currently serves? Is his nest egg large enough to pay
another professional accountant, maintain his business, pay the ongoing bills for his
mortgage, for his family's needs, even for the mundane but certain costs of electricity, water.
trash collection, the daily newspaper, fuel for his cars? And what of the condition that caused
Richard to be unable to work? Are his medical expenses fully paid by insurance? Probably
not. The addition of unreimbursed medical costs to a financial load already burdened by loss
of income can literally force into bankruptcy people who have never before experienced
severe financial problems. The culprit is the absence of ongoing income.

What's the Risk of Disability?

Few healthy people are able to envision themselves in this unfortunate position-the ability to
generate income being taken for granted, almost like breathing. We may take in grisly news
accounts of people injured in spectacular accidents, severely damaged, but alive. What does
not usually make the headlines is what happens later-the staggering accumulated bills,
medical and otherwise. The struggle to survive not just from the bodily injuries, but also
from the financial injuries. For most people, a life without income producing work is
unthinkable, but unthinkable or not, it is more likely to occur than most of us guess.

What are the chances of the average person suffering some type of disability? In a word,
high. Consider these statistics from The Society of Actuaries:

       Between the ages of 25 and 65, one in three working people will be disabled for
       three to six months, a relatively short time, but long enough to seriously erode or
       even wipe out accumulated emergency funds.

       Even at the age of 25-at the peak of youth-any one person has a 15% chance of being
       disabled for at least five years.

       As many as one in 10 workers will be permanently disabled before reaching age 65.
       If a three- to six-month disability can cause problems, consider the financial
       consequences of never recovering completely!

                                              4
Disability or Death?

Of all the uncertain but insurable events humans must contend with, disability is the single
most overlooked possibility. People insure their cars, their homes and their lives in much
greater numbers than they insure their incomes, even though income is the engine that drives
everything else. Unfortunately, it is not only consumers who fail to attend to the need for
disability income insurance, but also insurance agents, people just like you. If you sell life
insurance, you know that, while no sale is easy, at least you do not have to sell the
philosophy-everyone knows death will come, sooner or later. But disability income insurance
is definitely not the same since, as we've pointed out, few healthy people are able to perceive
their own inability to earn income.

Yet disability is far more likely to occur during the working years than death is. In recent
years, awesome scientific and technological discoveries have reduced by 32% the chances of
dying from the four major causes of death in the U.S., but at the same time, the chance of
disability has increased by 55%. Saving lives is one matter; preserving lifestyles is another
matter entirely

Insurers use mortality tables to predict death rates and morbidity tables to predict disability
rates. The numbers from these tables tell the story, as illustrated In Figure 1-1 (on page 6).

While the ratios of disability to death draw closer as people age, at all ages during the
working years, the chance of experiencing a disability for longer than three months is
significantly greater than the chance of death. A disability income insurance policy is the
only way to guarantee income replacement-a source of funds to pay expenses that does not
stop when income stops. Are you convinced?

Who Needs DI Insurance?

It's clear that everyone who works for a living and has no other source of significant income
needs some type of disability protection, but all of those people are not prospects for a
disability income insurance policy. The growth of government-sponsored disability programs
has essentially eliminated the need for individual personal DI coverage for people whose
annual incomes are about $25,000 and less. Social Security, workers compensation, veterans'
and other benefits replace a significant portion of income for people who are eligible for
these programs. We'll say more about these programs later; at this point, you'll just want to
know that the lower income spectrum is not a profitable place for you to prospect for DI
insurance business.

The largest group of potential prospects for disability income insurance is the tried-and-true
middle and upper middle class-people earning, roughly, between $30,000 and $100,000
annually. You'll find the greatest number of potential qualified prospects in this group.
However, another group is even more promising-people earning above $100,000 annually,

                                              5
usually professionals, highly-paid executive employees, or other high-income business
people, often self-employed. While this market has been much sought-after in recent years,
certainly it is not saturated and new prospects are constantly earning their way into these
higher income levels. A later chapter addresses special issues that affect extremely high
incomes coupled with significant net worth, a situation that can diminish eligibility for DI
insurance. However, those who are not affected by such issues comprise enough individuals
to make this a potentially lucrative source of disability income insurance sales.

What's the Game? Who's Playing?

The Game

The game is health insurance. Disability income insurance is a member of the health
insurance family because it addresses needs that arise when an individual's health is
damaged. "Health insurance often brings to mind medical expense coverages such as
insurance to pay for hospitalization, physician bills, prescription drugs, emergency services


                                             6
and similar items. DI insurance, of course, provides protection for lost income, rather than
for medical expenses.

DI and Life Insurance-Contrasts

People sometimes make a mental connection between DI insurance and life insurance since
DI coverage may be added as a rider to a life insurance policy. Life and disability insurance,
however, are vastly different, not just in terms of their ultimate purposes, but also in their
inherent characteristics. First, a life insurance policy pays when someone dies, while a DI
policy pays benefits when someone lives in a disabled condition. Another major difference is
that with a life insurance policy there is only one claim and there is normally no question
about whether death occurred (fraud being the possible exception). A DI policy, on the other
hand, can pay claims more than once since an insured person might have several short-term
disabilities covered by the policy.

The Greater Risks in DI Insurance

Under a life insurance policy, the insurer knows as soon as the contract is executed that if the
insured does not terminate the policy, a claim will certainly be paid one day-probably in the
distant future. The insurer also knows essentially how many dollars are involved in the death
claim. While there is risk to the life insurer-payment of just one premium obligates parent of
the death benefit if the insured dies right away-the DI insurer undertakes enormously greater
risk, first of all because the chances of disability versus death are much higher.

And what is being insured? With life insurance-the life of the insured period. With DI
insurance- income, but… what kind of income and how much can be insured? Under a DI
policy, only income earned from actively working in an occupation is insurable. Unearned
income from rental properties or investments, for example, may not be insured. Insurers will
not agree to replace all earned income because there's little reason for the insured to recover
and return to work in this case, and there Is a great deal of appeal to taking a permanent
vacation. So the insurer must decide how much insurance to make available-60%, 70%, or
more or less? It's no easy matter to determine the best percentage to fulfill two goals: (1)
Provide adequate assistance to the insured and (2) encourage the insured to return to work as
soon as it is safely possible.

In addition, the disability income insurer takes the risk of insuring someone apparently
healthy who might at any time become disabled from an accident or from a previously
undiagnosed disease. The underwriting of a disability income policy is more stringent than
underwriting life insurance because there are so many more variables. Prior health problems
or recent medical conditions complicate predicting the likelihood of disability claims, as do
various other factors outside the control of both the insured and the insurer, such as
economic, environmental and social factors. Insurers must also be wary of the availability


                                               7
of other disability benefits and the resulting potential for over insurance that can cause
reluctance to return to work.

All of these factors, which make the DI insurer extremely vulnerable to adverse risk, result in
a much higher rate of rejected or modified disability income insurance applications than is
typical for life insurance. Such rejections and ratings tend to discourage agents from working
the DI market. Later in this text we'll talk about some things you as an agent can do before
submitting a DI insurance application in order to reduce the chances of gaining a sale only to
lose it in the underwriting department.

The Players

The players are the insurers that write DI insurance, agents like you who want to sell it, and
the broad range of prospects who need it, whether they know it or not. Making sure they
know it is your mission if you choose to accept it.

Commercial DI insurance is available from life insurers, life and health insurers and
multiline companies. Some insurers specialize in disability income insurance: others avoid
the product entirely. While companies that specialize are likely to provide the most astutely
developed policies and policies that have consumer-responsive, cutting-edge benefits, don't
overlook the smaller players. As an agent you are probably targeted for extensive advertising
that will make you familiar with the insurers offering DI products. Once you know whom to
contact, you'll want to research each policy extensively in order to pinpoint characteristics of
the plans you can offer to individual clients.

Policy Types

Disability insurance policies are available in a variety of forms. An individual personal DI
policy covering a single individual is marketed much like an individual life insurance policy.
The insured pays for the policy from personal income and the policy protects that individual's
income in the event of disability. The concepts, policy provisions and other topics covered in
this text apply to individual DI policies unless otherwise stated.

Individual DI policies might also be provided on a group basis. That is, while the policy
insures a particular individual's income, the policy's unique terms, including the lower cost as
compared to non-group policies, are based on group insurance principles. The coverage is
available only to individuals who are members of a given group and the insurance expires
when a person leaves the group. Chapter Six of this text discusses the distinguishing features
of group DI coverage.

The term "professional DI policies" is used to distinguish DI insurance written for that
higher-income group mentioned earlier, usually professional people earning over $100.000
annually. Professional policies offer high benefits, often as much as $20,000 or $30,000 per
month, and may include very liberal policy provisions. Otherwise, they function essentially
                                              8
like any other individual disability income policy.

While group DI is generally associated with businesses, there is another completely different
group of disability policies uniquely designed for business uses. These do not provide income
benefits in the same way as other disability policies, but take into account the unique needs
of a business threatened by the disability of an owner or some other person whose services
are vital to the business. Such policies can reimburse a disabled business owner for ongoing
business expenses or for temporarily replacing him or herself or a key non-owner/employee.
Other policies can fund the buyout of a disabled person's interest in the business and allow a
business owner to continuing paying an employee's salary while the employee is disabled. A
separate chapter is devoted to these products.

This has been a short summary of the basic types of disability-related insurance available
today. As you proceed through the course you'll become thoroughly familiar with the
common and unique features of disability products that offer you opportunities in the '90s.




Chapter 1 Review Questions

1.     Early Disability Income policies were restrictive covering only disability that
       resulted from:

       a.      Accidental injury
       b.      Sickness
       c.      Both of the above
       d.      Neither of the above

2.     Insurers use ________tables to predict disability rates.

       a.      Mortality
       b.      Morbidity
       c.      Consumer price index
       d.      All of the above

3.     Disability Income Insurance is appropriate for which of the following groups?

       a.      Middle and upper middle class
       b.      Professionals
       c.      Highly-paid executives
       d.      All of the above


                                              9
4.   Disability Income Insurance is what type of insurance

     a.     Life insurance
     b.     Health insurance
     c.     Property insurance
     d.     Casualty insurance


5.   All of the following are types of Disability Income Insurance EXCEPT

     a.     Individual Disability Income policies
     b.     Group Disability Income policies
     c.     Professional Disability Income policies
     d.     Unprofessional Disability Income policies




                                             Answers
                                  1.    a accidental injury
                                  2.    b morbidity
                                  3.    d all of the above
                                  4.    b health insurance
                                  5.    d unprofessional Disability Income Policies




                                       10
                      Chapter Two
        The Language of Disability Income Insurance

Defining the Key Words

As an agent, you know it is important for you to be able to explain policy provisions to a
client. Bewildered consumers sometimes wonder why a policy can't be more straightforward:
"If your house burns down, we'll fix it. "If you die, we'll send the money to your heirs." "If
you're disabled, we'll pay you $2,000 every month." You know, of course, that such open-
ended promises are impossible and that's why insurance policies are written with many
qualifiers. Every DI insurance policy carefully defines key terms and concepts. Among
policies, the wording may differ slightly and mean the same, but not necessarily. A few
words can significantly alter the coverage.

In this chapter, you will study the terms that are fundamental to understanding DI insurance.
We will discuss variations in terminology that do and do not change the meaning of the
policy promises. This chapter will smooth your progress through the remainder of the course,
since these terms are used throughout. If you're new to disability income insurance, this
chapter will be a primer for you. If you're experienced, this chapter will refresh your memory
and help you review disability income concepts.

Know Your Policies

Even after you're completely comfortable with this fundamental terminology. be sure you
know the policies you, personally, will sell. Read every policy and identify the similarities
and the differences. An insurer may offer a policy in five states and four of the policies will
be identical, while the fifth has been changed because of some unique state requirement.
There is no substitute for knowing everything about a policy that allows you to help your
clients choose the most appropriate DI insurance coverage. You also must be aware that the
terms of government-sponsored disability Insurance programs may be vastly different from
the commercial insurance policies you sell. More about these policies appears later.
Additionally, you must be equally capable of understanding your competitors' policies in
order to explain the advantages of DI policies you sell.

Accidental Injury and Sickness

Most DI policies cover disability resulting from accidental injury and from sickness. More
limited policies do exist-covering only accidental injury or only sickness, rather than both,
but such policies are less common.



                                              11
Definition of Accidental Injury

With regard to injury, the policy might indicate there is coverage for disability resulting from,
simple “injury” then qualifies the term as accidental injury. It is common for the definition of
injury to mean:

        Bodily injury that results from an accident, independent
        of any other cause, with both the injury and the onset of
        disability beginning after the policy's effective date.

Accidental Means

You should also be aware of an older and more restrictive definition, rarely found in modern
DI policies, that requires the accident to result from accidental means. This qualification
means there must be no connection between the insureds willful actions and the injury,
whether or not the insured expected to be injured. For example, if an individual who is
playing a pick up game of basketball breaks his ankle on the return trip from a leap to the
basket, coverage for any resulting disability would be denied. Why? Because the injury
resulted from intentional means, rather than accidental means. The insured intended to jump
and intended to reconnect with the ground. By contrast, if someone else had accidentally
broken the insureds ankle during play, coverage would apply. You can readily understand
why this particularly severe definition is unpopular and is rarely used.

Definition of Sickness

The common definition of sickness is:

    An illness or a disease that is first diagnosed and treated
    during the policy period.

The resulting disability must begin after the policy's effective date. Policies typically cover
both physical and mental illness, the latter often defined as any type of mental, nervous or
emotional disorder. The benefit period for mental illness may be limited to a shorter period
unless certain conditions are met, such as extended confinement in a hospital or other
institution. At one time, disability income policies almost routinely excluded coverage for
disability from mental illness, but today that is rarely true.

Disability resulting from pregnancy is usually treated as an illness and qualifies for the same
benefits as any other sickness. Some policies offer the option to exclude pregnancy.
Exclusions and limitations in DI policies may further define what is not considered sickness.
In modern policies, the primary provision used for this purpose addresses pre-existing
conditions-those existing during a specified period before the policy's effective date. We'll
say more about pre-existing conditions later.

                                               12
Elimination Period

The elimination period is a key element in DI policies, serving to exclude coverage for
minor, short-term disabilities-two weeks' lost work because of the "flu" is a good example.
This period, during which no DI benefits are paid, begins with the first day of disability and
extends for a stipulated length of time. During the elimination period, the insured absorbs the
costs of living without income. The elimination period is sometimes compared to the
deductible for other types of insurance. Insurers offer various elimination periods from which
the insured may choose, typically 30, 60, 90 or 180 days or one year. A few insurers offer a
two-week period.

Selecting the Right Elimination Period

The elimination period is one feature that can be adjusted to alter the cost of a DI insurance
policy. The shorter the elimination period the higher the cost, the longer the elimination
period, the lower the cost. Agents always need to be aware, though, that most people have
limited means to endure a lengthy period without income, so a long elimination period may
be a mistake if no income is available from sources other than work-related earnings.
Another point to remember is that DI benefits are paid in arrears, so yet another month passes
after the elimination period before the Insured actually receives the first monthly benefit.

For example, suppose an insured has monthly expenses of $3,000 that will continue to be
incurred whether or not he is working. He has $10,000 in liquid savings, with insignificant
income from other sources. A 90-day elimination period would essentially deplete this
person's reserves, so a 60-day elimination period is probably the maximum this person
should consider.

On the other hand, suppose another insured, also with $3,000 of monthly expenses, has
$2,000 in monthly income from investments to supplement his liquid savings. Even if this
insured, just like the previous person, has only $10,000 in savings available, the elimination
period could be extended considerably since this individual can use the $2,000 investment
income toward ongoing expenses, and needs to replace only $1,000 each month from
savings. As you can see, the individual's unique financial circumstances are an important
factor in selecting the best elimination period.

Benefit Period

When the elimination period expires, the benefit period starts and the disabled insured
becomes eligible for monthly benefits. Remember, benefits are paid at the end of the month-
after the insured has, indeed been disabled during that month-not at the beginning of the
month, so still another month passes after the elimination period before a check is actually
sent to the insured.


                                              13
The length of the benefit period is another option the insured may choose, within the
boundaries established by a specific insurer. The most common options offered are:

               One year                                To the insureds age 65
               Two years                               Lifetime
               Five years

Know the options your companies offer since not all options are available from all
companies and some insurers offer other benefit periods.

Figure 2-1 illustrates how the elimination and benefit periods work together. This illustration
assumes a 60-day elimination period and a two-year benefit period. Note when the insured
actually receives the first monthly DI payment.

If the insured becomes disabled according to the provisions of the policy, benefits are paid as
long as the insured is disabled or until payments have been made for the duration of the
benefit period selected. For example, an insured named Marlin has a policy with a two-year
benefit period. Martin is able 10 return to work after receiving benefits for six months, so the
insurer stops paying the monthly benefits. However, 18 months of the benefit period remain
intact in the event Martin suffers another disability. On the other hand, if Martin's disability
had continued after he received two years' of monthly benefits, all benefits would cease when
the benefit period expired.




                                              14
                                       Figure 2-1
                             Elimination and Benefit Periods
                           (60 Days and Two Years Illustrated)




Selecting the Right Benefit Period

Insureds naturally want the longest possible benefit period, but longer periods require higher
premiums. Normally, agents attempt to sell the DI policy with the longest period for which
the individual is eligible and that is a good starting point. However, since premium savings
can be achieved by shortening the benefit period, this option offers a means to reduce the
premium if necessary. A valuable service agents can offer clients is the ability to illustrate
premium differences based on different benefit periods and to explain the consequences. For
example, although the odds of suffering some period of disability are relatively high, most
disabilities last one year or less, so a shorter benefit period can be quite adequate for the


                                             15
average person. A potential client might object that he or she could be one of the few who
suffer longer disabilities, which is correct, but the chances are relatively small. If a shorter
benefit period allows the individual to purchase the policy, agents can stress that receiving
disability income payments for a short period is more beneficial than receiving no income at
all if disability does occur.

Contemporary DI policies usually offer identical benefit period options for disability
associated with both injuries and sickness, but some policies might have different periods.
For example, all individuals disabled by accidental injury might be offered benefit periods
for a lifetime, whereas if the disability results from sickness, a benefit period might extend no
later than the insureds age 65.

Most insurers offer the longest benefit periods only to the very best classes of risks. For
example, an insurer might offer its best classes a lifetime benefit period for both sickness and
accidents. While you'll learn more later about how insurers classify risks, for now, you just
need to know that "white collar" professionals such as physicians and attorneys are in the
best classification. These, then, would be eligible for a lifetime benefit period, assuming the
insurer offered such a period. On the other hand, certain occupations that are not considered
"white collar," such as professional hair stylists and non-professionals, might be eligible for
benefit periods extending no more than five or ten years, depending on the particular insurer.

Total Disability

The condition that triggers DI benefit payments is the insureds total disability, a condition
that each policy defines precisely. Insurers carefully develop the policy wording to say
exactly what total disability means. Over the years, the definition used in commercial DI
policies has generally become more liberal, especially for policies offered to those the insurer
considers the best risks, such as the "white collar" professionals described previously.

Own Occupation Definition

The most liberal definition recognizes total disability in a person who is unable to work in his
or her own regular occupation. Definitions of this type are often referred to as “own
occupation” or “your occupation," or “regular occupation,” and they take into account only
the insureds regular line of work, rather than any other type of work the insured might be able
to do in another field. As we proceed through this section, you'll see more clearly bow
beneficial this definition can be to the insured.

Following is typical wording for this most liberal definition of total disability.

        Total disability means that, because of injury or sickness, you are unable to
        perform the substantial and material duties of your regular occupation.


                                               16
Some definitions slightly revise "substantial and material duties" to refer to "any and every
duty" or "the material duties" or "the regular duties of your occupation" or similar wording,
while maintaining the intent. What this means is that a person is considered disabled and
eligible to receive DI benefits if he or she cannot do the same work as before the injury or
sickness that caused disability-even though the person might actually be capable of doing
some other type of work. Here's an example.

Denise Valier was a right-handed surgeon before an automobile accident caused her right
arm to be amputated. Eighty-five percent of Valier's occupational effort was spent in actually
performing surgery, so surgery represents the substantial and material duties of her regular
occupation, which she can no longer perform. Under this most liberal definition, Valier is
considered totally disabled and eligible for DI benefits even though she is able to generate
income by other means. For example, by retraining to perform many functions with her left
limb, Valier can still examine and diagnose patients. In fact, with no additional training, she
can probably earn income through consultation and performing other valuable services in the
medical field. Nevertheless, because she can no longer perform the primary duties that
generated income for her before the injury, Valier will receive the full monthly DI benefits.

Own Occupation-Not Working

A slightly less liberal version of the "own occupation" definition begins in the same way as
the definition just described, then adds a qualifier:

        Total disability means that, because of injury or sickness, you are unable to
        perform the substantial and material duties of your regular occupation and you
        are not working in any gainful occupation.

In order to retain DI benefits under this definition-which may be called limited or modified
own occupation the insured must not be working for income at all. Dr. Valier in the previous
example would lose her DI benefits when she resumed working as described above. And,
because this definition refers to any gainful occupation, her benefits would cease if she
decided to do gainful work completely unrelated to her former profession. in actual practice,
this definition probably would not apply to the best professional risks, but to a somewhat
more risky group of people.

An important element of this definition is that the insured may choose whether or not to seek
a different occupation. If not, the DI benefits continue. If so, the benefit for total disability
may end-but more liberal policies are likely to pay part of the benefit if the insured returns to
some type of work. This is called a residual benefit, which you'll learn more about shortly.

Any Occupation Definition

The most restrictive way insurers generally define total disability is referred to as "any

                                               17
occupation" or "gainful occupation." A typical definition of this variety reads as follows:

        Total disability means that, because of injury or sickness, you are unable to
        perform the material duties of any gainful occupation for which you are
        reasonably suited by training, education or experience.

Usually used with policies written for people in more hazardous occupations, this definition
does not refer at all to the insureds specific regular occupation before the disability began.
However, the "reasonably suited" wording does take into account the particular insureds
history and experience, unlike earlier versions, which required the inability to work in any
occupation, whether or not the insured was suited for other work. For example, under the
later version, no insurer would expect a disabled unskilled laborer to attempt work as a data
entry clerk since the laborer is unlikely to have training, education or experience in that field.
Policies that use this definition typically take into account the insureds prior earnings as well.
For example, the definition would not be strictly applied without consideration for income
where the disabled person formerly earned $700 per week and the only job available for
which he or she is presently suited pays $300 per week. You will learn more about how the
insurer takes into account the ratio of current to former earnings.

Dual Definitions

Some DI policies are written with dual definitions of total disability, with one definition
applicable when the insured first becomes disabled and the second coming into play at a
specified later time. In this case, it's common for the most liberal “own occupation”
definition to apply before the more restrictive “any occupation” definition is required. While
the length of time this first definition is used varies, here is how such a provision might read:

        Total disability means that, because of injury of sickness, you are unable to
        perform the substantial and material duties of your regular occupation.

        After you have received benefits under this insurance for a period of (10)
        years, total disability shall mean that you are unable to perform the material
        duties of any gainful occupation for which you are reasonably suited by
        training, education or experience.

Depending on the insurer and the class of risk for whom the policy is written, the length of
the benefit period during which the first definition applies might range from as short as one
year to as long as the insureds age 55 or 60. After the stipulated period, the individual must
meet the second, more restrictive definition in order to continue receiving benefits.
According to the sample definition above, the insured person who is still unable to perform
her regular duties after ten years must seek other gainful work for which she is suited. Only if
she cannot perform that other gainful work is she still eligible to receive the DI benefits,
assuming the benefit period has not been exhausted.

                                               18
Physician's Care

Regardless of the particular definition used, DI policies require the individual to be under a
physician's care in order to qualify for total disability benefits. Policies also stipulate that
benefits will be paid for as long as the benefit period extends, provided the individual
remains disabled and is under a physician's care. Having so stated, in fact most policies
continue to pay when there is no question about disability whether or not the insured is under
continuous care of a physician. As a practical matter, some totally disabled people do not
need frequent medical attention. As a general rule, however, extended disability claims
require periodic medical exams on a schedule specified by the insurance company.

Presumptive Total Disability

Certain physical conditions are viewed as being so very serious that an individual suffering
such a condition might be considered disabled whether or not the person is actually able to
work. Many DI policies recognize this concept of presumptive total disability. Policies that
embrace presumptive disability pay the full monthly DI benefit when the insured person loses
certain bodily members, generally these:

        *   Loss of or loss of use of both hands
        *   Loss of or loss of use of both feet
        *   Loss of or loss of use of one hand and one foot.
        *   Loss of sight in both eyes
        *   Loss of hearing in both ears.
        *   Loss of speech

Where presumptive benefits apply, the insured might be able to perform some type of gainful
work, but for purposes of receiving the DI benefits. any work actually performed is ignored.
For example, suppose an interior decorator suffered an injury that resulted in blindness.
Eventually, this person is retrained as a phone sales person, using specially adapted
equipment, and is able to earn a living. In most policies that pay presumptive disability
benefits, the insured is still eligible for the full monthly DI benefit for the entire benefit
period. In addition, the elimination period is likely to be waived for a presumptive disability,
with monthly benefit payments beginning immediately.

Residual Disability Benefits

One of the goals of DI insurance is to pay a fair benefit when the insured qualifies, but also to
encourage the insured to return to work when possible. In the past, as soon as a formerly
disabled person began working again, DI benefits stopped, whether or not the individual was
able to work as many hours as before or earn a comparable income. You can easily see the
dilemma an individual faced: Return to work for, perhaps, 50% of former Income or not
return to work and receive, perhaps, 70% of former income in DI benefits. Contemporary

                                               19
policies take this situation into account by providing residual disability benefits. These are
partial DI benefits for which the insured becomes eligible upon returning to work at a
reduced income.

Eligibility

Insurers use one of two different methods to determine that an insured is eligible for residual
benefits. Under the first method, if the insured returns to work for earnings that are a certain
percentage less than earnings before the disability began, a residual benefit will be paid.
Usually, earnings must be at least 15% or 20% less. For example, assume James Abbott
formerly earned $3,000 per month. When he is ready to return to work, Abbott's former
employer is not hiring, but another employer in the same field hires Abbott for similar work
at only $2,100 per month. This is $900 less than Abbott earned before-a 30% loss of monthly
income. If his policy requires that earnings be at least 20% less, Abbott qualifies for a
residual benefit under this method of eligibility.

The second method of gauging residual disability requires a similar loss of a specific
percentage of earnings and in addition, requires that the insured be unable to work as
completely as before the disability occurred. Here are two ways this method might work.

       1. The insured can perform some, but not all, of the material duties of the regular
        occupation and is earning at least 20% less than pre-disability earnings, or

       2. The insured can perform all of the material duties of the regular occupation, but
        can do so only part-time and is earning at least 20% less than pre-disability
       earnings.

In the previous example, Abbott was able to collect a residual benefit simply by virtue of his
reduced earnings, but that would not be the case when the policy requires one of the two
conditions described for the second method. Under this method, Abbott would have to be
working only part-time or performing only a portion of former duties in order to be eligible.
Let's suppose, instead, that Abbott's former employer rehires him, but Abbott now works
shorter hours because lingering effects of the injury that caused his disability tire him
quickly. Abbott can do all of his former duties, but for no more than five hours each day, for
which he earns $2,100 instead of $3,000 monthly. Under these circumstances, Abbott
qualifies under this more stringent method of determining residual disability.

The Percentage of Income Loss

Not every worker earns a steady, fixed amount of income every month. And, while many
people's highest monthly earnings came in the most recent months just prior to disability, that
is not the case for everyone. People whose incomes fluctuate might have had lower earnings
just before disability, whereas monthly earnings were higher just a few months previous to
disability. Earnings of self-employed professionals and commissioned sales people are good
                                         20
examples. So, just how does the insurer decide what percentage of income the insured lost
after returning to work? Two common methods are used.

Method No. 1

The first method simply calculates the monthly average earnings for the 12 months
immediately before the onset of disability, like this example that assumes disability begins in
June:

                       Month                              Earnings
                       May                                $3,500
                       April                              $3,100
                       March                              $4,000
                       February                           $3,950
                       January                            $3,200
                       December                           $5,300
                       November                           $5,000
                       October                            $4,500
                       September                          $4,000
                       August                             $3,000
                       July                               $2,800
                       June                               $2.700

                       Total                             $45,050

                Average: $45,050           12       =      $3,754/month

The average earnings of $3,754 per month are considered the predisability earnings against
which earnings are compared after the insured returns to work. So let's suppose this person
returns to work and earns only $2,700 per month-$1,054 less than before. Here's how to
calculate the percentage loss:

                       $1,054         $3,754    =       .28   or 28%

Determining the Residual Benefit Amount

To determine the dollar amount of the monthly residual benefit, the percentage of loss-28%
for our example-is then applied to the total DI monthly benefit the policy provides. Let's say
this person's policy pays a monthly benefit of $3.000. The rest of the calculation is simple
multiplication:

                  $3,000    x   .28    =   $840 monthly residual benefit

As another example, if the policy had paid a total DI benefit of $4,000 per month and the
                                        21
percentage of lost income remained the same, the residual benefit would be 28% of $4,000 or
$1,120.

Method No.2

The second method looks back farther than 12 months and selects the 24 consecutive months
of highest monthly average earnings. The insurer decides exactly how many months will be
examined, but some insurers look back as far as five years. In the interest of space, we will
not show an example that uses that many months. When the 24 months are selected, the
average is determined in the same manner as described for Method 1. Calculations for both
the percentage of income loss and the amount of the residual benefit payment are performed
in exactly the same way. Let's use rounded figures and go through those final calculations
one more time.

We'll assume that the highest average monthly earnings during the 24-month period were
$3,000 per month for the insured, Darcy. After being disabled, Darcy returns to work and is
now able to earn only $2,100 per month or $900 less than before. The total disability monthly
benefit under Darcy's policy is $2,000.

                                $900  $3,000        =   30%

                  $2,000    x   .30   =   $600 monthly residual benefit


Monthly Adjustments

Since the amount an insured earns after returning to work might fluctuate, the insurance
company recalculates the percentage of loss each month that a residual benefit is paid.
Suppose Darcy from the previous example has only a 25% loss of former income during the
following month. The insurer then pays a residual benefit of $500 for that month-25% of
$2,000.

Inflation Adjustment

On long-term disability claims, insurers may make an inflation adjustment to the pre-
disability earnings in order to pay a residual benefit that bears some relationship to economic
conditions. For example, if the disability had not occurred, the insureds earnings would likely
have increased somewhat in response to inflation. In addition, without an inflation
adjustment, residual benefits would remain flat and not keep pace with inflation, placing the
insured in an ever-worsening financial position if disability continued during inflationary
periods.

The inflation adjustment might be a flat percentage or it might be tied to the Consumer Price

                                              22
Index (CPI). It is generally applied annually after a certain period of disability, probably no
less than a year. Let's assume an insurer guarantees to adjust the pre-disability earnings figure
by the greater of 3% or the CPI. Insured Biggs has a policy paying a total DI monthly benefit
of $2,700. Biggs earned $4,000 per month before disability and has now returned to work,
earning $2,000 per month-a 50% loss of income. The first residual disability benefits are
therefore 50% of $2,700 or $1,350. As time passes, Biggs continues to earn only $2,000
monthly (50% of his former income). Without an inflation adjustment, the insurer will pay
no more than $1,350 per month as a residual benefit even though inflation might be eroding
Biggs’ purchasing power.

Here's what happens when the inflation adjustment is made, assuming the 3% figure applies.
Three percent of $4,000 (the pre-disability earnings is $120. so the adjustment changes the
predisability earnings figure to $4,120 ($4,000 plus 3% of $4,000). Biggs is still earning
$2,000 monthly, which is $2,120 less, rather that only $2,000 less, than former earnings.
Computing the residual benefit figures as we did previously, we see the difference:

                                          Adjusted                      Percentage
        Income                          Pre-Disability                  of Income
         Loss                            Earnings                           Lost

        $2,120                              $4,120             =       .515 or 51.5%

       DI Monthly                        Percentage                     New Residual
        Benefit                              Of Loss                        Benefit Amount

         $2,700            x                 .515                =            $1,391

As the result of the inflation adjustment to pre-disability earnings, Biggs now receives a $41
monthly increase in residual benefits, assuming no change in actual monthly earnings. At the
next annual inflation adjustment the insurer will apply the 4% factor to $4,120 instead of the
original $4,000, again resulting in an increased residual benefit if Biggs’ actual earnings do
not increase (or increase less than inflation.)

Increased Residual Benefit Provision

Some policies include a provision that could temporarily provide the insured with a higher
residual benefit payment during the first six or 12 months after returning to work. This
provision allows the insured to be paid a monthly benefit equal to either 50% of the total
disability benefit or the actual percentage of loss, whichever is greater.

For example, suppose a previous insured, Darcy, has a DI policy that pays the higher residual
benefit for 12 months. Remember that Darcy's benefit for total disability is $2,000. When
Darcy returns to work, she has a 30% loss of income that results in a $600 residual benefit.

                                               23
Under this provision, however, Darcy will instead receive 50% of the total disability benefit,
or $1,000 for up to 12 months.

On the other hand, suppose that during the 12 months Darcy's income fluctuates, and at one
point she has a 60% loss of income. In this case, the actual percentage of loss produces a
higher residual benefit $1,200 than the 50% provision, so the insurer pays Darcy $1,200
instead of $1,000.

When you sell policies with this feature, be sure you know whether the increased residual
benefits apply for six months or for 12 months.

Residual Benefit Period

How long can the insured enjoy residual benefits? As long as the insured earnings are
reduced, the residual benefit period extends to the end of the benefit period contracted for
when the policy was purchased. In other words, if the policy benefit period is ten years. The
residual benefit will be paid until that ten-year period expires. Caution: This is not ten
years after the insurer starts paying the residual benefit, but, instead, is incorporated into the
overall benefit period. For example, if an insured is totally disabled for one year before
returning to work and before residual benefit payments begin, only nine years remain in the
benefit period. Therefore, if the relevant loss of income continues throughout the benefit
period, the residual benefits are paid for a total of nine years.

Qualification Period

Policies that pay residual disability benefits often require the insured to fulfill a qualification
period of total disability before becoming eligible for residual benefits. Depending on the
insurer, the qualification period is likely to be either 30,60, 90 or 180 days and runs
concurrently with the elimination period. For the least hazardous occupations-white collar
professionals again-no such qualification period is usually required, however.

Let’s see how this works, assuming a certain insured is required to fulfill a qualification
period of 60 days under a policy with a 30-day elimination period. Figure 2-2 (on page 25)
shows two different scenarios for this same insured. Under the first scenario, the
qualification period is fulfilled, so the insured is eligible for residual benefits upon returning
to work. Under the second scenario, however, the insured returns to work before the end of
the 60-day qualification period, so no residual benefits are paid. While this may appear at
first blush, to be punitive to the person who returns to work quickly, consider that a short
period of disability typically suggests a less severe injury or illness-one that is not likely to
reduce the insureds earnings ability upon returning to work.

Differentiating Residual from Total Disability

When determining whether residual benefits will be paid, insurers often recognize a point
                                         24
at which income loss is considered to be 100% even though the percentage is actually
somewhat less. For most insurers, a 75% or 80% loss of income is treated the same as a
100% loss. For example, if an insured formerly earned $3,000 per month and can now earn
only $750 monthly-75% less-the insurer would pay the full monthly total disability benefit,
rather than paying a residual benefit. A few very liberal DI policies make this distinction
when the income loss is as little as 50% of former earnings, but these are rare.



                                         Figure 2-2
                          Qualification Period - Residual Benefits




Partial Disability

Before the concept and practice of paying residual disability benefits gained favor, DI
insurance policies often paid partial disability benefits-and some policies still follow this
tradition. This is a considerably simpler way of paying a reduced benefit to an insured who is
able to return to work, but earns less than before the disability occurred in this case,
“simpler" is not necessarily better because the typical policy pays a partial disability benefit
that is a uniform 50% of the total disability benefit without regard to the actual reduction in
earnings.

The 50% partial disability benefit has an inherent unfairness that could operate two ways.
First, the insured whose income loss is greater than 50% will not receive a partial benefit
that bears any relationship to his or her actual financial loss. For example, assume former
earnings of $4,000 monthly and a policy paying a $2,500 total disability benefit. The insured


                                              25
returns to work, earning only $1,000-a 75% loss. The partial disability benefit is $1,250 (50%
of $2,500), resulting in total income of $2,250. This insured is still suffering a loss of nearly
44% of predisability income-a significant reduction in earnings and consequently, in the
standard of living the insured can now expect.

Here is the second way the inherent unfairness may be manifested by payment of the partial
disability benefit. The insured whose income loss is less than 50% may receive a partial
benefit that is great enough to discourage an active attempt to earn the same amount of pre-
disability income. Let's assume the same insured described previously returns to work and
earns, not $1,000 monthly, but $3,000 monthly-only a 25% loss. But the policy will pay the
same 50% partial disability benefit of $1,250. Now, the insured is receiving $4,250 monthly-
$250 more than before he was disabled. There is not much incentive to work harder or longer
to regain the $4,000 earnings in this case.

Benefit Period

For a scenario such as the one just described partial disability benefits typically include one
mitigating factor: the benefit period is much shorter than that of a residual benefit. You'll
recall that residual benefits, when applicable, are paid to the end of the regular policy benefit
period. Partial disability benefits, however, are limited to three or six months as a general
rule, occasionally extending as long as 12 months. Nevertheless, many people would be
tempted to receive more than their usual income for three months while working on a
reduced schedule. This brings us to the eligibility requirements for receiving partial disability
benefits.

Eligibility

A typical definition of disability that qualifies the insured for partial DI benefits includes
these element
        The insured is unable to perform one or more duties of his or her own
        occupation,
                                           or
        The insured is unable to be at work for more than half of the time required for
        his or her former regular full-time workweek.

Under the second portion of the definition, if full-time work was considered to be 40 hours
each week, the insured must be unable to work for more than 20 hours. If a full-time Job
involved 36 hours weekly, the insured would be eligible if unable to work more than 18
hours. Currently, a 40-hour workweek is considered the norm, but numerous businesses
follow a slightly shorter workweek, which would be taken into consideration.

Partial disability benefits are typically paid only after a specified period of disability. This is
similar to the requirement for residual DI benefits, but the period may be the length of the
elimination period. The elimination period still must be fulfilled as is the case with residual

                                                26
benefits. For example, assume a 30-day elimination period. The insured must be totally
disabled and receiving DI benefits for another 30 days before returning to work in order to
receive the partial disability benefit.

Recurrent Disability

The final term we'll define in this chapter involves payment of DI benefits when a disabled
insured returns to work only to suffer a relapse due to the same condition. This is known as
recurrent disability, and while the concept is easy enough to understand, you must be aware
of how a particular policy defines recurrent disability, especially in relation to reinstating the
elimination period. A typical definition says:

        Recurrent disability is one related to a previous disability for which we paid you
        a monthly benefit. A recurrent disability will be considered part of the previous
        disability if, after you have received disability benefits under this policy, you
        return to your regular occupation on a full-time basis, performing all of the
        material and substantial duties of that occupation for less than six months.

We have italicized the final four words because, while the entire definition is important, the
length of time the insured has been at work following disability is often the key to whether or
not the disability is treated as "recurrent." Yes, the disability must be "related to a previous
disability" for which the insurer paid DI benefits, but even when this is the case, the time that
has elapsed is crucial. Why does this matter? Because if the disability is not recurrent" as
defined, a new elimination period kicks In and the insured must again be disabled and forgo
benefit payments for that period before the insurer begins paying DI benefits. Here is how a
typical policy might make that point:

        If you return to your regular occupation on a full-time basis, performing all of
        the material and substantial duties of that occupation for six months or more, a
        recurrent disability will be treated as a new period of disability and you must
        complete another elimination period.

Again note the italics, emphasizing the key requirements, then refer to Figure 2-3, which
illustrates three scenarios concerning the possibility of recurrent disability.

In the first scenario, the insured, Tyler, has an accident that results in a disabling back injury.
After the 30-day elimination period, the policy pays full disability benefits for four months,
after which Tyler returns to work. Though his intentions are good, after one month at work,
Tyler's back injury again requires him to quit working. The insurer acknowledges this as a
recurrent disability and begins paying monthly benefits without requiring a new elimination
period.



                                                27
                                Figure 2-3
                  Recurrent and Non-Recurrent Disabilities




Now look at the second scenario. The same events as just described occur with one
important exception. The insured returns to work for eight months before his back
injury requires him to quit work. Although it's entirely possible the back problems
result from the earlier accident, the fact that Tyler has been at work for six months or
more means the insurer considers this a new period of disability. As a result, Tyler
must complete another 30-day elimination period before the insurer will pay DI
benefits.

The final scenario demonstrates what happens when the issue is the cause of the
subsequent disability rather than length of time at work. Again, Tyler suffers the
accidental back injury, fulfills the elimination period, receives benefits, and then
returns to work. But this time, after being at work for only one month, Tyler suffers a
heart attack and must quit work. This is not a recurrent disability because the heart
attack is a condition unrelated to the back injury that precipitated the prior disability.
Therefore, another 30-day elimination period must pass before Tyler may again
receive benefits.

Now that you see the critical differences in what qualifies a subsequent period of
disability as "recurrent," you can also understand the importance of your being able,
as an agent. to describe this provision to your clients. In response to customers who
see the six-month cut-off as an arbitrary (and possibly unfair, in their opinion) rule,

                                           28
you can point out the difficulties in ascribing the same cause to an injury that occurs
much later. For example, consider Tyler's second back injury, which occurred after
he had been at work for eight months, in relation to the original injury. Remember
that he fulfilled a one-month elimination period, received benefits for four months,
and then returned to work for eight months. It has now been 13 months since the
original back injury-a lime span that makes it ever more difficult to say with certainty
that the original injury is the source of the back problem causing the second period of
disability.

Before You Continue...

This concludes our discussion of the key fundamental definitions underlying
disability income insurance. If this chapter has been primarily a memory refresher for
you, you're no doubt ready to move on. If you're new to the DI insurance field and
feel comfortable that you've grasped these basics, you too are ready for the next
chapter. Before you go on, though, we invite you to review anything in Chapter Two
about which you might still be uncertain since these are the concepts that will carry
you through the rest of the text. In any event, please complete these review questions
before you continue.


Chapter 2 Review Questions

1.     To meet the definition of an injury covered under a typical disability income
       policy, the injury must have which of these characteristics?

       a.   It must have been accidental.
       b.   It must have occurred independent of other causes.
       c.   It must have occurred on or after the policy's effective date.
       d.   It must have all of the characteristics described above.


2.     The period after disability begins during which the insured does not receive
       DI benefits is called the (qualification period/elimination period/residual
       benefit period).


3.     An insureds DI policy has a ten year benefit period. At the age of 40, the
       insured becomes totally disabled for the remainder of his life. Benefits will be
       paid for what period? (ten years/to age 65/lifetime)


4.     Of the definitions of total disability often used in DI policies, the most liberal
       is the definition casually known as (own occupation/any occupation/limited
       own occupation).
                                           29
5.    When a policy pays the total monthly DI benefit because an insured suffers a
      double amputation, without regard to earnings loss, the policy includes a
      provision for (presumptive disability/partial disability/residual disability/any
      of the proceeding).


6.    In order to be eligible for a residual disability benefit, the insureds earnings
      after returning to work usually must be at least what percentage less than pre-
      disability earnings? (20%/50%/75%)


7.    Keith's DI policy pays a residual benefit, for which he qualifies. He was
      formerly earning $5,000 per month. When he returns to work following a
      disability, his earnings drop to $3,500. The DI benefit the policy paid monthly
      during total disability was $3,000. What is the amount of the residual benefit
      Keith will receive? ($2.l00/$l.050/$900)


8.    The period during which an insured must have been totally disabled and
      receiving DI benefits before the insured will be eligible for residual DI
      benefits is called the (qualification/ presumptive/benefit) period.


9.    An insureds policy pays partial disability benefits. This insured is able to
      return to work, performing all of the substantial and material duties, but
      works only 80% of the former workweek. The insured (will/might/will not)
      receive a partial disability benefit.


10.   Atypical definition of recurrent disability requires that the injury following
      the insureds return to work occur fewer than how many months after the
      return? (3 months/6 months/12 months)

                     Answers
                     1. d is correct
                     2. elimination period
                     3. ten years
                     4. own occupation
                     5. presumptive disability
                     6. 20%
                     7. $900 (30% of the former benefit. Divide the income loss, $1,500,
                         by former earnings of $5,000 to arrive at 30%.)
                     8. qualification
                     9. will not (an insured who can perform all duties remains eligible
                          only if unable to be at work for more than half of the regular
                          workweek.)
                     10. 6 month
                                    30
                                Chapter Three
                             Provisions and Riders
Health Insurance Policy Provisions

Every individual health insurance policy, including disability income insurance policies, must
include certain provisions. The governing law that orders these provisions to be included is
the Uniform Individual Accident and Sickness Policy Provision Law. The provisions are
often called the Uniform Policy Provisions. In addition to the mandatory provisions, another
group of uniform provisions are optional and insurers may or may not include them. In both
cases, the provisions are essentially standardized among health insurers and the states. Many
of the same provisions also appear in some form in-group disability income insurance plans.

In addition to including these standardized provisions, insurers write health insurance
policies with other provisions that clarify the coverage. Many insurers provide unique
options to make their policies competitive and more attractive to customers. In this chapter,
you’ll look at the Uniform Policy Provisions and a variety of other provisions. Some are used
by many insurers, while others are found in only a small number of DI policies.

Uniform Policy Provisions

You have no doubt been exposed to the Uniform Policy Provisions in earlier study as you
entered the health insurance field, so this section very briefly reviews each of the 12
mandatory and 11 optional provisions. If you need additional information, please consult a
basic health insurance reference. Remember that the wording of both the mandatory and
optional provisions need not be duplicated exactly in the insurance policy, but the wording an
insurer uses must be no less beneficial to the insured than the wording of the standard
provisions.

Mandatory Provisions

Entire Contract and Changes
This provision affirms that the entire contract between the insured and the insurance
company is contained in the insurance policy, the application. and any riders attached to the
policy. These documents make up the only enforceable contract. No change, may be made
except in writing as agreed to by the Insurer and the insured, and attached to the policy.

Incontestability

The incontestability or time limit on certain defense provision, limits the insurer's ability to
cancel or void the policy because of representations the insured made in the application. The
time limit is stipulated in the policy and is usually two years. No time limit applies, however,
if the insured has engaged in fraud.
                                                31
Grace Period

All insurance policies must specify a grace period following the premium due date during
which the insured may pay the premium without losing any contractual rights. The length of
the grace period is typically 31 days, but this may be shortened to seven days when premiums
are paid weekly or ten days for monthly premiums.

Reinstatement

If a policy lapses because the insured failed to pay the premium within the grace period,
reinstatement may occur under certain conditions:

   * The insurer accepts a late payment from the insured without requiring re-application.

   * The insured applies for reinstatement and the insurer fails to respond within 45
     days.

   * The insured applies and the insurer accepts within 45 days.

In the last situation, the insurer may require ten days to pass before it will approve a claim
for sickness, while an accident claim will be honored any time after reinstatement.

Notice of Claim

This provision requires insured to submit a notice of claim within a stipulated period-
usually 20 days-after a covered event occurs, or within a "reasonable period." For
disability claims, when benefits are paid for two or more years, the insured must notify
the insurer every six months that the disability continues.

Claim Forms

Within 15 days after receiving a notice of claim, the insurer must send claim forms to the
insured. Failing that, the insurance company must allow the insured to submit the claim in
any manner as long as the pertinent information is included.

Proofs of Loss

Insureds must submit proofs of loss within 90 days after the covered event occurs, unless
its not reasonably possible to do so, in which case a full year is permitted. The time limit
is waived for people who do not have the legal capacity to meet this requirement.




                                             32
Time Payment of Claims

The time payment of claims provision informs the insured when claims will be paid. For
disability income policies, payments must be made at least monthly.

Physical Exam and Autopsy

This provision gives the insurer the right to request that the insured undergo a physical
exam. For ongoing DI claims, the insurer may require periodic exams on a reasonable basis.
If the insured dies, the insurer also may request an autopsy except where prohibited by state
law. The insurer pays the cost of physical exams and autopsies performed under this
provision.

Legal Actions

Insureds who want to take legal actions against the insurer must wait at least 60 days after
they submit proofs of loss. There is also a time limit by which such actions must be
instituted, generally three years, sometimes two years, as stipulated by state law.

Change of Beneficiary

A health policy that pays any type of death benefit includes a change of beneficiary
provision, allowing the insured to select a different beneficiary as long as an irrevocable
beneficiary designation has not been made. This is the final mandatory provision.

Optional Provisions

Remember that insurers may choose to use any, all, or none of the optional provisions
presented in this section.

Change of Occupation

The change of occupation provision allows tile insurer to adjust premiums or benefits if the
insured changes to an occupation that is more or less hazardous. This provision is often used
in disability policies since the occupation Is a key element in the cost of the policy. We will
discuss this topic at length in a later chapter.

Misstatement of Age

If the insurer discovers a misstatement of age on the insureds part, this provision allows a
benefit adjustment to provide the actual benefits that would have been payable if the correct
age had been known from the onset of the policy.


                                              33
Other Insurance in This Insurer

The other insurance in this insurer clause, also called the duplicate coverage clause,
describes two methods the insurer may use to assure it pays only once for the same claim
even if the insured has another policy with the insurer. Under one method, the insurer
specifies a maximum dollar amount for which the insurer is liable, agreeing to return any
excess premiums paid by the insured. Under the other method, the insured may select which
policy will pay benefits and the insurer then returns premiums paid for the other policy.

Insurance with Other Insurers

This is actually a two-part provision dealing with situations where the insured has insurance
with other insurers. The insurance company may choose to use one or both parts (or not use
it at all since it is an optional provision). The first portion deals with benefits paid for
expense incurred services-such as those provided by a medical expense policy. Although this
doesn't apply to a typical DI policy, you will learn about a certain type of policy for
businesses that pays on this basis.

The second part of the provision deals with all other types of benefits, Including DI benefits.
Under both parts, the provision states that each insurance company will share in the benefit
payments in proportion to the benefit amounts each insurer provides under its own policy. If,
as a result of this proportionate sharing, the insured has paid excess premiums, those are
refunded.

Relation of Earnings to Insurance

The relation of earnings to insurance provision is especially pertinent to disability income
policies, addressing situations where DI benefits are payable under more than one policy.
This clause restricts total benefits paid from all policies to no more than either (1) the
insureds monthly earnings at the time disability occurred or (2) the insureds average monthly
earnings for the two years preceding disability. Further, each insurer pays only its
proportionate share of benefits, with excess premiums refunded to the insured if necessary.
Later in this text you'll learn how to avoid over insurance situations such as this by taking
into account all potential sources of DI benefits while completing the application.

Unpaid Premiums

If unpaid premiums are outstanding when the insured makes a claim, this provision allows
the insurer to deduct the amount of the premium from the amount payable to the insured.

Cancellation

Some states prohibit use of the cancellation provision, but where it is permitted, this clause

                                              34
requires the insurer to notify the insured in writing at least five days in advance of canceling
a policy. The insured, on the other hand, generally may cancel a policy at any time without
notice. Cancellation requires the insurance company to return any unearned premium to the
insured. However, some policies are written so cancellation may occur only at a renewal
date, in which case all premium has been earned and no refund is due.

Conformity with State Statutes

The conformity with state statutes provision automatically amends any policy terms and
conditions that conflict with state laws where the policy is issued. This prevents policies
from becoming obsolete when state legislatures revise insurance laws, as well as eliminating
the necessity for different policy forms in different states.

Illegal Occupation and Intoxicants or Narcotics

The illegal occupation and intoxicants or narcotics clauses are the final two optional
provisions. In both cases, the provisions allow the insurer to exclude coverage for injury or
sickness that occurs as the result of and while the insured was either:

       * Engaging in an illegal occupation, or
       * Under the influence of intoxicants or narcotics.

In the latter case, exception is made for drugs that were prescribed or administered by a
physician, recognizing that people sometimes have unexpected reactions to legal drugs. This
concludes your review of the Uniform Policy Provisions. A basic health insurance text can
provide more information if you need it. Be sure to study the policies you sell to determine
which, if any, of the optional provisions are included.

Renewability Provisions

In the following paragraphs, we will again review provisions you should already be
somewhat familiar with-those dealing with guarantees about a policy's renewability. DI
insurance policies may be written with any of the provisions discussed here as permitted by
law. You will want to be completely knowledgeable about the circumstances under which the
policies you sell are and are not renewable. Renewability is extremely important from the
insureds point of view since people are more likely to become uninsurable as they grow
older.

Guaranteed Renewable

A policy that is guaranteed renewable allows renewals up to a specified age, usually 60 or 65.
In some states, these policies must guarantee renewal for at least five years if the policy


                                              35
is issued after the insured reaches age 54. The insurance company may cancel a guaranteed
renewable policy only if the insured does not pay the premium. The premium may not be
increased for any individual insured, but rates for an entire class of insureds, such as
everyone working in a certain occupation, may be raised. Many disability income policies are
guaranteed renewable.

Guaranteed Renewable by Class

Other policies are guaranteed renewable by class, which means the insurer will renew an
individual policy as long it renews all policies in that particular class. Likewise, the insurer
may choose not to renew a policy only if it refuses to renew all such policies. Other features
are the same as a guaranteed renewable policy.

Noncancelable

The most liberal type of renewability provision is a policy that is noncancelable and
guaranteed renewable to a certain age. Failure of the insured to pay premiums is the only
reason an insurer may cancel a noncancelable policy. Furthermore, the premium may never
be raised for any reason. noncancelable disability income policies are generally reserved for
the very best occupational risks, such as professionals and highly compensated executives.

Optionally Renewable

Policies that are optionally renewable give the insurer the right to refuse renewal at a
specified time, typically only at the end of a period for which the premium has already been
paid. The insurer must give the insured advance notice that it will not renew the policy. The
insurer may increase premiums only for classes of insureds, not for any one individual.

Conditionally Renewable

Under a conditionally renewable provision, the insured may continue to renew the policy as
long as certain conditions exist. In a disability income policy these conditions generally relate
to the insureds continuing to work in a gainful occupation. The insureds health may not be
one of the conditions. If the conditions are not met, the insurer may no (cancel the policy, but
may opt not to renew only at a policy anniversary date. Premiums may be raised only for
classes of insureds.

Cancelable

Many states currently prohibit cancelable policies. Where they are permitted, the insurer may
cancel coverage by notifying the insured in advance and returning any unearned premium.
Some cancelable policies may be canceled at any time, others only at an anniversary date.
Premiums for cancelable policies usually may be increased.

                                               36
This concludes your review of policy renewability. If you need additional information, please
consult our basic health insurance text. The table that follows provides a summary of the
features just discussed.


                                 Renewability Provisions

                                                                      Premium
                                                                      Increases
      Type                                 Renewal*                   Permitted
Guaranteed Renewable                  Guaranteed to age 60-65        By class only
Guaranteed Renewable                  Guaranteed as long as entire
by Class                              class is renewed             By class only
Noncancelable                         Guaranteed to age 60-65        No
Optionally Renewable                  Insurer has option not to
                                      renew at specified time        By class only
Conditionally Renewable               Insurer has option not to
                                      renew if certain conditions
                                      do not exist                   By class only
Cancelable**                          Not guaranteed                 Yes
* All policies may be canceled for nonpayment of premiums.
**Prohibited in some states.


Miscellaneous Provisions

In this section, we will discuss provisions commonly included in DI policies. Since not every
policy includes every provision, as usual it is important for you to be familiar with the
particular policies you sell.

Nonoccupational Clause

When a nonoccupational clause is included in a DI policy. it states that the policy will not
pay any benefits if workers compensation or similar compulsory benefits for employed
people are payable for a condition otherwise covered by the DI policy. For example, if the
insured is injured on the job and disabled as a result, the employer's workers compensation
policy will typically pay disability benefits.

An individual DI policy that has the nonoccupational clause will. in this case, pay nothing

                                             37
to the insured, whether the workers comp benefits are adequate or not. Although you should
watch for this provision, it is more common for contemporary DI policies to coordinate
benefits with workers compensation payments to provide a reasonable amount of
replacement income. Later in the text, you'll learn more about coordinating the benefit
amount of a DI policy with other benefits.

Premium Waiver

Virtually every DI policy includes a premium waiver provision, under which the insured is
relieved of paying further policy premiums after disability continues for a specific length of
time. Generally, the insured must be disabled for 90 days to trigger the waiver, but some
policies use the elimination period instead. The insurer usually refunds any premiums the
insured paid during the 90-day period or the elimination period, if that is the trigger for
waiver.

Most policies waive premiums until the insured reaches age 65 if disability continues that
long. This corresponds with the age at which many policies would no longer be renewed.
More liberal DI policies continue to waive the premium for 90 days after a recovered insured
returns to work.

Rehabilitation Benefit

Insurance companies often pay a rehabilitation benefit, aimed at assisting a disabled
insured to return to the workplace. This type of benefit may be available whether or not a
specific policy provision addresses rehabilitation and would be offered by the insurer
sometime after disability benefits have been paid.

Some companies pay only for medical rehabilitation, such as physical therapy services or to
cover training in the use of a new prosthesis when the insured has suffered a limb
amputation. Other companies might also pay benefits for vocational rehabilitation, which
would involve training or education costs associated with preparing for employment in a
different job.

Rehabilitation benefits might take two different forms. One is an additional income benefit to
help defray the costs of rehabilitative services such as those mentioned in the previous
paragraph. Another is payment for the full cost of those services. Sometimes insurers do not
specify a maximum rehabilitation benefit that will be paid, allowing themselves the
discretion to fund substantial rehabilitation services if they believe this course of action is
most likely to return the insured to gainful employment. Many times, a one-time cash outlay
for rehabilitation will provide significant cost savings over providing no rehabilitative help
and continuing to pay monthly benefits instead.



                                              38
Transplant Benefit

The transplant benefit is a truly humanitarian provision found in a few disability income
policies. When an insured is temporarily disabled because he or she has donated an organ to
be transplanted to another person, the insurer recognizes this disability as a sickness covered
by the policy. The benefit amount payable during such a disability is the same as the total
disability benefit that would be paid under any other covered circumstances.

Nondisabling Injury Benefit

Although typical disability income insurance does not pay benefits for medical expenses,
some policies include a nondisabling injury benefit that does just that. Also known as
medical reimbursement and treatment for injury, this provision allows payment of a benefit
when the insured receives medical treatment for an injury that does not cause total disability.

The maximum benefit is generally a portion of the monthly disability income benefit, ranging
from one-fourth to one-half the benefit. For example, if the monthly payment for total
disability is $3,000 and the portion is one-third, the policy will pay up to $1,000 for medical
expenses, but not more than the actual cost.

Offered in various ways, this benefit might be available as a rider to the policy, rather than
incorporated. In some cases, the benefit is paid only when the insured was not hospitalized
for the injury. Most policies pay this benefit only for accidental injury, not for sickness.

Transition Benefit

When a disabled insured who has been receiving benefits dies, some policies pay a
transition benefit 10 survivors for a short time after death. Usually, the insured must have
been receiving benefits for a certain period before dying, often 24 months. Tile transition
benefit is the same as the monthly benefit the insured was receiving and continues for a
stipulated period, usually three to six months after the insureds death, but no longer than any
time remaining in the policy benefit period. If the maximum policy limits have been
exhausted, no transition benefit is available.

Automatic Indexing/Increasing

One remedy insurers have developed to deal with the problem of inflation is automatic
indexing, which is also called automatic increasing. This feature automatically increases the
amount of the monthly disability benefit at certain times. The third, fifth and seventh policy
renewal dates are common. the increase may be a percentage that is either stipulated in the
policy or determined by the Consumer Price Index (CPI). Figure 3-1 (on page 41) shows you
how automatic indexing works when the original monthly benefit is $4,000 and the index is a
flat 4% applied at the third, fifth and seventh renewals.

                                              39
At the first use of the automatic indexing feature, on the third renewal date, the 4% figure is
applied to the original $4,000 monthly DI benefit: $4,000 x .04 $160. The monthly DI
benefit then becomes $4,160 ($4,000 + 160).

On the fifth anniversary, the 4% index applies to the larger amount: $4,160 x .04 = $166.
This $166 figure is added to $4,160 for a new monthly benefit of $4,326.

At the seventh renewal date, $173 is added to $4,326 for a monthly benefit of $4,499. You
can see the advantage of the cumulative effect. After seven years, the monthly benefit has
increased by nearly $500.

Automatic indexing causes a corresponding premium increase. Depending on the particular
policy, the insured might or might not have an option about whether to implement the
indexing and pay the additional premium. If you sell policies with automatic indexing, be
sure you know whether this is a feature the insured may refuse. The provision may have a
limited lifetime, expiring after a certain number of years. While the idea behind automatic
indexing is similar to cost of living increases provided by a rider, the two features are
different. Later in this chapter you'll learn about the cost of living rider.

Exclusions and Pre-Existing Conditions

Most disability income policies written today specify very few blanket exclusions. Older
existing policies often list more situations that are not covered. The most common exclusions
are for injury and sickness resulting from acts of war. Policies that pay lower benefits and
are written for more hazardous occupations also might exclude disability caused by an injury
suffered during attempted suicide.

Pre-Existing Conditions

Disability income policies exclude coverage for pre-existing conditions, but this exclusion
disappears after a certain period has passed. When the period is over, the policy covers any
future disability related to that condition. The exact period varies, but 12 to 24 months after
the policy's effective date are common examples.

The definition of a pre-existing condition varies from policy to policy, but is always related
to a specified period before the policy's effective date. For example, any sickness or injury
for which the insured was treated during the two years immediately preceding the effective
date is a pre-existing condition for some insurers. Instead of two years, the period might be
six or nine months, one year, five years or essentially any other period the insurer wants to
use. You'll want to be aware of the definition in your policies. Obviously, the farther back the
policy looks for treatment of a condition, the less advantageous the provision is to clients.



                                          40
                                     Figure 3-1
                                Automatic Indexing
                    (4% on 3rd, 5th and 7th Renewals Illustrated)




Let's say that the look-back period for one insurer is two years and the provision disappears
after one year. The insured, Leo Perks, was treated for a knee injury six months before the
policy went into effect. Although Perks has had no recent problems, nine months after the
policy effective dates the knee problem recurs. Because Perks is a telephone lineman who
must be able to climb, he is unable to work. Perks cannot receive DI benefits for this pre-
existing condition because not enough time has passed. If, however, the recurrence had
occurred after the policy was in effect for at least one year. Perks would be eligible for DI
benefits.

More liberal DI policies, written for the least risky occupations, often take a different
approach to pre-existing conditions. Under these policies, disability resulting from the pre-
existing condition will be covered provided the insured person had fully disclosed the
condition on the application. In other words, a pre-existing condition is not covered only if
the insured tried to conceal it from the insurance company. Still another approach is to cover
disability from a pre-existing condition for an increased premium, or on a more limited basis.

For example, the insurer might agree to pay the monthly benefit for a shorter period if

                                             41
disability occurs because of a pre-existing condition. Thus, if perks above had this policy, the
insurer might pay DI benefits for only six months instead of the five-year benefit period
available for disability resulting from other causes. Or perhaps the insurer might extend the
elimination period for pre-existing conditions, so whereas Perks' elimination period for other
situations might be 90 days, the insurer requires 180 days before benefits are paid for the pre-
existing condition. Once again, you can see the importance of knowing the details of the
policies you sell.

Rider Options

In this section you will learn about options that are typically provided by means of a rider
added to a DI policy. Some of the most popular riders are discussed here; companies you
represent might offer others.

Guaranteed Insurability Rider

Agents who are familiar with the guaranteed insurability rider available for life insurance
will be happy to know a similar rider is available for DI insurance policies. Also referred to
as the future income option, this rider is probably even more valuable in the DI field since the
greater chance of disability increases the odds of becoming uninsurable. Many DI experts
believe agents should attempt to sell this rider with nearly every DI policy and, without fail,
to younger people who have many working years ahead during which their incomes are likely
to increase.

How It Works

The rider gives Insureds periodic opportunities to increase the monthly benefit without
proving insurability. The only requirement is proof that income has increased, warranting a
higher benefit. Specific details vary among insurers, but the policy typically must be in force
for one or two years before the first option becomes available. Then, additional options to
purchase more coverage occur every two or three years up to a stipulated age. The age at
which the options expire varies widely. Some examples include: to age 45,49, 50, 55, 60 or
older, but probably expiring before age 65.

The insurance company notifies the insured in advance of when the option is available. The
insured may decline to take advantage of the increase, but usually the option must be
exercised from time to time to remain available. Each rider will specify the exact conditions.

Disability on an Option Date

If the insured happens to be disabled and receiving DI benefits on an option date, some
insurers allow the insured to increase the benefit-but the increase does not apply to the
current disability. How the increase applies if the insureds disability is permanent is an

                                              42
individual company decision. More liberal policies, on the other hand, do allow the increased
benefit to apply to the current disability.

Increase Restrictions

The amount by which an insured may increase the current monthly benefit is limited, first of
all, by the insureds earnings. For example, if earnings have increased by $500 per month, the
insurer obviously is not going to allow the benefit to increase by $800 per month. The
relation of earnings to insurance clause discussed earlier comes into play here in order to
avoid over insurance.

In addition to considering the actual earnings, the insurance company also has an overall
maximum of some type. Some insurers use a percentage of the current DI monthly benefit.
For example, suppose the insured, Maria Cortez, has a policy that currently provides a $2,000
monthly benefit. The guaranteed insurability rider stipulates the maximum increase permitted
is 10% of the current benefit, which would be $200 in this case. This means that even if her
monthly income has increased to a level that would make her eligible under a new policy for
a $2,500 benefit, Cortez will be limited to a new monthly benefit of $2,200.

Other riders specify a maximum flat amount that may be added to the current monthly
benefit, qualified by an additional limit on the total increase and taking into consideration all
DI insurance currently available to the insured. For example, a policy might permit a monthly
increase of up to $500, as long as the monthly benefits from all DI policies in place provide
no more than one and one-half times the current total benefits. And. of course, the actual
increase in the insureds earnings is the starting point for determining the benefit increase.

The Cost Question

As you examine the details of the guaranteed insurability riders offered by your companies,
you'll see that this rider can add up to 10% to the cost of the DI policy-an increase that, at
first blush, can cause your clients to resist. Is it worth it? You can definitely make the case
for it.

Let's say your client is 30-year-old attorney Kimbra Kelly, who is employed by a successful
law firm at a base salary of $56,000 annually. You've sold Kelly on the idea of buying a DI
policy that provides a monthly benefit of $3,200 per month for which she will pay $1,200
annually. We'll assume the cost of the guaranteed insurability rider from this insurer is 9% of
the annual premium-an additional $108 annually. Your experience as an agent will tell you
that even though your sales skills have persuaded Kelly to pay the $1,200 premium, she still
may resist adding another $108 to that amount. But if she turns down the rider, consider what
can happen.


                                        43
Compared to the average 30-year-old worker, Kelly has quite a nice income that one can
assume will continue to increase as Kelly pursues her career. But compared to average
attorneys' incomes, $56,000 annually is fairly low and Kelly can expect it to increase
significantly. Let's now look up the road to Kelly's age 40. Her annual income has now nearly
tripled to $150,000, which breaks down to$12,500 per month But Kelly still has only this
single DI policy you sold her ten years ago, providing $3,200 per month-$8,300 less than she
is accustomed to earning. Because a person's standard of living generally rises in tandem with
earnings, Kelly probably spends considerably more than the monthly DI benefits just for
routine expenses. So let's suppose Kelly now wants to purchase additional coverage. She
believes she could live on as little as one-half her current income if she were disabled, about
$6,200 per month. Her existing policy provides $3,200 monthly and she wants to purchase
another $3,000 of coverage. If she is in good health, let's say the additional coverage will cost
$1,800 annually at her age 40. She'll now pay $3,000 annual premium-$1,800 for the new
coverage and $1,200 for the existing policy assuming she is able to purchase the coverage at
all.

The key question is whether or not Kelly is still insurable. If not, she won't be able to
purchase DI coverage at any cost. If Kelly is insurable, but has developed a medical
condition that makes her a less attractive risk, she might be able to purchase additional
coverage, but the insurer may charge an additional 40% of the premium because of her risky
health-increasing the annual premium on the new policy by $720. The new coverage
premium is now $2,520: the existing premium is $1,200: so Kelly must now pay $3,720
annually to get the amount of DI insurance she wants.

By paying the additional $108 annually to purchase the guaranteed insurability rider, on the
other hand, Kelly would have been guaranteed that:

1.      She could purchase additional DI coverage, and
2.      She could purchase the coverage at standard rates, rather than higher rates
        based on her deteriorated health.

Over the ten year period, Kelly would have paid a total of $1,080 additional for the rider,
guaranteeing that she could purchase coverage at standard rates instead of paying the
additional $720 annually in our example above. She would have recouped her $1,080
investment in the rider in less than two years. Furthermore, if Kelly had purchased the rider
originally, it's likely she would have exercised the option to purchase more coverage over the
years as her income increased and today her monthly benefit would bear a much closer
relationship to the earnings she'll lose while disabled.

Be sure to do your homework on this issue in order to demonstrate the risks insureds take by
passing up the opportunity to purchase additional insurance when there's no question about
insurability and especially when they are young with many earning years and potential
income gains ahead. It's important for clients to actually see in writing, in real figures related

                                             44
to their personal circumstances, the potential financial costs of failing to provide for future
income replacement now, while they're insurable, particularly in view of the one in three
odds of suffering at least a short-term disability before age 65. Living Adjustment (COLA)
Rider

Cost of Living Adjustment (COLA) Rider

Earlier you learned about the automatic indexing feature used in some DI policies to help
combat inflation. Another inflation control is the cost of living adjustment (COLA) rider,
which operates differently from automatic indexing. The COLA rider also adjusts the benefit
in response to inflation, but only when the insured becomes disabled and remains disabled
for at least a year. That is, the benefit is not increased during the first year of disability.

The COLA Percentage

Determining the figure by which the increase will occur can be fairly complex. In most cases
the increase is based on the Consumer Price Index (CPI). By comparing the CPI for the first
year of disability with the CPI for the current year, the insurer determines the percentage by
which to increase the benefit, Some insurers use a guaranteed percentage instead of making
the CPI calculation, or if the CPI is the base, the insurer might guarantee 4% or 5% in the
event the CPI is less.

How It Works

As long as the insured remains disabled, the COLA adjustment is made each year after the
first, applying the applicable percentage to what is then the existing monthly benefit being
paid. For example, if the original benefit of $3,000 per month has been increased to $3,100
by virtue of the COLA rider, the next adjustment is made to $3,100 rather than to the original
$3,000. This method continues throughout the insureds disability. While most of us think of
the CPI as ever rising, in fact, it could fall. If, during the period of disability the insureds
benefit had been increased by the COLA rider, the benefit amount could actually be reduced
instead of increased. In no event, however, would the benefit ever be less than the basic
amount contracted for in the DI policy.

Insurers specify a maximum increase. This might be a maximum increase the insured is
permitted to receive during a one-year period, a maximum total increase for the entire benefit
period, or both. For example, a policy that provides a $3,000 monthly benefit or a total of
$36,000 annually might stipulate that the annual increase is limited to 10%, $3,600 in this
case, and no more than $15,000 total over the entire benefit period. Check the details of the
policies you sell to determine the exact limitations.

The following is important to understand: When the insured recovers and returns to work, the
monthly benefit is not frozen at whatever benefits the COLA rider is currently producing.
Instead, the benefit available drops back to the amount for which the policy was originally
                                              45
written (assuming there has been no automatic indexing. use of the guaranteed insurability
option or any other change in the policy benefit).

Refer to Figure 3-2, which illustrates how the COLA rider works. In this example, the
original monthly benefit is $4,000. During the first year of the insureds disability, no COLA
adjustment is made, so the insured receives $4,000 each month. At the beginning of the
second year, the insurer determines the CPI adjustment. 3.8% in our example, and applies
this figure to $4,000 for a total monthly increase of $152. The insured then receives $4,152
during the second year of disability.

At the beginning of the third year, the CPI is 4.2%, which is applied to the current benefit of
$4,152. The result is an increase of $174 and a new monthly benefit of $4,326 ($4,152 +
$174).

In the fourth year of disability, a CPI of 4.9% applies to $4,326 for a $212 increase. The
monthly benefit becomes $4,538. The insured recovers and returns to work at the beginning
of the fifth year after the disability began, at which point the monthly benefit drops back to
the original $4,000.

                                      Figure 3-2
                       COLA Based on CPI Applied to $4,000 Benefit




Buy-Back Option

While the general rule is that the benefit returns to the original amount when the insured
recovers, some insurers offer another option. The insured might be permitted to purchase an
additional benefit equal to the amount of the increase existing when the insured returns to
work. This is called a buy-back option. In this case, if the insured again becomes disabled

                                                46
at a later date, the monthly benefit is equal to the benefit the insured was receiving at the time
of the prior recovery and will serve as the basis for COLA Increases if the insured is again
disabled longer than one year.

COLA and Residual Benefits

When the COLA rider is attached to a policy that pays residual disability benefits, the
adjustment also applies to the amount of the residual benefit. Here's how it works.

First, let's briefly review how the residual benefit works. The key factors follow with a dollar
amount assigned to each for illustration purposes.

        * Monthly earnings before disability                            $10,000

        * Monthly benefit for total disability                          $6,500

        * Monthly earnings after disability                             $5,000

The insured has a 50% income loss after returning to work, so:

        Residual benefit = 50% of $6,500 or $3,250

This is the monthly residual benefit the insured receives for the first year after returning to
work. With the COLA rider attached, the adjustment to the residual benefit is first made at
the beginning of the second year, just as was the case when the total DI benefit was adjusted.
But the application for a residual benefit is even better. The adjustment applies not just to the
monthly benefit, but also to the pre-disability earnings. This double indexing means the pre-
disability income that the post-disability earnings are compared to increases so the insured
does not suffer a loss by virtue of increases in the post-disability income

Look at the following example, which continues the situation previously described. For
simplicity, we'll use a flat 60/0 increase instead of the CPI. We're also assuming the insureds
post-disability earnings have increased during the year, to $5,250 monthly.

                  Pre-disability monthly earnings increased by 6% COLA:

                                  $10,000 x 1,06 = $10,600

                        Post-disability monthly earnings = $5,250

                         Determine the percentage of income lost:

                                 $5,250 + $10,600 = 49.5%

                                               47

Now, you might expect that this 49.5% loss would be applied to the original monthly benefit
of $6,500 to determine the residual benefit, but that's not the case when the COLA rider is
attached. Instead, the original $6,500 is first increased by 6%:

                                    $6,500 x 1.06 = $6,890

This adjusted monthly benefit figure, then, is the amount that the 49.5% loss applies to for
determining the residual benefit:

                                    $6,890 x 495 = $3,410

This $160 increase in the residual monthly benefit over the previous year's benefit stays in
place for the full year, after which the calculation is made all over again. In the second year,
following the method you learned for calculating second-year total DI benefits under the
COLA, the 6% applies to the adjusted pre-disability monthly earnings of $10,600 and the
adjusted total DI benefit of $6,890. These adjustments continue as long as the residual
benefit is payable.

While this is a typical example of COLA rider applications. insurers develop a variety of
creative ways to provide the most adequate inflation protection for insureds. Be sure to study
the COLA riders offered by companies you represent to be certain how the increases apply.
This feature is a very attractive selling point.

And Now, the Cost

That's the good news. The (comparatively) bad news is the high cost of the COLA rider,
which may be 25% to 30% of the policy's annual premium. The benefits of this rider In the
event of a long-term disability, however, are so significant that you'll want to carefully
illustrate the effects of not including it.

Let's return to 30-year-old Kimbra Kelly from an ea4ier example. Her basic DI policy costs
$1,200 annually and provides a monthly benefit of $3,200. Adding the COLA rider will
increase her premium by $360 to $1,560 annually. Let's say she pays premiums for ten years,
then is disabled. With and without the rider, Kelly will have paid:

        With COLA rider                                  $15,600 premiums paid
        Without COLA rider                               $12,000 premiums paid

        DIFFERENCE                                       $ 3,600

Kelly is disabled for a total of five years. We're not going to show all of the calculations here,
but we'll assume the policy with the COLA rider provides a flat 5% annual increase, which
goes into effect at the be-ginning of the second year of disability. Here's the comparison of
the total benefits Kelly will receive:
                                                48
        With COLA rider                                  $212,172 benefits paid
        Without COLA rider                              $192,000 benefits paid

        DIFFERENCE                                      $ 20,172

The figures show clearly that for a five-year disability, the benefits far outweigh the cost.
Naturally, in any given case the figures will change with the situation. Imagine, for example,
an insured who pays premiums for only two years-in Kelly's case, a cash outlay of only
$3,120, for which she would receive over $200,000 In benefits. On the other hand, an Insured
might pay premiums for many more years. If Kelly paid $l,560 for 20 years, for example, her
premium outlay would be $31,200 versus $24,000 without the rider, a $7,200 difference. The
benefits are still obvious. If you find the exercise valuable, you can make a number of
comparisons, extending and reducing both the premium payment and disability periods, and
keep these figures handy to illustrate the situations to your customers, using actual figures for
the policies and riders you sell.

Customers (and you) may well wonder, "Why does it cost so much and since most
disabilities last less than a year-the trigger point for the COLA-why would I want it?" The
dollar illustrations you've just seen should answer the first part of the question, but to
elaborate, the insurer takes a significant risk by providing the rider. Remember, an insured
could pay only a few premiums in return for hundreds of thousands of dollars in benefits: and
even when the insured has paid $30,000 or more in premiums, the insurer's obligations can
quickly exceed the average risk assumed when the insurer agreed to write the policy. The
average risk, of course, is what makes insurance possible and it would not require many
long-term COLA-adjusted claims to put an Insurance company at the brink of severe
financial problems.

As for the second part of the question, it's a matter of the risk an insured is willing to take.
Save the additional premium and gamble that no long-term disability will occur or pay the
premium as a hedge against the lower but genuine odds that long-term disability will occur?
There's no easy answer. As an agent, you can attempt to sell the benefits of this rider every
time you believe the prospect can afford to pay for it, but the decision is likely to be based as
much on the individual's risk-taking nature as on the solid facts and figures you present.

Accidental Death & Dismemberment (AD&D) Rider

Another rider sometimes offered with DI policies pays a lump-sum benefit if the insured
suffers accidental death or dismemberment. This rider is often abbreviated to AD&D. No
benefit is available under this rider for death or dismemberment resulting from sickness.
Some policies pay a lump sum that is a multiple of the monthly disability benefit, while
others stipulate a flat dollar amount. Still other policies offer the benefit in more than one
way, allowing the insured to choose the amount within the limits established by the insurer.


                                          49
Most policies define dismemberment as loss of limbs and loss of eyesight, but others might
include loss of hearing or speech, so be sure to check your own policies. Often, a half benefit
is paid for lesser dismemberment’s, such as loss of one foot, and the full benefit is paid if the
insured loses both feet.

Hospital Confinement Rider

At least two different types of hospital confinement riders are available with DI policies, each
type paying a benefit only when the insured has been hospitalized as the result of accident or
sickness covered by the policy.

One version of this rider either completely waives the disability income elimination period or
pays a reduced benefit during the elimination period when the insured is in the hospital.
When the elimination period is waived, benefits are payable from the first day the individual
is disabled and hospitalized. If a reduced benefit is paid, it is often one-third the total
disability benefit and it, too, is paid from the first day the insured is disabled and
hospitalized. The benefit stops when the insured leaves the hospital or when the elimination
period expires, whichever occurs earlier. If the insured leaves the hospital before the
elimination period expires, for example, the benefit stops and the remainder of the
elimination period must be completed before the regular DI benefit is paid. On the other
hand, if the insured is still in the hospital when the elimination period is over, the rider's
benefit stops and the policy's monthly DI benefit begins.

The other type of rider pays a stipulated dollar indemnity for every day the insured is
confined in a hospital up to a specified number of days. The actual number varies from policy
to policy, but the maximum is usually 180 days. As long as the insured is hospitalized (up to
the maximum), even during the elimination period, the daily indemnity is paid. If the insured
is still hospitalized when the elimination period ends, the hospital confinement benefit
continues in addition to the monthly DI benefit. Assume an insureds policy, which will pay a
monthly DI benefit of $2,000, has a 60-day elimination period and the hospital confinement
rider pays $50 per day. On day 61, the insured is still hospitalized and remains so for 10 more
days. The insured will receive a benefit totaling $2,500 for this period, reverting to $2,000
the next month since the insured is no longer hospitalized

Social Insurance Offset Rider

Various riders available in many forms from different insurers are known as social
insurance offset riders or Social Security Offset riders. The original breed of these riders was
intended primarily to offset benefits paid under a commercial DI policy against Social
Security benefits, specifically. More commonly today, a single rider is used to offset any type
of social insurance disability benefits, including not only Social Security, but also workers
compensation and a myriad of other federal, state and local government disability benefits.
You may still find some such riders that apply specifically to Social Security alone. Other

                                          50
terms used to describe the broader riders are social insurance supplements and social
insurance substitutes.

The purpose of these riders is to provide adequate DI coverage for individuals without
causing the problems of over insurance that can result when an individual is also eligible for
government-sponsored DI benefits. The riders do this by stipulating that the policy benefits
will be offset by any social DI benefits the individual actually receives.

Why It's Needed

In the past, particularly when Social Security DI benefits were more generously paid, insurers
began reducing the monthly benefit for which a DI policy would be written by the amount of
Social Security DI benefit an individual had the potentta1 to receive. For example, if the
person could otherwise qualify for a $3,000 benefit for a particular insurer and had the
potential to qualify for an $800 Social Security benefit, the insurer would write the policy for
no more than $2,200. The problem with this solution is that very few people actually qualify
for Social Security disability benefits. This dilemma left the Insured with considerably less in
the way of income replacement than would have been available if Social Security were not an
issue at all. For the insurer, the problem was further compounded by the fact that the amount
of Social Security benefits changes from time to time. The solution: first the Social Security
offset rider and now the social insurance offset rider to accommodate the many other
government benefits that could be available. These riders stipulate that benefits under the DI
policy will be coordinated with other benefits or substitute for those benefits when the
government denies them.

How It Works

A social insurance rider is generally designed in one of three different ways.

1.     A dollar-for-dollar offset, under which the DI policy's monthly benefit is reduced one
       dollar for every dollar paid by any form of social insurance. For example, the
       monthly benefit is $2,000. The insured actually receives $500 monthly in some form
       of social DI benefits. The policy will pay only $1,500 monthly.

2.     A percentage offset, under which the DI benefit is reduced by a certain percentage
       depending on what type and amount of social benefit the insured receives. For
       example, the policy might pay 30% less than the normal benefit if the insured
       receives Social Security benefits or 90% less if the insured receives both Social
       Security and another social insurance disability benefit. For a DI policy paying
       $2,000, then the benefits would be reduced to $1,400 in the first case and to only
       $200 in the second.



                                            51
3.     Total offset, under which the DI policy pays no benefit at all if the insured receives
        any social insurance DI benefits, without regard to the amount. If an insured receives,
        for example, a $600 DI benefit from workers compensation, the $2,000 policy pays
        nothing.

In a later chapter we'll say more about coordinating the monthly benefit you sell with social
insurance and all other types of DI benefits for which an insured might be eligible.

Supplemental Social Security Rider

One of the problems with Social Security DI benefits is that, even if an individual qualifies to
receive them, up to a year may pass before the Social Security Administration (SSA) makes
that decision. Individuals must first be disabled for five months, after which six or more
months may pass before any benefit is paid. While Social Security DI benefit payments are
retroactive to the sixth month, an individual's living expenses continue with or without
income.

Insurance companies devised the supplemental Social Security rider to address this
situation. When attached to a disability income policy, this rider pays greater monthly
benefits during the Social Security "waiting period," for up to one year after the insured first
becomes disabled. When Social Security benefits begin, the DI policy benefit drops to the
lower benefit stipulated in the policy.

Here's an example, assume an insured qualifies for a policy benefit of $2,600 monthly, taking
into account the possibility of receiving $800 per month from Social Security. The
supplemental Social Security rider permits payment of $2,600 + $800 or $3,400 for the first
year of disability when the Insured is unlikely to have ally response from the SSA. The
policy's elimination period must be completed before benefits begin. For example, with a 60-
day elimination period, no benefits are paid for the first 60 days (two months), then the larger
$3,400 benefit is paid for 10 months, completing the year. At the end of that period, the
benefit drops to the lower $2,600 monthly benefit for the duration of disability, whether or
not the insured actually receives any Social Security DI benefits.

That same policy, however, could have been written not only with the supplemental Social
Security rider, but also with the social insurance offset rider. Now, at the end of the year, if
the insureds Social Security benefits are denied, the offset rider takes over and continues to
provide the $800 that Social Security would have paid if the insureds claim had been
approved.

Cutting Edge Benefits

This final section of Chapter Three discusses three relatively new benefits that demonstrate
how insurers respond to changing consumer needs and desires in the disability income

                                          52
insurance field. These are just a few examples of innovations insurers may undertake to
provide a responsive product.

Cash Value/Return of Premium Benefit

One of the greatest objections consumers have to disability income insurance is the high
dollar investment in a policy most people believe they will benefit from only minimally, if at
all. The inability to conceive of oneself as being disabled is a major stumbling block for
many people. To answer this objection, some insurers have introduced a cash value type of
benefit that allows insureds to recover part of their premium outlay when their DI policies
have paid minimal or no benefits. Depending on how the particular feature operates, it may
be referred to as a cash value or a return of premium benefit. Another term associated with
this feature is the money back benefit. Some newer policies include this feature as a built-in
policy provision, while others offer the benefit as a rider.

The Cash Value Approach

The cash value approach is comparable to cash value life insurance. The insured pays a larger
premium in order to both accumulate cash values and pay for the insurance coverage. The
portion of the premium set aside for cash values earns interest. If the insured terminates the
policy in the early years, the policy typically pays no return. However, as the policy ages, an
increasing percentage of the premiums paid will be returned if the insured terminates the
policy.

Here's an example of how the insured might benefit, assuming the yearly premium is $1,800
and the insured has never been disabled during the life of the policy. The figures show the
differences between leaving the policy in force for five, 10 and 20 years.

                                     15 Years         10 Years       20 Years

   Percent Returned                    10%              30%             82%
   Premiums Paid                       $9,000          $18,000         $36,000
   Value Returned                      $ 900           $ 5.400         $29,520



In all cases, by the time the insured reaches age 65 with the policy still in force and no
benefits paid, the return is 100%.

Suppose, on the other hand, the insured has been disabled and has received DI benefits
sometime during the life of the policy. In that case, rather than receiving a return of all
premiums paid, the total amount of DI benefits paid to the insured is deducted before the
cash value is returned. Using the 20-year figure above, assume the insured, which is age 50.

                                             53
Terminates the policy at this point, having received $8,400 in DI benefits during the policy
period. The $29,520 figure is reduced by $8,400 and the insurer returns $21,120 to the
insured.

The Return of Premium Approach

As an alternative, the return of premium approach operates in a similar manner, but the return
is available much sooner. While the example above indicated nearly 20 years must pass
before 80% of the premiums paid are available to the insured, some insurers use this
approach to guarantee that an 80% refund will be paid in just 10 years. If the policy
continues, another 80% refund occurs when 10 more years have passed. Other insurers return
a smaller percentage in 10 years (or five, or any other number the insurer stipulates), ranging
from 50% up, but still returning faster than under the cash value approach. Another way to
write these policies is to guarantee a certain percentage return at specific ages, when the
insured reaches age 55 or 62, for example. Insurers write the terms of this type of provision
in various ways.

The quicker return naturally costs more. For example, the insured might pay an additional
30% of the premium annually under the cash value approach, but 50% or 60% additional
under this approach. Interest is paid on the accumulating values in both cases.

The insured may use the return to pay up future insurance premiums if desired, or receive the
refund in cash. As is true with the cash value approach, the amount of any DI benefits paid to
the insured is deducted.

Objections to the Cost

Using one of these riders adds significantly to the cost of the policy, but the built-in savings
are often enough to overcome objections. For example, let's say an Insured buys a policy at
age 40, paying $1,800 in premium. Of this premium, $1,200 is the cost of the base policy and
$600 buys the money back benefit. This is a 50% increase in premium. At age 50, 10 years
later, the insured has paid $18,000 in premiums of which $6,000 pays for the rider. However,
the insured is now entitled under this particular policy to receive a premium return equal to
80% of premiums paid or $14,400, assuming no DI benefits have been paid during this
period. By deducting the extra $6,000 paid for the rider, we see the insureds gain:

                                           $ 14,400
                                             -6,000

                                            $ 8,400

Currently, these benefits are treated as a return of excess premium and, therefore, not taxable
income, just as is the case with dividends paid on participating life insurance policies.

                                           54
A final word about prospects for the cash value/return of premium benefit: This feature is
generally available only to the highest quality occupations that pose the lowest risk to
insurers-primarily white collar professionals. These people have the greatest financial ability
to pay the extra premium and also the greatest chances of receiving a 100% return since they,
as a group, are among the least likely to collect DI policy benefits.

HIV Benefit

The risk of exposure to HIV Infection that medical professional’s face has inspired another
insurer innovation, the HIV benefit. Originally developed as a separate policy that did not
sell well, the HIV benefit has now been incorporated into certain policies written for high-
income professionals. Coverage might also be provided as a rider. At this time availability is
extremely limited, but insurers that do offer this benefit believed it is appropriate for policies
offering high monthly DI benefits of $20,000 or more.

One of the unique features of this benefit is that a portion of the policy's maximum dollar
limits may be paid in a lump sum for the insured to use in whatever way he or she chooses,
while the remainder is paid in monthly benefits. For example, if the policy maximum is
$1,000,000, perhaps 50% or $500,000 will be paid to the insured as soon as the insurer has
confirmation of the diagnosis. The remaining $500,000 would be retained by the insurer for
payment of the monthly income. Although essentially no "strings" are attached to the insureds
use of the lump-sum benefit, insurers encourage using the money for experimental treatments
that are not covered by traditional medical expense insurance.

Assault Benefit

Another benefit that responds to changing circumstances is the fairly new assault benefit.
This provision adds to the DI policy a lump sum that is paid in addition to monthly DI
benefits when the disability results from certain assault situations described in the policy.
Typically, the disability must result from circumstances such as battery, car jacking, civil
riots or similar events during which the insured suffers a disabling assault.

The assault benefit, a relatively small, flat amount of $2,000 to $4,000, is not deducted from
the maximum DI policy benefits. The insured may use the benefit for any purpose. In order to
collect the benefit, the insured must have a police report of the incident and proof that the
assault caused the insured to be unable to work for at least five days. Like the HIV benefit,
the assault benefit is generally available only for DI policies that provide high monthly
income payments-those written for the best class of risks.

Future Benefits?

Insurers who remain active in the disability income insurance marketplace will no doubt
maintain their competitive edge by continuing to offer new features and options not currently

                                             55
available. In addition, they will amend existing provisions-as permitted by law-to make DI
insurance products more attractive and responsive to consumers.

As an agent working the DI field, you have a responsibility both to yourself and to your
clients to know what changes are occurring among insurers you represent. Staying abreast of
the latest developments helps you serve your customers competently while enhancing your
own career.

Please take a few minutes to complete the review that follows before going on to the next
chapter.




Chapter 3 Review Questions


1.     Of the optional standard health policy provisions, which of the following is likely to
       be included in disability income policies because it is pertinent to the type of
       coverage provided?

       a.    Relation of earnings to insurance provision.
       b.    Time of payment of claims provision.
       c.    Unpaid premiums provision.
       d.    Conformity with state statutes provisions.




2.     From an insureds point of view, the most beneficial policy type is one that is
       (guaranteed renewable / noncancelable / optionally renewable).



3.     Some DI insurance policies provide for payment of a benefit to help the disabled
       insured retrain for a new job when performing the former occupation is impossible
       because of his disability. This is called the (residual/rehabilitation/nondisabiling
       injury) benefit.

                                            56



4.     A benefit that continues DI payments to a disabled insureds survivors after the
      insureds death is the (residual/transition/AD&D) benefit.



5.    A certain disability income policy includes automatic indexing. You know that when
      this feature is exercised, the insureds premium cost (increases/decreases/remains the
      same).




6.    Which of the following correctly describes the typical pre-existing condition
      provision in DI policies?

      a.   Benefits will never be paid when disability is caused by a pre-existing condition
           as defined in the policy.
      b.   When disability is caused by a pre-existing condition as defined in the policy,
           no benefits will be paid until the policy has been in force for a stipulated period.




7.    What rider allows an insured to purchase additional DI insurance without providing
      medical insurability? (cash value rider/guaranteed insurability rider/cost of living
      rider)




8.    A disabled insured receives the contracted DI benefit of $3,000 per month. She is still
      disabled after 12 months, at which time her benefit is increased to $3,150 by her
      COLA rider. Seven months later, the insured returns to work and eight months after
      that she is again disabled. Assuming no other changes have been made to her policy,
      the DI benefit she receives now is ($3,000/$3,150/$3,150 plus the COLA increase).



9.    What DI policy rider allows payment of a larger benefit during the insureds first year
      of disability only? (social insurance offset rider/supplemental Social Security rider/no
      rider does this)



                                       57
10.   The type of “money back" rider or provision that allows for a fast build-up of
premiums, a large portion of which will be returned to the insured after 10 years
when no DI benefits are paid is called the (cash value benefit/return of premium
benefit/social insurance benefit).




                             Answers

                             1.     a is correct
                             2.     noncancelable
                             3.     rehabilitation
                             4.     transition
                             5.     increases
                             6.     b is correct
                             7.     guaranteed insurability rider
                             8.     $3,000 – the amount reverts to the original benefit
                                    unless changed contractually
                             9.     supplemental Social Security rider – to assist the
                                    insured during the period when the SSA is determining
                                    eligibility for Social Security DI benefits
                             10.    return of premium benefit




                                   58
                             Chapter Four
                    Other Disability Income Sources

Who Else Is Paying?

An issue of primary concern for commercial disability income insurers is who else might pay
DI benefits if a particular insured is disabled. The importance of avoiding over insurance is a
theme that recurs in any discussion of DI insurance. Insurers always want to know if there are
other DI benefits which, if combined with the benefit an insurer has been asked to provide,
might act as a disincentive for the insured to return to work.

Part of an agent's field underwriting responsibility is to discover what other DI benefits are
even potentially available to the applicant. These include other commercial DI policies the
applicant holds, disability riders attached to life insurance policies, group DI plans, and
benefits from corporate pension plans business associations arid government- sponsored
plans for which many people are eligible. While Social Security and workers compensation
are the most universally available benefits, various other government programs provide
disability benefits for thousands of current and former government employees.

In this chapter we'll discuss other sources of DI benefits and focus on:

              *What the sources are
              *How the plans work
              *When benefits might be available
              *How easy or difficult it is to qualify for benefits
              *Effect on eligibility for a commercial Dl policy

The major thrust of this chapter is government sponsored benefits and non-government
sources other than business and employment-related benefits. The two chapters following
this one cover business uses for disability policies and group DI coverages.

Social Security-The Pride of Uncle Sam

Without question, the Social Security system is the best-known source of benefits for U.S.
citizens. In 1992, more than four million people were receiving DI benefits from Uncle Sam
in spite of the relative difficulty of qualifying. While Social Security is generally associated
with the retired, many benefits are available to younger people who meet certain


                                              59
requirements. Unemployed family members of workers covered by Social Security, including
children, are among those who may receive certain Social Security benefits.

Since this course concerns employed adults who are your potential prospects for disability
income insurance, however, we're interested in Social Security regulations that affect only
that group of people. The rules governing Social Security are wide-ranging and complex, but
this chapter takes a "broad brush" approach, providing you with the essential information you
need in order to work through the implications of Social Security for people who are
prospective purchasers of the DI policies you sell.

General Eligibility Requirements

Let's briefly-and superficially-discuss the general eligibility requirements every employed
person must meet to receive any type of Social Security benefit. An individual must have
worked and paid Social Security taxes for a long enough time and during a recent period to
have earned a specific number of work credits. For any particular individual, this calculation
is based on the unique facts of that person's work history. The general rule for all people is
that the younger the person is, the fewer the credits required for eligibility and vice versa.
You should also know that some people who have never paid into the Social Security
program or who have few work credits might be eligible if their incomes are low enough,
however, these people are not good prospects for commercial DI insurance in any event.

Uncle Sam's Definition of Disability

Even after a working person has enough work credits to be generally eligible for Social
Security benefits, it is fairly difficult to qualify for disability payments. The reason is the
extremely narrow definition of disability. The exact wording under federal law is quoted
below. We have broken down this very long sentence into separate parts for easier
understanding:

      "The Inability to engage in any substantial gainful activity

       by reason of any medically determinable physical or mental impairment

       which can be expected to result in death or

       has lasted or can be expected to last for a continuous period of not less
       than 12 months

       or, in the case of a child under the age of 18, if he suffers from any
       medically determinable physical or mental impairment of comparable severity."


                                              60
For our purposes, you can ignore the final part of the definition, which is printed in plain type
instead of boldface type. This portion concerning children is not pertinent to this course of
study.

Notice, first of all, the reference to any substantial gainful activity. “Any” does not take into
consideration what the individual is suited to do by training, education or experience as
commercial insurance policies generally do. Neither does the definition consider whether or
not employment is actually available where the individual is located. In recent years we've
seen pockets of the U.S. where job openings simply did not exist.

“Substantial gainful activity” does not necessarily mean full-time work: neither does it mean
profitable work. For Social Security disability eligibility, it simply means the individual is
not earning more per month than the ceiling stipulated by law. Figure 4-1 shows the separate
limits for people who are legally blind and for all other people in 1993. These figures are
adjusted periodically for inflation.

The second portion of the definition indicates that the reason for the disability must be a
physical or mental impairment that can be determined medically. This appears to be fairly
straightforward-but beware the common condition of a backache for which a physician might
have difficulty locating the cause. Back problems are quite common and can, in fact, be
debilitating-as can other conditions-even when no medical explanation is apparent.

The remainder of the impairment section is even more difficult. The condition must be
expected to result in the individual’s death or is long-term, meaning lasting continuously for
12 months or more. Remember the earlier statistics-most disabilities extend for less than a
year. Think about a middle-income worker who is severely injured in an

                                          Figure 4-1
                      Eligibility for Social Security Dl Benefits
                                  1993 Income Limits




                                               61
accident that leaves her disabled for nine months. In all ways except the 12-month period,
she meets the requirements of this definition, but that alone disqualifies her. Many people
would be hard-pressed to survive for nine months without income-but no Social Security
disability benefits are available to this person.

Uncle Sam's definition of disability is probably the strictest in existence, more so than other
government-sponsored disability programs and considerably more stringent than most private
insurance plans. A quick review of the definitions in Chapter Two will confirm that fact for
you.

Five-Month Waiting Period

Individuals must be disabled for five months before they will be considered for Social
Security disability benefits. Unfortunately, the approval process often extends many more
months. It's not uncommon to wait as long as 12 months following injury to receive approval.
If approved, benefit payments are retroactive to the sixth month and payable as long as
disability continues. Figure 4-2 Illustrates the Social Security DI benefits waiting period and
potential approval period.

As you can see, a full year may pass during which an individual has no income and no
benefits, while expenses continue. In addition, the rejection rate is high. Various sources
indicate that from one-half to two-thirds of all applicants for Social Security DI benefits are
rejected-the higher figure coming from the Social Security Administration's own statistics.
Claims finally approved are often denied initially and go through an appeal process, further
lengthening the period when the individual receives no benefits.

The typical 12-month delay before benefits are either approved or denied was the impetus for
insurers to develop the supplemental Social

                                       Figure 4-2
                 Social Security DI Benefits Waiting & Approval Periods




                                          62
Security rider discussed in Chapter Three. As you can see, most wage earners will find it
difficult to qualify for disability benefits from the Social Security program. Those who do
qualify are often in lower income groups that are not prime prospects for the policies you
offer. As a result, the possibility of receiving Social Security DI benefits should not pose a
major obstacle to your DI policy sales. On the contrary, you are in an excellent position to
explain the requirements to your prospects, most of whom won't know how difficult the
process is. As you describe the hazards of counting on Social Security to breach the income
gap during disability, your sales potential should be enhanced rather than hampered, because
the need for personal disability insurance becomes quite apparent.

Workers Compensation

Another source of disability benefits is the workers compensation system, which is
administered separately by the individual states. While workers comp laws provide other
benefits in addition to disability, we're concerned here only with the latter. Workers
compensation benefits are available only to individuals who suffer occupational injury or
illness. Disabilities resulting from causes that do not arise from and in the course of
employment are not covered by workers comp. For example, a person who is injured in and
disabled from an auto accident while not working could not receive workers comp disability
benefits, but could receive benefits from an individual DI policy.

State Differences

While the basic principles of workers compensation are uniform among the states, the actual
details-waiting periods, benefit amounts and periods, maximums, and so forth-vary widely
from state to state.

Waiting and Retroactive Periods

For example, waiting periods, which are the equivalent of elimination periods, range from
one to seven days, after which disability parents begin. Many state laws provide that, if the
person is disabled for a certain length of time-called the retroactive period-benefits will be
paid for each day from the first day of disability. Among the states, this period ranges from
one day to six weeks.

Benefit

Benefit amounts differ from state to state, though they are typically based on the individual's
average weekly wage for the previous year. The actual weekly benefit for which an
individual is eligible is equal to a certain percentage, ranging from 60% to 75% in most
states, with 66 % being the most common figure. Generally, both a weekly minimum and
maximum also apply. A few states deviate from the common formulas for determining

                                              63
benefits, using instead 80% of the worker's "spendable earnings." a term defined in the law.
Typically, this would be after-tax income. A few states pay a greater percentage for a short
period followed by a reduced percentage if the disability continues. Most states stipulate that
if the person's actual earnings are less than the minimum, the actual wage is paid.

The table following shows the wide variations among several states in a recent year. These
figures change as states amend their workers comp laws or when automatic indexing occurs
in some states. Where the state provides figures in dollars-and-cents, this table drops the
cents. For your comparison and enlightenment, we've included at the end of the table the
figures for                     employees.

                       Workers Compensation Benefit Variations
                                 in Selected States
                                   Percent       Weekly        Weekly
State                              of Wages      Minimum      Maximum
Arkansas                           662/3%        $ 20         $226
Idaho                              60% or more* $150          $300
Illinois                           662/3%        $100-124** $618
Iowa                               80% of spend $123          $703
                                   able earnings
New Jersey                         70%           $ 99         $370
Puerto Rico                        662/3%        $ 10         $ 65
U.S. Gov't.                        662/3% or
Employees                          75%***        $171         $1,110

       *Up to 90% depending on number of dependents.
       **Based on either temporary or permanent disability.
       ***Based on civil service grade level.

       Table adapted from U.S. Department of Health and Human Services bulletin.

Some states have different minimums and maximums depending on whether the disability Is
temporary or permanent. In some cases, the law provides for the benefit to be based on what
is called the state average weekly wage (SAWW) for jobs similar to the individual's when
computations based on actual wages do not provide what the particular state considers an
adequate benefit to meet basic income needs.

All states currently provide rehabilitation benefits to pay for medical or physical
rehabilitation services, such as physical therapy, and for vocational rehabilitation to retrain
disabled workers for new jobs.



                                              64
While most states pay benefits for the person's lifetime when disability is permanent and
total, several states specify maximum benefit periods and/or dollar maximums. Maximums
might apply only to temporary disabilities only both temporary and permanent disability. The
maximum benefit period is typically expressed in weeks. This next table provides a few
examples, again illustrating the wide variation.

                         Maximum Benefits In Selected States

State                  Maximum Period and/or Amount
Florida                260 weeks (temporary disability only)
Indiana                500 weeks or $147,000
Kansas                 $100,000
Mississippi            450 weeks or $92,970
New Mexico             700 weeks
Tennessee              550 weeks or $92,400: after 400 weeks
                       benefit reduced to statutory minimum

Table adapted from U.S. Department of Health and Human Service bulletin.

Many states have one or more unique twists concerning how and in what amounts benefits
are paid, but discussing these Is beyond the scope of this course. Find out how workers comp
benefits apply where you do business because, the amount of those benefits can affect the
benefit amount you may offer in a DI policy.

Disability Definitions

Workers compensation laws define four different types of disability:

      Temporary Total Disability: An individual is currently unable to perform any duties
      of the regular occupation, but will eventually be able to perform all such duties. Most
      disabilities are at least initially classified as temporary total.

      Permanent Total Disability: An individual is unable to perform the duties of any
      occupation and will never be able to do so. This definition may include certain
      presumptive disabilities such as loss of limbs or eyesight, without regard to the actual
      ability to work.

      Temporary Partial Disability: An individual can perform some of the duties of the
      regular occupation or can perform duties on a part-time basis and will eventually be
      able to perform all duties full time.



                                             65
      Permanent Partial Disability: An individual is permanently disabled, but is able to
      perform some duties of the regular occupation or some other job.

These definitions, which control how and in what amounts workers comp benefits are paid,
appear to be unambiguous. However, subtle differences in wording and interpretation have
contributed to a significant body of state and federal case law about workers compensation,
indicating the terms are not as clear as they seem. As a result, determining eligibility and
benefit amounts can be complicated.

Uncle Sam and Workers Comp

For the most part, workers compensation is a state-regulated program. However, tile federal
government is involved in the workers compensation system in the District of Columbia and
in the U.S. possessions-Guam, Puerto Rica, the Virgin Islands and American Samoa.
Additionally, federal regulations apply to certain occupational groups including all civilian
employees of the federal government wherever they are physically located: longshore and
harbor workers: and employees such as miners and railroad workers whose jobs are highly
hazardous.

DI Policies and Workers Comp

The impact of the workers compensation system on the DI policies you sell differs from case
to case. You'll recall that many commercial policies include the nonoccupationa1 injury
provision, which excludes coverage for injuries covered by workers compensation and
similar employment-related disability benefits. For workers who earn up to as much as
$30,000 per year, workers camp DI benefits alone can effectively replace enough income to
prevent severe financial problems during disability. Remember, however, that workers
compensation benefits are payable only when disability results from injury or sickness arising
out of and in the course of employment. Therefore, the need still exists for an individual DI
policy to cover disability from causes not related to employment.

Social Security and Workers Comp

Another consideration is how workers camp benefits are integrated with Social Security
benefits. As a general rule, someone receiving workers compensation DI benefits will not
receive Social Security DI benefits at the same time. Workers comp would be paid for the
full benefit period allowed by law and if the person is still disabled, Social Security DI would
take over from that point. However, when workers camp benefits are very small, the two
types are sometimes and paid at the same time to provide up to 80% of the individual's
average earnings. Still, workers comp is primary, paying the maximum available, with Social
Security supplementing the benefit up to 80% of earnings.


                                              66
The potential benefits from both of these programs must be considered when determining the
monthly benefit available under a personal disability policy. As indicated earlier, a social
insurance offset rider can help prevent over insurance by coordinating the policy benefits
with government-sponsored programs such as these.

Temporary Disability Benefits

Currently, five states and Puerto Rico provide short-term benefits covering nonoccupational
disabilities excluded from workers comp coverage. The five states are California, Hawaii,
New Jersey, New York and Rhode Island. Among the jurisdictions, these benefits are
variously called temporary disability, state cash sickness or nonoccupational disability
benefits.

These plans have no provision for permanent, long-term disability. Their benefit periods are
loosely related to the lag time associated with qualifying for Social Security DI benefits.
Maximum benefit periods range from 26 to 52 weeks, depending on the state. Benefits
generally are paid after the individual has been disabled for seven days. In California and
Puerto Rico, no elimination period is required if the individual is hospitalized from the first
day.

Benefit levels in each state correspond roughly with the state's workers compensation
benefits, generally replacing at least half of the individual's weekly earnings, subject to
minimum and maximum amounts. Note that, while these benefits cover disability from injury
and sickness not associated with employment, eligibility is based on past earnings or
employment. Individuals who have not been employed for some time lose their eligibility for
these temporary benefits.

Definition of Disability

In most cases, disability is defined as the inability to perform the duties of the individual's
regular occupation. However, in New Jersey the person must be unable to perform any
gainful work to qualify for temporary benefits.

A social insurance rider attached to an individual disability income policy can address
temporary disability benefits. However, at lower income levels, these benefits, coupled with
other government-sponsored benefits, can replace an adequate portion of the worker's
income. Again, such individuals would not be prospects for commercial DI policies.

Miscellaneous Government Sources

As you seek prospective customers for disability income policies. It is important for you to
know that your greatest "competitor" may be government. Virtually every government

                                              67
employee-whether at the federal, state or local level-is potentially eligible for some type of
disability benefit. In some cases, the benefits may be so small that they are negligible in
terms of eliminating the need for a separate DI policy. On the other hand, certain programs,
especially those sponsored by the federal government, are generous enough to eliminate the
need for other DI coverage. Some insurers, in fact, will not consider applications for
individual policies from people who are eligible for these federal benefits. The major federal
programs (other than Social Security) are associated with the following groups and laws:

       *Veterans Administration
       *Armed Services
       *Civil Service
       *Federal Employees Compensation Act
       *Railroad Retirement Act
       *Longshore and Harbor Workers Compensation Act

These programs cover virtually everyone who has worked or currently works for the federal
government, plus certain non-government employees who have received special attention
from the federal government. Check with your insurers about their own procedures for
applications from people covered by any of the programs mentioned above. If you want more
information about the programs themselves, you can phone or write the various agencies.
Check your phone directory for listings of the governmental offices in your community.

Below the federal level, government-sponsored disability benefits, aside from workers comp,
might be less than adequate for income replacement. If you want to sell DI insurance to these
other government employees, you can ask about the level of DI income in their plans and
suggest an additional benefit through a commercial DI policy that will provide a higher level
of replacement income.

Miscellaneous Non-Government Sources

You've seen that various levels of government provide numerous potential sources for
disability income benefits. DI benefits are available from several non-government sources as
well. One source is commercial DI policies available from your direct competitors to cover
individuals, businesses, and groups such as employers, trade and professional associations,
and labor unions.

Life Insurance Policy Rider

A disability income rider can be attached to a life Insurance policy. You might have written
any number of such contracts yourself. DI riders generally offer a monthly benefit equal to a
percentage of the life insurance policy face amount. For example, the benefit might be 1% or
$10 for each $1,000 of life insurance. On a $100,000 policy, the DI benefit would be

                                             68
$1,000, limited by both a maximum dollar amount and a specified percentage of the insureds
earned income.

Typically, a disability rider requires coordination with any other DI benefits available-such as
the individual policy you're trying to place with the insured. DI riders usually require total
and permanent disability, with the “permanency” requirement being fulfilled after six months
of disability. The same six months may represent the rider's elimination period. Some
insurers offer a four-month elimination period.

How Do They Stack Up Against Individual Policies?

With the exception of other individual DI policies and life insurance riders, coverage from
any of the other sources mentioned in this section has certain drawbacks. The coverage is
likely:

1.     To be cancelable at the insurance company's option.

2.     To end when the individual's relationship with the group ends.

3.     To end if the group or association plan is terminated voluntarily.

4.     To be subject to premium increases at the insurance company's discretion.

While you must consider other potential sources of DI benefits when attempting to place
your policies, in most cases the benefits the others provide are neither adequate nor secure
enough to be the individual's sole source of income replacement. We'll discuss group
disability income insurance in more depth in another chapter. Later you'll also learn how to
coordinate other DI benefits with benefits provided by your policies. Before you continue
your study, complete this short review.



Chapter 4 Review Questions

1.     The eligibility requirements for Social Security DI benefits require the individual's
       inability to perform which of these?

a.     His or her regular occupation.
b.     Any gainful work.
c.     Either the regular occupation or any other occupation, depending on the state where
       the individual resides.


                                              69
2.   How long is the waiting or elimination period for Social Security DI benefits? (one to
     seven days/one to six weeks/five months/12 months)


3.   The Social Security Administration estimates that it rejects as many as what
     proportion of applicants for DI benefits? (one-fourth/one-half/two-thirds/three-
     fourths)


4.   What insurance company rider helps offset the Social Security waiting and approval
     periods during the first year of disability? (supplemental Social Security rider/life
     insurance policy DI rider/social insurance offset rider).



5.   Workers compensation DI benefits are available for disabilities associated with
     which of the following?

     a.       Employment.
     b.       Injury (not sickness).
     c.       Sickness (not injury).
     d.       Nonoccupational injury or sickness.



6.   The percentage of earnings most commonly used as the basis for workers
     compensation DI benefits in the various states is (50% / 60% / 602/3% / 70%).



7.   When an individual would otherwise be eligible for both workers compensation and
     Social Security DI benefits, which program takes precedence? (workers
     compensation/Social Security)



8.   Five states and Puerto Rico provide short-term disability benefits under temporary
     disability or state cash sickness programs, covering disabilities that are (occupational/
     nonoccupational either occupational or nonoccupational).




                                            70
9.    As a general rule, individuals associated with which of the following would not be
      good prospects for commercial DI insurance?

      a.     Local government employment.
      b.     Federal government employment.
      c.     Professional associations.
      d.     A group DI plan.



10.   When DI benefits are provided in the form of a rider to a life insurance policy, the
      benefit is generally expressed as a (flat dollar amount/percentage of the policy
      face amount / percentage of average monthly earnings).


                                    Answers

                                    1. b is correct
                                    2. five months
                                    3. two-thirds
                                    4. supplemental Social Security rider
                                    5. a is correct
                                    6. 662/3%
                                    7. workers compensation
                                    8. nonoccupational
                                    9. b is correct
                                    10. percentage of the policy face amount




                                           71
                               Chapter Five
                          Exploring Business Needs
Where We're Headed

In this chapter, you will learn about several types of disability insurance associated with
businesses. Each coverage is an individual insurance policy designed for a special business
need. Group disability coverages, which are also associated with businesses, are not included
here. A separate chapter addresses group insurance. This chapter covers:

        *Professional DI insurance
        *Business overhead expense coverage.
        *Disability buyout or buy-sell insurance.
        *Key person DI insurance.
        *Executive bonus DI coverage.
        *Salary continuation plans.

As we proceed, you'll see how each of these can help a business avoid financial problems
when business owners or associates are disabled.

Professional DI Insurance

What It Is

So-called professional disability income insurance can address a combination of business and
personal needs since the professional person's work is the source of income that pays for both
business and personal expenses. For insurance purposes, professional DI policies are those
written for people in certain occupations that generate incomes over $100,000 annually.
Insurers write professional policies for individuals who need income replacement in the
range of $20,000 to $30,000 per month. Since not every insurance company is willing to
provide monthly benefits in these amounts, you will want to locate those that do in order to
serve this market.

Income, however, is not the only characteristic that defines this group. Eligibility is generally
restricted to professionals who are independent and self-employed, but highly compensated
executive employees might also be considered. Typical occupations acceptable for
professional DI insurance includes physicians and other health professionals such as dentists,
optometrists, psychiatrists and pharmacists; lawyers: accountants; engineers; architects; and
some executives, generally PhDs or those who are otherwise highly educated. This is just a



                                               72
sampling of eligible occupations. The companies you represent provide a complete list of
occupations they will consider for professional DI policies.

Aside from the large dollar benefits involved, professional DI policies operate essentially like
any other individual policy. As indicated in an earlier chapter, professionals are eligible for
the most liberal benefits of any occupational group. Chapter Eight of this text discusses the
various occupational classes more fully. Because of the high incomes involved, one of the
major differences between writing professional DI policies and others is that social insurance
benefits are not large enough in comparison to actual earnings to interfere with the income
replacement calculations and cause over insurance problems.

The Key to the Professional's Livelihood

Reading the list of typical professional occupations above, you can see that these are people
who provide vital services for society and who are frequently self-employed. Performing
these services is the key to the professional person's livelihood. The inability to earn income
by performing these services affects not only personal finances, but also the very life of the
business itself since it is those services that keep the business operating.

Consider, for example, a self-employed physician, operating without partners and employing
a small staff. If this individual is unable to work, first of all, no income is generated to pay
for personal expenses. Second, no income is generated to continue the medical practice by
paying ongoing business expenses, including a substitute physician to see the disabled
doctor's patients. If a medical practice shuts down temporarily, patients must look elsewhere
for services and there's no guarantee they will return even if the disabled physician recovers.
The physician is likely to suffer a double loss: current loss of income and loss of the business
he or she might have spent years building. There is no substitute for disability insurance to
overcome these problems. Later you'll also learn about some specialized disability policies
that address ways to keep a business intact during the disability of someone whose active
working presence is key to the business.

What Competes with Professional DI Insurance

While social insurance benefits are not a significant issue, professionals often have DI
coverage through a professional association, such as the American Medical Association or
the American Bar Association, to name just two possibilities. While having such coverage
may prompt an objection to purchasing an individual DI policy, association insurance does
not eliminate the need for an individual policy.

Association policies typically may be canceled for the entire group of covered people at the
insurer's option. If the individual drops his or her membership in the association, the


                                              73
coverage terminates. In both cases, the individual will likely pay more to replace the
coverage with an individual policy simply by virtue of being older or having developed a
medical condition that increases the cost. Worse, if the person is no longer insurable, be or
she will be unable to purchase replacement coverage at any cost.

An association policy probably has a more restrictive definition of total disability than your
professional DI policy, as well as other less liberal provisions. For example, you may offer a
noncancelable policy with presumptive and residual disability provisions and payment for
rehabilitative services, features that are probably not available in the association policy.
Insurers you represent might even offer some of the latest policy features such as the HIV
benefit, which can be especially attractive to medical practitioners. Finally, an association
policy probably does not offer riders, such as the cost of living adjustment, that are appealing
to high-income professionals.

These are just some of the trade-offs people make when they buy lower-cost policies and you
can use them as selling points for your own more liberal DI contracts. Professionals need not
drop their association policies in order to purchase an individual DI policy, but the benefit
amounts must be coordinated.

Protecting Income that Protects the Business

Earlier we stressed the potential impact of a professional person's disability on the life of the
business itself. Selling to professionals can lead to additional insurance for needs such as
paying business overhead expenses and funding buyouts from disabled business owners.
These specialized coverages protect business interests in the event of a key person's
disability-interests that are just as important and just as much at risk as the individual's
personal earnings.

Protecting a business during disability is a concern for all business owners, including sole
proprietorships, partnerships and closely held corporations. Small to medium-sized
businesses offer the best prospects for selling specialized disability coverages for two
primary reasons:

        1.      In raw numbers, many more smaller businesses exist than large
                conglomerates.

        2.      Small and medium-sized businesses are more accessible to you, the agent,
                and are less likely than large corporations to have business disability
                Insurance already in place.




                                               74
Review of Business Types

Briefly review the three types of small to medium-sized businesses you will encounter. Sole
proprietorships are businesses owned by one person who may or may not employ others in
the business.

Partnerships involve two or more Individuals who jointly own businesses. A partnership,
like a sole proprietorship, may or may not employ other people.

Finally, closely held or close corporations are incorporated businesses that have a very
small group of stockholders. The stock of the company is not traded publicly, but is "closely
held" by a small group of people. The stockholders generally both control and actively work
in the business. Often, a single individual is the majority stockholder as well as the primary
operator of the business. You will find numerous small businesses organized this way,
running the gamut from in-home businesses to attorneys' offices. An example you've no
doubt observed is a professional corporation (PC) operated by a physician or other
professional person on this basis.

Let's move on now to two specialized disability policies that benefit these businesses.

Business Overhead Expense (BOE) Policy

When a business owner becomes ill or is injured and unable to work, certain business
expenses continue whether or not business income is being generated at the same level as
before the disability. Smaller businesses in particular can suffer significant revenue losses
during even a short-term disability. Remember the previous example of a physician
practicing as a sole proprietor-that person's services are the sole source of income for the
business. The inability to provide services can kill the business. Professional DI policies are
designed primarily to replace the individual's personal income and might provide a small
amount for business expenses if the individual is willing to sacrifice a portion of personal
income for that purpose. In most cases, however, additional funds are needed to pay ongoing
business expenses. This is the purpose of business overhead expense (BOE) insurance.

Reimbursement of Covered Expenses

Unlike a disability income policy, the BOE does not pay a fixed monthly benefit based on the
individual's earnings. Instead, BOE insurance reimburses the insured for expenses the
business actually incurs, usually at 100%, rather' than the lower percentage paid as DI
benefits, subject to a maximum monthly amount. Figure 5-1 illustrates basically how the
BOE benefit works, using a $5,000 maximum monthly benefit. Notice in the first figure,
expenses total $4,000 ($1,000 less


                                              75
                                       Figure 5-1
                                   BOE Reimbursement
                           ($5,000 Maximum Benefit Illustrated)




than the maximum), so this is the amount the insurer pays. In the second figure, expenses
total $6,000, but the policy pays only $5,000, the maximum benefit.

The specific expenses for which a BOE policy reimburses the insured are generally those that
continue during disability and which arc also accepted as deductible business expense by the
Internal Revenue Service (IRS). These are common:

       *Rent or mortgage payments for the property housing
       *Utilities for the business.
       *Employee salaries and employer-paid benefit contributions.
       *Office expenses.
       *Insurance premiums (other than those waived during disability).

This is just a sampling. Other items may also be covered and each business is likely to have
some reimbursable expenses unique to that type of operation. With regard to mortgage
payments, most insurers agree to pay only the interest and tax portions of the payment,
although a few cover the entire payment.

Excluded Expenses

BOE policies typically list a number of business-related costs that are not covered. First of
all, the insureds salary is never covered: this expense requires an individual disability income
policy. Neither is their coverage for the salary of anyone who does the same work as the
insured. For example, if the business is a partnership made up of two attorneys with five
employees, the BOE policy covers the employees’ wages, but not salaries the attorneys pay
themselves.

                                              76
       Other limitations apply, the BOE does not reimburse for:

       *Salary paid to anyone who temporarily replaces the disabled insured.
       *Salary paid to family members if they were not previously employed full time by
       the business
       *Cost of goods sold or other inventory used during the period of disability; this
       expense is usually, but not always, excluded.

The reason there is no reimbursement for the salary of someone who does the same work as
the insured is the expectation that such a person will generate at least some income that can
help pay ongoing expenses, including his or her own income.

When BOE Is and Is Not Needed

You should be aware, too, that the larger the number of people involved in the business and
performing the same job, the smaller the need for BOE insurance. For example, suppose a
professional corporation is comprised of five geriatric physicians. If one physician is
disabled, it's likely the other four doctors will continue seeing the disabled individual's
patients, so the business can generate essentially the same income to pay business expenses.
This would be true of any other type of business where several people performing the same
function are in a position to take over the disabled person's work, at least temporarily.

On the other hand, the number of key people alone does not eliminate the need for DOE
coverage since each person might have strikingly different duties. For example, a business
might have four partners, one whose expertise is general management. Another is the major
sales person and manages two other sales people. The third is the "numbers" person who
keeps the business finances on track and the fourth is an advertising specialist. As you can
see, each partner brings diverse and specialized skills to the business. As a result, one person
is not necessarily able to step in and perform the work of another who becomes disabled,
unlike a medical or legal partnership where skills are essentially the same among all partners.


Maximum Monthly Benefit

While DOE policies reimburse for actual expenses incurred, a monthly maximum applies as
stipulated in the policy. Insurers offer monthly maximums ranging from $5,000 too as much
as $20,000. However, if expenses are less than the maximum during one month, the unused
portion of the benefit may be carried forward to another month when expenses are higher.
For example, assuming a maximum benefit of $5,000 per month, if actual expenses were
$3,000, a surplus of $2,000 remains available. If, during another month expenses total
$5,500, the excess expenses of $500 may be reimbursed from the $2,000 excess. Actually,
insurers use several different methods under which unused monthly benefits are made

                                              77
available to the insured. We'll discuss these in more depth after you learn about DOE
elimination and benefit periods.

Elimination and Benefit Periods

The most common elimination period for a DOE policy is 30 days. Insurers may offer 60-
and 90-day periods as well, but longer elimination periods are rarely used since DOE policies
are designed primarily to cover expenses during short-term disabilities only.

For the same reason, benefit periods are also relatively short, ranging from 12 to 24 months.
Different insurance companies might offer somewhat shorter or somewhat longer periods.

Most insurers correlate the benefit period with the maximum dollar amount payable under
the policy so benefits can continue beyond the stipulated period if unused benefits remain
and the insured is still disabled. For example, a 12-month benefit period and a $5,000
monthly maximum correspond to an overall maximum benefit of $60,000 (12 months x
$5,000). At the end of the 12 months, the insured is still disabled. Total DOE benefits paid
during the 12 months equal $53,000.

                       12 months x $5,000 = $60,000         Maximum benefit
                                             -53,000        BOE benefits paid

                                                  $ 7,000

$7,000 of the maximum overall benefit available has not been used. Most insurers will
continue reimbursing expenses until the $7,000 is exhausted as long as the insured is still
unable to work.

Monthly Benefit Applications

Immediate Reimbursement of Excess Expenses
Previously, we described a method whereby a portion of the maximum monthly benefit,
unused when monthly expenses were lower, was carried over to another month when
expenses were greater than the monthly benefit. In that example, the benefit was $5,000 per
month and expenses during a certain month totaled $3,000, leaving $2,000 unused. Then, for
a month when expenses were $5,500, this full amount was reimbursed even though it
exceeded the $5,000 maximum, using $500 of the $2,000 surplus from the earlier month. In
this case, the insured received an immediate reimbursement of excess expenses because the
surplus was available. Obviously, if expenses had been greater during the first month, before
any surplus was available, those expenses would have to be carried forward to some later
time when a surplus becomes available.


                                             78
When an insurer uses this method, surplus from any month(s) when expenses are lower than
the maximum benefit continues to accumulate during the benefit period. At any time the
insured needs to draw from the surplus because expenses are higher than the maximum
monthly benefit, the surplus is then reduced by that amount. In the previous example, the
$2,000 surplus was reduced to $1,500 when the insureds expenses were$500 higher than the
maximum benefit. As a result, the amounts available to cover excess expenses fluctuate
during the benefit period.

Reimbursement when Benefit Period Expires

Some insurers do not make the unused benefits available immediately during the benefit
period. Instead, they pay only the actual expenses each month, but never more than the
maximum benefit. At the end of the benefit period, if any surplus remains from months when
expenses were lower than the maximum benefit, the insured may receive the excess at that
time.

For example, with a $5,000 monthly benefit stipulated, here is how the following actual
expenses would be reimbursed during the benefit period. We're assuming a 12-month benefit
period and have not illustrated the elimination period, when no benefits are paid.

        Actual                         Amount                        Unreimbursed
       Expenses                         Paid                           Expenses
       $5,400                          $5,000                            $400
       $4,900                          $4,900                              -0-
       $5,100                          $5,000                            $100
       $5,300                          $5,000                            $300
       $4,750                          $4,750                              -0-
       $4,800                          $4,800                              -0-
       $5,400                          $5,000                             $400
       $5,300                          $5,000                             $300
       $5,250                          $5,000                             $250
       $4,600                          $4,600                              -0-
       $4,500                          $4,500                              -0-
       $4,300                          $4,300                              -0-
       $59,600                        $57,350                           $1,750

At this point, the insureds business has incurred $1,750 more in expenses than the policy has
reimbursed. However, the insurer has paid out only $57,350 of the maximum $60,000
available ($5,000 per month for 12 months), leaving unused benefits totaling $2,650.




                                             79
                                       $60,000
                                        -57,350

                                        $ 2,650

Since the benefit period has now ended, the insurer will reimburse the $1,750 to the insureds
business, after which $900 ($2,650 - 1,750) still remains. If, during the next month, the
insured remains disabled and has at least $900 of covered expenses, many insurers will
reimburse this additional $900 even though the benefit period has expired.

Using either of the methods described, you can see that the insured must find another source
of income to make up any shortfall between expenses incurred and expenses reimbursed by
the BOE policy-and this is in addition to expenses incurred during the elimination period
when no benefits are paid. A third method gives the insured a head start on covering
expenses.

Elimination Period "Credit"

This reimbursement procedure allows a “credit” toward future expenses to be established
during the elimination period. While the insured still must absorb the expenses incurred
during this period, one month's maximum benefit becomes available immediately following
the elimination period to help pay expenses that exceed the monthly benefit. Assume again
the monthly benefit is $5,000 and the elimination period is 30 days. The insured is disabled
and the $5,000 "credit" is established, after the elimination period, the first month's covered
expenses total $6,000. Under the other reimbursement methods, only $5,000 is paid and the
$1,000 excess must be carried forward until some future time when (1) expenses are lower,
resulting in a surplus. or (2) the benefit period ends and a surplus is available.

Under this third method, however, because of the $5,000 "credit" from the elimination
period, the insurer will pay the full $6,000-the $5,000 maximum monthly benefit plus $1,000
from the "credit." The $5,000 put in place during the elimination period is now reduced to
$4,000. The insured can continue to draw from the $4,000 during months when expenses are
higher than the monthly benefit. When expenses are lower than the monthly benefit, the
difference is added to whatever remains of the "credit" at any given point, with the surplus
fluctuating during the benefit period as surplus amounts are added or amounts are deducted
to cover excess expenses.

Other BOE Policy Features

Following are several additional features that typify BOE policies. Most business overhead
expense policies are either guaranteed renewable or noncancelable until the insureds age
65. The most common definition of disability that triggers coverage is:

                                              80
       The inability to perform the substantial and material (or
       usual) duties of the insureds regular occupation as the
       result of injury or sickness as defined in the policy.

Injury and sickness are generally defined the same or comparable to definitions provided in
Chapter Two.

Most BOE policies include a premium waiver provision that becomes effective when the
insured has been disabled for the lesser of 90 days or the length of the elimination period.
After the stipulated period, the waiver may be retroactive to the first day of disability.

Like disability income policies. BOE policies often pay benefits for presumptive disability.
waiving the elimination period and ignoring the definition of total disability when the insured
suffers loss of limbs, eyesight or similar injuries. If the insured dies while disabled, a BOE
policy might also pay transition benefits to the insureds survivors for a short period-usually
up to two months after the insureds death-if unused benefits remain available.

Partial or Residual Disability

Under many BOE policies, expense reimbursement benefits cease as soon as the insured
returns to work. Other policies, however, pay a type of partial or residual disability benefit
if the insured returns to work part time or is able to work full time, but is unable to perform
all of the previous duties. Such benefits are handled in a variety of ways: four possibilities
follow.

Full Benefit for 50% Earnings. Some policies continue paying the monthly BOE benefit
only if the insured returns to work and cannot earn more than 50% of the pre-disability
income. For example, assume a monthly benefit of $6,000 and pre-disability earnings of
$10,000 per month. Following total disability, the insured is able to work part time only,
earning $5,000 the first month-exactly half of prior earnings. Expenses for that month are
$6,200. Because the insureds earnings are 50% less, the maximum monthly benefit of $6,000
is paid. The next month, the insureds earnings are still at $5,000 and expenses are $5,800.
The full $5,800 is reimbursed. But let's say that in the third month, the insured can work
longer and earns $6,000. Now the insured has income that is more than 50% of pre-disability
earnings, so the DOE policy pays no benefits.

One-Half Policy Benefit. Other policies pay one-half the benefit that would normally be
paid for a stipulated period after the insured returns to work-three or six months are common
periods. For example, suppose the period is three months and the maximum monthly DOE
benefit is $6,000. Here are actual expenses during the first three months after the insured
returns to work part time and the amount the insurer will pay:


                                              81
                Actual
               Expenses                      Reimbursement

               $59000                  $2,500          (1/2 actual expenses)
               $6,200                  $3,000          (1/2 maximum benefit)
               $6,000                  $3,000          (1/2 actual expenses)

Income Offset. A third way insurers pay partial BOE benefits is by offsetting from the
monthly expenses the amount the insured actually earns upon returning to work. For
example, suppose the insureds reduced earnings during the first month after disability total
$4,000. Covered expenses for that same month total $7,500. Subtracting the $4,000 earnings
from the $7,500 expenses results in a partial benefit of $3,500 for that month. As long as
benefits are being paid, the amount is recalculated each month, using actual earnings and
expenses after the fact.

True Residual Benefit. Finally, some BOE policies pay a true residual benefit calculated in
the same way as described in Chapter Two. First, a calculation is made to determine the
percentage of income lost after returning to work in comparison to pre-disability earnings.
That same percentage is applied to the monthly BOE benefit that would otherwise be paid.

For example, the insured earns 40% less than pre-disability earnings during the first month
she returns to work. Covered BOE expenses total $4,000 that month. The maximum BOE
benefit is $5,000. In this case, the policy pays 40% of actual expenses, or $1,600 (.40 x
$4,000).

Let's say the same person earns 40% less in a month when expenses total $5,200. Since the
maximum benefit is $5,000, the residual benefit this month is 40% of $5,000 or $2,000. The
percentage of income lost and the residual benefit amount are both recalculated each month
the benefit is paid.

Riders

Certain policy riders are frequently offered to business people who apply for business
overhead expense coverage. Two of these are the guaranteed insurability rider and the cash
value/return of premium rider discussed in Chapter Three. If you need to refresh your
memory about these two riders, please review that chapter.

Substitute Salary Rider

You'll recall that one expense item not covered by the standard DOE policy is salary paid to
someone who temporarily replaces the disabled insured at work. The substitute salary rider
helps close the resulting expense gap. Policies vary, but the amount of the benefit is generally
either:
                                              82
                *50% of the maximum monthly BOE policy benefit, or
                *A stipulated percentage of the insureds pre-disability salary.

Let's suppose the BOE policy benefit is $4,000 per month and the insureds former monthly
income is $7,000 per month. While the insured is disabled, a benefit of $2,000 per month
(50% of $4,000) helps pay the salary of someone substituting for the insured. Alternately, the
policy might pay 70% of the insureds former salary-$4,900 in this case. Be sure you know
exactly how the rider works for policies you sell.

The rider becomes effective as soon as the elimination period is completed, provided the
business is actually incurring expenses to pay a substitute worker. The substitute must be a
person who is qualified to perform the insureds job and who is not a family member. This
includes a spouse's family. Payment of substitute salary benefits is generally limited to either
six or 12 months, depending on the policy.

Claims-Made Malpractice Liability Rider

A rider that addresses the costs of claims-made malpractice liability insurance will be of
particular interest to professionals subject to malpractice lawsuits. Before we discuss the
rider, let's briefly talk about the insurance itself. Malpractice liability insurance is similar to
the Errors & Omissions Insurance many agents purchase to protect themselves against client
lawsuits claiming the client was harmed by something the agent did or did not do.
Malpractice liability insurance for physicians, as an example, protects them against patient
lawsuits claiming the patient was harmed by something the doctor did or did not do while
treating that person. The premium for malpractice insurance is covered as a business expense
under the BOE policy, so that basic premium Is not what we're concerned with here. We are
concerned with the cost of an endorsement that Is required because of the peculiar nature of a
claims-made liability policy.

This rather awkwardly named policy is complex in terms of how claims are judged to be
payable. While space does not allow a complete discussion of a claims-made policy, we will
briefly explain how it works. A claims-made policy covers only liability claims that were
first made against the insured while that particular policy was in force. In other words, if the
policy expires before a claim is filed, the policy no longer protects the insured against that
claim, even though the event that led to the claim occurred during the policy period. A
claims-made policy differs on this specific point from an occurrence policy, which pays only
for events that occurred during the policy period even if the claim itself is made after the
policy has expired.

Since claimants sometimes file a claim long after an event occurs, it is possible for the
claims-made policy to have expired and been replaced by a different policy before the
claimant files, leaving the insured unprotected. This quirk makes it necessary for owners of

                                                83
claims-made policies to buy an extended reporting period (ERP) endorsement that keeps the
insurance coverage intact for a specified period after the policy expires solely for events that
occurred during the policy period but for which the claim has been delayed beyond the policy
expiration date.

For example, suppose a physician's claims-made policy was in effect from June 1,1991 to
June 1,1994. During the policy period, on May 23, 1994, the physician treats Patient Smith-
eight days before the policy expires. The physician now acquires an occurrence liability
policy to replace the expired coverage. On August 1,1994, two months after the claims-made
policy expires, Patient Smith files a malpractice liability claim, citing problems that arose
during the treatment on May 23. The new occurrence policy does not apply because the
treatment did not occur during its policy period. Unless the insureds claims-made policy has
the extended reporting period endorsement, that policy won't pay because the claim was not
first filed while the claims-made policy was still in force. With the ERP endorsement,
however, the claims-made policy will cover this event even though the claim was not first
made during the policy period.

Figure 5-2 further illustrates how the ERP endorsement applies. In a situation such as the
physician faced in the previous scenario, the ERP endorsement can be vital. Without the
ERP, the physician would have had no liability coverage at all for this particular claim.
Therefore, the ERP is quite important to people with claims-made liability policies. And the
ERP is also quite expensive. The premium for the ERP endorsement can be up to 200% of
the premium for the insureds previous year's entire liability policy. So, if the physician had
been paying $20,000 per year for the malpractice liability insurance, adding the ERP may
cost as much as $40,000.

The purpose of the malpractice liability rider is to continue paying the ERP endorsement
premium while the Insured is disabled. Most riders pay 100% of the ERP premium, but some
might pay a lesser percentage as stipulated in the rider. Typically, the insured must be
disabled for a certain period-usually six or 12 months-before the rider pays the ERP
premium.
                                       Figure 5-2
                       Claims-Made Policy & ERP Endorsement




                                              84
Before you sell this rider, you must know what type of liability policy the insured has in
place since this is needed only for claims-made policies. If the individual has an occurrence
policy rather than a claims-made policy, the rider is not needed since the only requirement for
the insureds coverage to apply under this type of liability policy is that the event occurs
during the policy period. With an occurrence policy, when the claim is actually made is not
relevant as it is with a claims-made policy.

The insurers you represent might offer other riders designed to benefit disabled professionals
and other business owners. Be sure to find out all of the options you can offer your clients.


When BOE is Not the Answer

Business overhead expense coverage is intended to cover business expenses for a relatively
short time. BOE is a temporary measure that assumes the disabled person will eventually
recover and once again be a fully functioning member of the business. Some people,
however, will remain disabled indefinitely, with no hope of returning to the business any
time in the foreseeable future.

Permanent disability usually requires the individual to sell his or her interest in the business.
Another type of insurance is available to allow the remaining business partners or
stockholders to buy the disabled person's share at a price that is fair for both the seller and the
buyers. Insurance designed to fund such a purchase is called disability buyout or disability
buy-sell coverage.


Disability Buyout or Buy-Sell Insurance

You may be familiar with the concept of buy-sell agreements funded by life insurance and
designed to allow an orderly buyout of a business interest when a business owner dies.
Similarly, when a business owner is permanently disabled and has no hope of returning to
active participation, disability buyout or buy-sell insurance can accomplish transfer of the
business interest.

The need for such an agreement in the case of permanent disability is, perhaps, even more
urgent than for buy-sell life insurance. As you've learned, mortality rates have improved
while morbidity rates have deteriorated, which means a business owner's disability is more
likely than death to threaten the financial stability of a business. When an owner is disabled,
both personal and business expense continue, so the disabled person's need for income from
the business does not diminish. From a humanitarian point of view, the disabled owner's
business partners are likely to want to provide financial assistance, whether or not the
business can actually afford to do so. The result can be both a moral and financial crisis when

                                                85
perceived obligations to the nonproductive disabled partner strain the financial resources of
the business.

Disability buyout insurance, arranged before disability occurs, provides a guaranteed way to
avoid many of the problems associated with a business owner's disability. This type of
coverage allows the non-disabled business owners to buy the disabled person's interest so the
business is saved and the disabled person is compensated. When the business is a
partnership, the buyers are the other partners. When the business is a close corporation, the
buyers are the stockholders. Even a sole proprietorship may use disability buyout insurance
to fund such an agreement, with the buyer being some other specified party.

A buy-sell agreement is a legal document that requires the services of the insureds attorney
and accountant. Your role as an agent is to provide access to the insurance policy that funds
the agreement. insurance is the only funding mechanism guaranteed to be available exactly
when needed-when disability occurs, in this case.

Cross-Purchase Plan

One type of buyout agreement is called a cross-purchase plan, under which each business
owner purchases a policy covering the potential disability of each other partner or
stockholder. The funds from each policy are payable to the person who purchased the policy
if one of the business owners becomes disabled. The person who receives the funds from the
policy then uses that money to purchase the disabled person's business interest. If there are
two partners, for example, the remaining partner purchases the entire interest of the disabled
partner. If there are three partners, each of the two remaining partners purchases half of the
disabled partner's interest, and so forth, depending on the number of people involved. The
three illustrations in Figure 5-3 (on page 87) show you how this works. Refer to this figure as
you read the paragraphs following.

Partner 1 purchases two-disability buyout policies-one each covering the potential disabilities
of Partners 2 and 3. Likewise, Partner 2 buys policies covering Partner I and Partner 3. And
Partner 3 buys policies covering Partners 1 and 2. Six disability buyout policies are involved.

In the second part of Figure 5-3, Partner 3 becomes disabled and triggers the buyout. The
policy benefits from the policies Partners 1 and 2 own are paid to these two partners
separately. Partners 1 and 2 then pay the proceeds to disabled Partner 3 in order to purchase
Partner 3's business interest. Partners 1 and 2 continue to operate the business and Partner 3
are compensated.

And finally, the original policies Partners 1 and 2 purchased, covering each other, remain
intact. At this point, each individual's business interest has increased, so the original amount
of insurance on these policies is no longer adequate. As an agent, if you have actively

                                              86
serviced this account, you now have the opportunity to advise the remaining partners about
the need for additional coverage and to close this sale.

Entity Purchase Plan

Another method for funding a buy-sell agreement is through an entity purchase plan. In this
case, rather than each individual business owner buying a policy on every other owner, the
business entity itself buys as many individual policies as there are owners. In the previous
example, the business entity would have purchased three individual policies-one covering
each owner. Let's say that the name of that business is The Three, Refer to Figure 5-4 (on
page 88) as you read the paragraphs following.

In the first part of Figure 5-4, you see that The Three buys one disability buyout policy
covering Partner 1, one policy for Partner 2 and one policy for Partner 3-three individual
policies instead of the six that were needed under the cross-purchase plan. The Three owns
these policies rather than each individual partner owning the policies on the others.

Then, Partner 3 is permanently disabled, triggering payment of the disability buyout policy
benefits. The proceeds are paid directly to The Three partnerships, which owns the policy-
covering Partner 3. The Three uses the policy benefits to buy Partner 3's business interest,
which then becomes the shared interest of Partners 1 and 2.

Finally, the original policies covering Partners 1 and 2 and owned by The Three remain
intact. Again, because the individual interests of Partners 1 and 2 have increased, they need
additional insurance to cover their interests in the event either of them becomes disabled in
the future.
                                         Figure 5-3
                                    Cross Purchase Plan
                                 (Three Partners Illustrated)




                                             87
Each of these arrangements has its own tax consequences when premiums are paid and when
a claim is paid. You'll learn the details in the tax chapter later in this text.

The Buyout Policy Benefit

When the legal buy-sell agreement is written, it spells out exactly how the business Interest is
valued. This valuation is the basis for the disability buyout policy benefit amount. Some
insurers specify a lump-mum benefit representing from 80% to 100% of the individual
owner's interest. For example, if one person's business interest is valued at $100,000, a policy
that pays a lump-sum benefit at 80% pays $80,000 when that person is permanently disabled
and the buyout is triggered.

                                        Figure 5-4
                                   Entity Purchase Plan
                                 (Three Partners Illustrated)




Another insurer might write the policy for 95%, paying $95,000, and still another pays 100%
or $100,000, Check with the insurers you represent to determine what percentage of an
individual's business interest they are willing to cover. The maximum benefit available
differs from insurer to insurer, usually ranging from $25,000 to $1,000,000 for the smaller
business market.

Not all disability buyout policies pay the funds in a lump sum. Other insurers pay monthly
benefits either to a trustee or to the other business owners during the benefit period specified
in the policy. The monthly benefits from the disability buyout policy then provide the
funding that allows the non-disabled owners to make installment payments to the disabled
person for a specified period. In this case, the buy-sell agreement should be written to
stipulate that the purchasers will pay installments of a certain amount at a stated rate of

                                              88
interest, backed up by a promissory note guaranteeing that the purchase transaction will be
completed. Check with your insurers to determine how their policies handle payouts. Some
insurers offer both options. The ultimate purpose, whether funds are paid in a lump sum or in
installments, is the same for the disability policy as for a business life insurance policy-to
provide the buyout funds when an owner is unable to continue in the business.

Indemnity vs. Reimbursement

A disability buyout policy may be written to pay the benefit on an indemnity basis or a
reimbursement basis. Under an indemnity policy, the maximum benefit stipulated in the
policy is paid in full when the buyout occurs. If the maximum benefit is $100,000, the insurer
pays $100,000 for the buyout.

Under a reimbursement policy, however, the insurer may reduce the benefit it actually pays
if the value of the business interest is less than it was at the time the policy was written. The
insurer might specify that the benefit, paid will be determined by a valuation than it was at
the time the policy was written. The insurer might specify that the benefit paid will be
determined by a valuation formula specified in the buy-sell agreement when it was executed.
For example, suppose a $100,000 policy covers the potential disability of partner Wilson.
When Wilson becomes disabled, triggering the buyout, the value of Wilson's interest has
diminished to $90,000, due to economic conditions and application of the valuation formula.
Under a reimbursement policy, the insurer will pay only $90,000 to the partner or entity that
owns Wilson's policy.

Elimination Period

Disability buyout insurance has a relatively long elimination period since business owners
typically would not want to sell their interests before they are absolutely certain they cannot
return to the business. A long elimination period allows time for full recovery before the
buyout is triggered. Because statistics indicate that a person who has been disabled for a year
is unlikely to completely recover, 12-month elimination periods are most common. Insurers
also generally offer 18 and 24 months and less commonly, 36 months.

The end of the elimination period triggers the buyout and payment of the policy benefit.
When that happens, there is no turning back; the buyout must occur. You can see, then, that
selecting the elimination period is an important component of the disability buyout
transaction. The insured must feel comfortable that the period selected is adequate to delay
the sale until such time as there is no hope the disabled insured will be able to return to work.

As a rule, disability buyout policies, unlike other disability policies, do not require a
continuous run of days or months to fulfill the elimination period. This is a safeguard to
allow the insured to attempt to return to work without forfeiting any of the privileges under

                                               89
the policy. For example, suppose an individual's elimination period is 12 months. After six
months of disability, this person attempts to return to work, but two months later the
disability recurs and it seems unlikely the individual will ever be able to participate fully in
the business. At the time of the recurrence, the elimination period picks up from the point at
which the insured returned to work. So, rather than being required to start a new 12-month
elimination period, the insured needs to fulfill only six more months, the first six having
occurred during the first phase of disability. The end of this six-month period then triggers
the buyout. As is generally true of recurrent disability provisions in disability income
policies, the disability typically must recur within six months to be considered part of the
same condition. For the example above, if the insured had the recurrence, not two months,
but nine months after returning to work, a new elimination period would be required.

Definition of Total Disability

In a disability buyout policy, the usual definition of total disability is:

        Because of accident or sickness, you are unable to perform
        The substantial and material duties of your regular
        occupation and you are not actively at work in the business.

Note the qualification that the Insured is "not actively at work in the business." This is
important because the buyout is not triggered if the insured is able to work in the business in
any manner.

Also notice that this definition uses the "own occupation" terminology which indicates the
insured could work at another occupation in some other business. The disability buyout
policy would still pay the benefit to purchase the insureds interest in that particular business.

Other Features

Disability buyout policies are generally renewable until a specified age, usually 62 to 65,
with no premium increases permitted. This makes the policy essentially noncancelable, but
buyout policies will terminate if the insured stops working full time in the business.
Otherwise, the policy may not be canceled unless the premiums are not paid.

Most policies have a premium waiver feature, effective after 90 days of disability and
continuing either until the insured recovers or the buyout occurs.

Other Business Applications

The section just concluded focused on insurance that covers the financial needs of owners,
stockholders or other business principals. Disability insurance has other applications for

                                               90
individuals who may or may not be owners and principals. In some cases, business owners
use insurance coverages as extra benefits to reward valuable employees and/or to protect the
financial stability of the business if a key person who is not an owner becomes disabled.
remainder of this chapter discusses some of these applications.

Key Person Disability Insurance

Especially in smaller businesses or businesses that offer a unique product or service, people
who are considered key to the business are often owners. However, in any business, a key
person might be an employee whose talents are critical to the business. In either event, key
person disability insurance is designed to protect the business, not the individual, if the
key person is disabled. The key person should, of course, have an individual DI policy to
protect his or her own income.

How It Works

A key person disability policy provides a business with funds that can be used for various
purposes. including:

        *To replace a disabled key person either temporarily or permanently.

        *To pay ongoing expenses that are no longer being offset by the key person's
         contribution to the business.

        *To cover other costs and to help alleviate financial problems arising from or
         increased by the disability.

The business purchases and owns the policy covering the disability of a certain person. if that
person does become disabled, the policy benefits are triggered. The insurer pays benefits to
the business, not to the insured person, and the business may then spend the funds on various
expenses. Figure 5-5 (on page 92) illustrates how the coverage works.

If you are familiar with key person life insurance, you can see that the disability coverage
fills a similar need. We remind you again that, since the odds of disability are greater than the
odds of death occurring in the near future, there may be a greater need for key person
disability insurance. Business owners are likely to overlook this type of insurance. S so you
can provide a significant service by discussing this need.

Who Is a Key Person

Identifying key people in a business is one of the primary obstacles to successful sales,
especially when you are considering non-owners. In most cases, those who own the business

                                               91
are key people, but the decision becomes more difficult in identifying others who fit the
description. Generally, a key person is one whose ongoing contribution is critical to the
financial health of the business. The loss of that person's services must have a significant
economic consequence to the business in order for this coverage to be written. You should
look for characteristics such as unique skills, business contacts, technical knowledge or other
contributions that could not readily be replaced by someone else.

Let's contrast someone who does not fit the profile of a key person with someone who does.
For example, it is too simplistic to assume that a highly paid employee is a key person for
insurance purposes, especially when that person is employed by a large business. Such a
person may, indeed, be a highly paid and highly respected executive of a large business, but
if the business employs others who could step in immediately to assume that person's
responsibilities, negative economic consequences would be nonexistent or minimal at worst.
This person, then, is not a candidate for key person disability insurance. On the other hand, a
similar individual employed by a small to medium-sized business that doesn't employ anyone
else with the same talents is likely to be a key person for insurance purposes. Some insurers,
in fact, do not write key person insurance for large companies, but only for smaller
businesses.
                                           Figure 5-5
                                Key Peson Disability Insurance




Key person disability coverage is a relatively new insurance concept and insurers are still
experiencing some underwriting difficulties because of the ambiguities involved in
identifying key people. Furthermore, someone who is, 'key" today might not be as important
to the business tomorrow. For example, key person insurance might be written to cover the
disability of a small business's sales manager. As time passes, the sales force grows and the
sales operation is no longer so dependent on the sales manager's activities. While this person
remains valuable to the business, others could take over the sales responsibilities in the event
of disability. Insurers are naturally reluctant to pay claims for a person whose disability no

                                              92
longer has a significant financial impact on the business. Additionally, the business owners
now have less incentive to encourage the formerly key person to return to work. These are
some of the problems associated with key person disability insurance that insurers continue
to address in order to develop acceptable policies.

Common Features

Elimination periods of 30, 60 and 90 days are typically available for key person insurance.
When the elimination period passes. the policy pays month]y benefits directly to the
business. The "own occupation" definition of total disability you learned earlier is the
trigger for benefit payments after the elimination period ends.

Because key person insurance is considered a short-term coverage, the benefit period is
short six, 12 and 18 months are the terms commonly offered. The policy is written with the
assumption the individual will recover and return to work or will be replaced.

Key person disability coverage generally includes a waiver of premium provision, effective
after 90 days of disability. Policies are guaranteed renewable to the insureds age 65 as long
as the key person continues to be employed full time by the business that purchases the
policy.

Benefits

Another key person disability underwriting uncertainty is the amount of the monthly benefit.
Unlike a policy that replaces a wage earner's income, this coverage is intended to help
replace dollars representing the individual's value to the business-a nebulous figure and one
that exceeds the salary paid to the key person.

Different insurers are likely to have different methods for determining the coverage, but a
common measure is twice the individual's monthly salary. A policy covering the disability of
a key person earning $4,000 monthly could be written, then, to provide the business with an
$8,000 monthly benefit. Part of the benefit could be used, if the business desires, to replace
the key person's income if he or she does not have a personal DI policy and if the business
wants to pay the salary during disability in order to retain the employee. The remainder of the
benefit can then be used for other expenses associated with the person's absence. A
maximum monthly benefit is also stipulated.

Another way to write the benefit is to have two policies paid for by the business. One is the
key person insurance payable to the business and the other is a personal DI policy for the key
person's personal use, with these benefits paid separately and directly to the key person by the
insurer.


                                              93
     Personnel Replacement Rider

     Although the key person disability policy benefits may be used to defray the costs of
     replacing a disabled person either temporarily or permanently, some companies also offer a
     separate rider for this purpose. The personnel replacement rider is designed to cover costs
     incurred for permanent replacement of a disabled employee. Typical covered expenses
     include:

            *Employment agency or search firm fees.
            *Advertising in newspapers and periodicals.
            *Travel, food and lodging expenses associated with interviewing.
            *Moving expenses for the replacement person.
            *Up to three months' salary for the replacement person.

     The amount of insurance available ranges widely from insurer to insurer, from as little as
     $1,000 to as much as $50,000, paid in a lump sum. However, the rider pays on a
     reimbursement basis, which means the insurer pays the lesser of actual expenses or the
     maximum benefit. The business must prove that the expenses were actually incurred.

     The rider applies only after the key person has been disabled for a specified period, such as
     six months. Following that period, the business must incur replacement expenses within one
     additional year, Figure 5-6 provides an example of how the rider works, assuming a $10,000
     maximum benefit.

     Check with the insurers you represent to determine who offers this rider and on what basis.

                                            Figure 5-6
                                    Personnel Replacement Rider
                                    ($10,000 Benefit Illustrated)




                                                  94




77
Executive Bonus DI Insurance

The key person insurance we just discussed is written to benefit the business, not the
individual. Businesses may also purchase coverage that pays income directly to certain
employees. This coverage is commonly called executive bonus disability income
insurance, and is provided separately from any group disability coverage (covered in the
next chapter). As you'll see, group coverage must benefit nearly all employees of a business
and meet stringent nondiscrimination guidelines. Executive bonus DI, on the other hand, is
not subject to those rules and can be used as a reward or bonus for selected employees. You
may be familiar with executive bonus plans built around life insurance. The principles are the
same for executive bonus disability income insurance

Section 162 Plans

Any type of executive bonus plan may be called a Section 162 plan, referring to the particular
part of the Internal Revenue Code that allows businesses to take tax deductions for such
bonuses and other expenses. Section 162 requires the expenses to be “reasonable,” without
defining the term. What constitutes a reasonable amount is largely a matter of common sense
and the particular situation. For example, a $20,000 bonus paid to an employee earning
$15,000 annually would probably not be considered reasonable and might raise a red flag for
the Internal Revenue Service. On the other hand, a bonus equal to 10% of an individual's
income probably is reasonable.

Bonus dollars that fall under this section can be used to purchase life or disability income
insurance policies for executives a business wants to single out for a reward. Because Section
162 plans need not meet the stiff regulations associated with other employee benefits, the
business may selectively choose who will be rewarded by such a plan.

Premium Payment and Taxes

Although we'll discuss taxes more fully later, it's appropriate to address them briefly here so
you can see why it is important to set up an executive bonus plan in a certain manner. If the
business itself pays the premiums for executive bonus DI insurance, any disability income
benefits the insured receives are fully taxable to the insured. On the other hand, if the
executive/insured pays the premiums, benefits are not taxable as current income.

Therefore, an executive bonus plan typically operates like this: The business pays the bonus
to the executive, who then uses the bonus monies to purchase an individual DI policy. The
business is able to take a tax deduction under Section 162 for the amount of the bonus. The
executive must pay current taxes on the bonus, but paying taxes while working is generally
preferable to paying taxes while disabled and living on reduced income-which would be
required if the employer paid the premium for the insured. Figure 5-7 (on page 96) illustrates
this most advantageous way to set up an executive bonus DI plan.
                                             95
Other Advantages

When the executive bonus DI insurance is established as described above, the DI policy is
Jjst like any other individual DI policy for which the executive would otherwise be eligible.
Benefits, elimination and benefit periods, and other provisions are the same. The only real
difference from the insureds point of view is that the insured does not have to pay the
premiums out of pocket: the yearly bonus from the business pays the premiums.

Because the policy belongs to the executive, not to the business, the policy does not
terminate if the individual leaves that particular employer (which is what happens with group
DI insurance). If the executive leaves the job, of course, he or she must then pay the
insurance premiums to keep the policy in force. However, this is a small trade-off against the
possibility of either being completely uninsurable or being required to pay higher premiums
because of advancing age.

Salary Continuation

Another way for a business to selectively provide short-term income for disabled employees
is through a formal salary continuation plan, sometimes called a sick pay plan, funded with
disability income

                                        Figure 5-7
                               Executive Bonus DI Insurance




                                             96
policies. Under Section 105 of the Internal Revenue Code, employers may establish such
plans and take a tax deduction for contributions made on behalf of their employees. Section
105 also allows for plans to address an employee's death or retirement needs, using life
insurance for funding.

A salary continuation plan allows an employer to continue paying the regular wages of an
insured who is temporarily off work because of an accident or illness. Many employers want
to offer this benefit to their valued employees and often try to continue paying salaries from
operating income. However, using current income for this purpose can place a financial
strain on the business, so most companies could not continue paying salaries for long
periods.

A funding mechanism, such as a DI policy, solves the problem of salary continuation
expenses. Furthermore, a formal, written plan is necessary for the employer to meet Section
105 regulations and deduct the cost as a business expense. Many businesses are not aware
that the plan must be formalized to qualify for Section 105 tax breaks, so you can offer this
knowledge as part of selling the concept. Because these plans are not subject to employee
nondiscrimination rules, employers may offer benefits somewhat selectively. For example,
the plan can provide different benefits at different income levels and based on years of
service with the employer. Here's an example:

                                                       Benefit Period
       Weekly          Maximum                        Years Employed
       Income          Weekly Benefit          Under 5 Years       5 Years & Up

       Up to $575      100% of Income              14 days             Up to 2 years

       Over $575       100% of Income
                       up to $1,500               14 days              Up to 5 years

Under this arrangement, all employees can receive salary continuation funds for 14 days.
Employees who have been with the business five years or more receive benefits even longer,
depending on their salary level. The differentials also allow the employer to reward certain
long-term employees whose income levels demonstrate their value to the company. This
selectivity is not permitted under a group DI plan, so salary continuation gives the employer
more latitude to reward specific employees.

Salary continuation plans can be considered supplemental to group DI plans, which generally
specify a maximum monthly benefit payable regardless of actual income and percentage
guidelines. While this maximum is often adequate for lower and middle-income earners, the
cap may be inadequate for highly compensated employees. For example, if the maximum is

                                             97
$5,000 monthly, but an executive is earning $8,000 per month, this individual is penalized by
the group policy's maximum. Salary continuation plans funded by DI insurance can be paid
in addition to the group plan benefits and provide a benefit that is more closely related to
actual income.

Paying the Premiums

As was true of executive bonus plans, if the employer pays the premiums, employees must
pay current income taxes on any benefits received from a salary continuation plan. Still, this
is preferable to receiving no income replacement at all. On the other hand, salary
continuation plans may be set up so the employee pays all or part of the premium. If the
employee pays the entire premium, all salary continuation benefits are received tax-free.

If the employee pays part of the premium, benefits attributable to the employee contribution
are received tax-free and those attributable to the employer's contribution are taxed. For
example, suppose the employer and the employee each pay 50% of the premium. The
employee receives salary continuation benefits totaling $3,000 and pays current income taxes
on only $1,500.

Plan Features

The disability income insurance used to fund salary continuation plans is written as an
individual DI policy for each person covered. This means the benefits are probably more
liberal than any group DI plan since group plans are generally more restrictive. Under the
salary continuation plan, the definition of disability, the elimination and benefit periods,
benefit amounts and other provisions are determined under the same guidelines as other
individual policies.

However, the cost is less because the premium is discounted if the plan covers many
employees. The employer is responsible for paying the premiums directly to the insurer even
if the employee contributes to premium payment. The insurer saves administrative expense
by using a “list billing” to bill for a single premium. The list shows each employee covered
under the plan and the individual premium for each employee, along with a single total
premium the employer pays on behalf of the employees.

A salary continuation plan funded with DI policies results in individual policies that
employees take along when employment is terminated. However, the premium will be
greater since the multiple-employee discounting is no longer available to that individual.
Again, this is a trade-off against being unable to purchase any DI insurance because of
deteriorating health or advanced age.

Employers sometimes think of salary continuation apart from disability income insurance

                                             98
because such plans may be funded by any means the employer chooses. As an agent, you are
in a position to point out that when the time comes, the money from other sources simply
might not be available and the employer would be unable to pay salaries while employees are
not working. With DI insurance, however, the funds are guaranteed to be available when
needed.

Business Disability Coverages and the Agent

Throughout this chapter we have presented a number of scenarios that demonstrate why and
how businesses and their employees benefit from various disability insurance coverages. But
what about you, the agent? Why should you pursue this market?

First of all, it can be a lucrative source of insurance business. Some of the policy types we've
discussed involve dollar amounts that translate to significant income for you. In addition,
when you've convinced your prospects of certain needs, others follow almost automatically.
For example, the business overhead expense policy is a short-term solution for a disabled
business owner; the disability insurance funded buyout is a natural next purchase.

Second, fewer individual disability income policies are being sold today for two major
reasons. The first is the glut of social insurance disability income benefits that has eliminated
a large market segment that formerly represented a pool of prospects. The second is the
growing number of group disability income plans employers’ make available to all of their
employees. While group plans are subject to termination because of employee turnover,
you'll find many people objecting to the individual policy on this basis and It can be a
difficult objection to overcome. Rather than fight it, you can join it by becoming active in the
group market yourself; the next chapter gets you started. And you can use the business
coverages discussed here as an entree to the group DI market-or vice versa. Whichever
approach you take, small and medium-sized businesses offer a staggering number of
opportunities for you in the disability insurance field.




Chapter 5 Review Questions

1.      A certain individual disability income policy pays a $20,000 monthly benefit. This
        insurance is (a BOE policy/professional DI coverage/key person insurance).




                                               99
2.   Which of the following is an expense that is typically not reimbursable under a
     business overhead expense policy?

     a.   Utilities such as electricity, gas, water.
     b.   Salary for a person temporarily replacing the disabled insured.
     c.   Rent for the business property.
     d.   Employee salaries.



3.   An insureds BOE policy has a maximum monthly benefit of $6,000. During the first
     month after the elimination period, covered expenses total $6,200. Since this is a
     reimbursement policy, you know the policy will pay ($6,000/$6,200) for this month's
     expenses.



4.   A certain BOE policy pays a partial benefit tied to the relationship of the insureds
     post disability earnings to pre-disability earnings. Under this particular arrangement,
     the benefit is not a true residual benefit, but a certain amount is paid if the insureds
     earnings are 50% or less than before the disability occurred. Assuming this is the case
     and the insureds policy pays a maximum monthly benefit of $4,000, what is the
     amount of the benefit she will receive for partial disability? ($4,000/$2,000/the same
     percentage as the percentage of lost income)



5.   The claims-made malpractice liability rider attached to a BQE policy pays the
     premium for which of these during the insureds disability?

     a.   The claims-made policy.
     b.   The extended reporting period endorsement for the claims-made policy
     c.   Both of the above.
     d.   The policy only, the endorsement only, or both. depending on the insureds
          wishes.



6.   The benefit from a disability buyout policy is paid in what form? (A lump
     sum/Monthly benefits/either of the preceding depending on the insurer)



                                          100
7.    Max Wilson's disability buyout policy agrees to pay the full maximum benefit
      stipulated in the policy if a buyout is triggered. Which statement is correct?

      a.   Wilson's policy is an indemnity policy.
      b.   Wilson's policy is a reimbursement policy.
      c.   Not enough information is provided to determine which type of policy this is.



8.    Assuming the person insured under a disability buyout policy is disabled as defined
      in the policy, what triggers the buyout?

      a.   When the insured has been disabled for six continuous months, the buyout is
           riggered.
      b.   The buyout is triggered by the first day of total disability, but completing the
           buyout is delayed by six months to be certain the insured will not return to
           work.
      c.   Completion of the stipulated elimination period triggers the buyout.
      d.   The buyout is triggered by the execution of the buy-sell agreement at the
           request of the other non-disabled owner or owners.



9.    An insured is disabled for five months. returns to work for one month, then suffers a
      recurrent disability. Under a disability buyout policy with a 12-month elimination
      period, which statement is true?

      a.   A new 12-month elimination period begins.
      b.   The portion of the elimination period already fulfilled is taken into
           consideration, so only seven months remain in the elimination period.
      c.   The elimination period is waived, so the buyout will be triggered immediately
           if and when the insureds disability is diagnosed as permanent.



10.   The benefit from a key person disability policy is paid to (the business/the
      insured/both the business and the insured).




                                          101
11.   A common method for determining the monthly benefit for a key person disability
      policy is which of these?

      a.   Establish a benefit equal to the key person's monthly income.
      b.   Establish a benefit equal to one-half the key person's monthly income.
      c.   Establish a benefit equal to twice the key person's monthly Income.
      d.   Establish a benefit equal to the key person's monthly income plus expenses that
           would be offset by that person's earnings if he or she were actively at work.



12.   A personnel replacement rider attached to a key person disability policy pays
      expenses to replace the disabled key person on what basis?
      (indemnity/reimbursement/either indemnity or reimbursement at the insurer's option)




13.   Which of these plans may be established on a selective basis, rather than covering
      every employee in a business?

      a.   Executive bonus Dl plans.
      b.   Salary continuation plans funded by DI insurance.
      c.   Both of the above.
      d.   Neither of the above.




14.   When an insured employee leaves the employment, which of these plans would
      terminate at the same time? (executive bonus DI insurance/salary continuation
      funded by DI insurance/both plans/neither plan)



15.   When is income taxable to the disabled insured under a salary continuation plan
      funded by disability insurance? (always/never/when the insured pays the
      premiums/when the business pays the premiums)




                                         102
Answers
1.     professional DI coverage – the amount and the fact that this is an individual policy are the clues to
       these answers.
2.     b is correct
3.     $6,000 – the maximum; but the additional $200 may be paid during a month when expenses are lower
       or would be paid immediately if the insurer allows an elimination period “credit”
4.     $4,000 – this is the method that pays the entire benefit if the insured earns no more that 50% of pre-
       disability earnings
5.     b is correct
6.     either of the preceding depending on the insurer
7.     a is correct
8.     c is correct
9.     b is correct
10.    the business
11.    c is correct
12.    reimbursement
13.    c is correct
14.    neither plan – both are written as individual DI policies that continue as long as the insured pays the
       premiums
15.    when the business pays the premiums




                                                    103
                       Chapter Six
             Group Disability Income Insurance
A Review of Group Insurance Principles

Before we discuss the specific details of group disability income insurance, let's briefly
review the basic principles of group insurance coverages. In general, group insurance refers
to various insurance products available to those who collectively belong to a definable group,
as opposed to individually purchased insurance policies. The most common type of group
associated with group insurance is employment related. Employers frequently offer insurance
to their employees as a way to attract and retain high quality people.

Although group insurance includes life and health coverages, this chapter addresses only
group disability income insurance, which is a member of the health insurance family. While
many benefits are the same as those found in individual DI policies, group DI insurance is
defined by several distinctive features discussed in this chapter.

Eligible Groups

Exactly what constitutes an eligible group for group insurance purposes is regulated by law
since certain tax benefits accrue to group participants. Following is a short summary of the
common types of groups the law deems eligible for group insurance plans.

Single Employer Groups

A single employer group is probably the most familiar type. Under this arrangement, a single
employer makes group benefits available to its employees. Employers can be sole
proprietors, partnerships or corporations. Medium and larger sized companies provide the
primary market for single employer groups, which account for most existing group insurance
plans. They are also a lucrative source of new business for agents selling group insurance
plans.

Multiple Employer Trust

Groups composed of two or more small employers who join together to receive the same
group insurance consideration as larger employers are called multiple employer trusts or
METs. Without METs, many small employee groups would be ineligible for group benefits
since a group must have a minimum number of people-usually 10-to qualify. A separate trust
is formed to handle the group business, from collecting and paying premiums to filing
claims. Insurance companies and non-insurance organizations sponsor and administer METs.


                                             104
Organized Unions

Organized unions are groups comprised of workers in related fields, such as the
Communications Workers of America, the United Auto Workers and any other organized
labor or workers' union. Federal law requires a trust to be established to collect funds and
otherwise administer employee benefits for unions.

Associations and Miscellaneous Groups

Associations and other miscellaneous groups encompass nearly any other type of group for
whom insurance benefits are made available on a group basis. Types of eligible groups in this
classification vary according to state law. Typical examples are professional associations
such as the American Bar Association and the American Medical Association, associations
made up of people who are members of automobile clubs, fraternities, sororities, and just
about any other group with a common relationship that is recognized by state law.

Creditor-Debtor Groups

Creditor-debtor group insurance is offered by a lender to people who borrow money. The
purpose of credit DI insurance is to protect the creditor to whom the policy's benefits are paid
if the debtor becomes disabled (or dies, in the case of credit life insurance) before the debt is
paid. Some credit coverages are provided as individual policies, rather than group policies.

What qualifies each of these entities for group insurance is the factor the members have in
common-their employer, their union or association, or their group status as debtors to a
particular financial institution. Some insurers also make group insurance available to those
whose common relationship is even more tenuous, such as people who hold a major credit
card through the same organization. Some of these less well defined groups are solicited for
group insurance through the mail or other direct advertising. Because people so solicited
essentially select themselves for coverage, rather than being qualified by an insurance agent
and underwriter, these groups tend to have a greater tendency toward adverse selection-a
preponderance of high-risk insureds who are most likely to have claims.

Group Underwriting

Naturally, insurers want to avoid adverse selection by balancing the number of high-risk
insureds with low risk insureds. This is the essence of group underwriting. Most types of
group insurance have this balance built in since there is a large pool of people of varying ages
and health conditions who come and go and are being replaced in the group with some
regularity. Group plans require the participation of a high percentage of eligible people to
ensure that the plan is not composed primarily of those who are likely to have claims.
Additionally, group members must sign up for insurance coverage very soon after they

                                              105
become eligible-usually within 30 or 31 days. This prevents those who do not purchase the
coverage initially from changing their minds when they are injured or ill and want to use the
plan's benefits-another feature of group underwriting that helps avoid adverse selection.

Of the eligible groups, METs are scrutinized more carefully than others because each "sub-
group" is small, whereas group insurance underwriting principles depend on larger numbers.
The MET sponsor decides what requirements the smaller groups must meet in order to be
accepted into the group. When enough sub-groups are included in the MET to form a large
group, underwriting and resulting rates are essentially identical to those of larger groups.

Advantages of Group Coverage

The characteristics of group insurance we've described help insurers avoid adverse selection,
but the same characteristics are also the foundation for the advantages group coverage offers
the group members. One advantage is that people who sign up within the specified time are
not normally subject to medical examinations that could uncover an uninsurable condition.
Therefore, essentially everyone in the group may have coverage regardless of their current
physical conditions. That's the general rule: there are exceptions.

Some insurers routinely require individual medical exams and underwriting for the very
smallest groups only, while members of larger groups need not meet this requirement. This is
typical. but there are exceptions, so it is important to know exactly how a particular insurer
writes group coverage. Some insurers require new group members to complete an application
and answer medical questions, but not to have physical examinations.

However, a more recent trend among insurers is to require more medical exams and financial
information about individual group members. These stricter requirements have arisen from
the more liberal benefits appearing in many group DI plans-benefits similar to those provided
in high quality individual DI policies that offer greater monthly benefits and fewer
restrictions. You'll learn more about how insurers underwrite DI policies in Chapter Eight.

As long as individuals remain with the group, they have some measure of security that the
coverage will remain in place. Group plans may be canceled only if the insurer cancels the
entire group: no person's group coverage may be canceled individually because of poor
claims experience. While it's possible for a particular group's experience to be so adverse an
insurer might choose to cancel the entire group, this is a fairly rare event. And finally,
members of the group benefit from insurance rates that are lower than individual rates. The
lower cost is possible because the insurer's risk is spread among so many people, most of
whom will never have a claim. As a result, premiums from the entire group help offset the
disability claims that do occur.



                                             106
Group DI Compared to Individual DI

How does group DI coverage compare to individual policies? Some of the primary
differences and similarities are presented in this section, then expanded later under the
descriptions of short-term and long-term DI coverage. While direct comparisons are difficult
because of wide variations in benefits and other provisions among both types of coverage,
this section highlights typical differences.

Employee Benefit Regulations

Like all employer-sponsored group benefits, group DI is subject to both state and federal
regulation. Laws governing employee benefits address issues such as nondiscrimination.
employees' rights and privileges, dependents' rights and privileges, to name just a few. The
details of employee benefit plan regulation are beyond the scope of this course. If you plan to
work this market and you are unfamiliar with the area, we encourage further study outside
this course.

Eligibility

Employees must meet eligibility requirements for group DI coverage just as they do for other
group benefits and the details may vary somewhat among employers and among particular
group plans. A basic requirement for group DI is full-time employment, which is usually
defined as 30 or more hours per week.

Workers must be continuously employed for a probationary or waiting period before
becoming eligible for the plan. A 90-day period is most common. When that period expires,
employees who are still actively employed full time may sign up for the coverage during the
enrollment period, which typically extends for 30 or 31 days.

You'll recall that little or no medical or financial underwriting is usually required when
eligible employees enroll promptly, unlike individual DI coverages that always require
medical and financial information. Employees who fail to enroll during this period may still
be eligible for the coverage at a later date, but generally would be required to undergo a
medical exam at that time and take the chance of being rejected for coverage based on the
results of the exam.

Policies and Premiums

Like all group insurance plans, group DI is written with the employer or other sponsor as the
master policyowner. The employer holds a master policy and each enrolled individual
receives a certificate of insurance detailing his or her particular coverage. While these plans
must be nondiscriminatory, the certificates differ somewhat because of salary levels. For

                                             107
example, a maximum monthly dollar benefit must be specified in the certificate and that
maximum will often be quite different for clerical workers than for highly-paid executives.
Because of group underwriting principles, premiums for group DI are typically less than for a
comparable individual policy. However, because of the wide variations in benefits, direct
comparisons are not easy to make. Employers may pay all or part of the premiums for
employees, but tax rules make it more advantageous for employees to pay their own
premiums. Remember that DI benefit payments are not taxable income to disabled employees
who paid the premiums themselves. Conversely, any part of the benefit attributable to
employer premium contributions is taxed as current income.

Many employers today pay the premiums for short-term disability (STD) benefits (often
through salary continuation plans funded by DI insurance) and require employee
contributions for long-term disability (LTD). STD benefits are generally defined as those
extending up to 52 weeks (although 13 and 26 weeks are more common) and LTD benefits
are those payable for longer than one year. It is also becoming more common to require
employees who want to participate to pay 100% of the premiums for LTD plans. When
employee contributions are mandatory, the employer must provide a way to collect the
premiums and pay the insurance company, usually by payroll deduction.

Provisions for STD and LTD

When a group plan provides both short-term and long-term disability benefits, different
provisions may apply to each. For example, the elimination period for STD benefits might be
as short as seven or 14 days, compared to the typical 90-day elimination period for LTD. If
the employee becomes eligible for STD benefits and later for LTD benefits, these must be
carefully coordinated to avoid over insuring.

A dual definition of total disability is common in-group DI policies. For both STD and LTD
benefits, the "own occupation" definition is typically used initially. Then, if disability
continues beyond a stipulated period, the disabled person must qualify under the "any
occupation" definition.

Other Group Provisions

Group DI policies usually cover only nonoccupational injury or sickness, specifically stating
that benefits provided by workers compensation or similar disability plans will not be
duplicated or replaced by the group policy.

The pre-existing conditions provision in-group DI policies is sometimes more restrictive
than its counterpart in individual policies, largely due to the absence of medical underwriting.
However, sometimes the pre-existing conditions provision must be eliminated from a group
DI plan when the plan replaces an existing one under which an employee had already

                                             108
satisfied the pre-existing condition requirements. For example, suppose the existing plan did
not pay for a pre-existing condition until after the employee had been in the plan for 12
months. Employee Baxter has met that 12-month requirement under the existing plan for
herniated disk. Now Baxter's employer drops the plan and installs a new plan with another
insurer. The new insurer is prohibited from imposing another pre-existing condition
restriction on Baxter for the disk problem. Whether or not this restriction applies may depend
on state regulations and/or the insurers involved.

We have discussed a number of desirable benefits and optional riders that are often available
with individual DI policies. Many such benefits and rider options are not available for group
DI policies.

One of the most significant differences between group and individual policies is that most
group DI coverage may be canceled for the entire group at the insurer's option. The insurance
company also may raise premiums for the entire group. You've learned that individual
policies, on the other hand, are often noncancelable and for the best classes of risks,
premiums remain level throughout the policy term. Now we will look in more depth at group
STD and LTD plans.


Short-Term Disability (STD) Plans

In the previous chapter, we discussed salary continuation or sick pay plans that provide
short-term disability (STD) benefits for employees. You learned that one way to fund such
plans is with disability income policies. Another market for STD policies exists in some of
the five states that require employers to provide short-term temporary benefits for
nonoccupational disability. If you plan to do business in any of these States-California,
Hawaii, New Jersey, New York and Rhode Island-you must determine whether a commercial
DI plan may be used. Some states require a state-operated plan to provide these benefits
while others allow employers to use commercial policies.

Another name for STD benefits that you will encounter in some jurisdictions is weekly
indemnity insurance. In some locales, the term used for STD benefits is accident and
sickness insurance. This can be misleading since the accident and sickness terminology more
often refers to medical expense insurance.

Probationary Period

For group STD policies, the probationary period following employment and during which the
employee establishes eligibility extends for three months or less. A few STD plans eliminate
the probationary period completely, but these are rare. On the eligibility date, the employee
must be actively at work in order to enroll in the plan.

                                             109
Elimination and Benefit Periods

STD policies have a very short elimination period for sickness-either seven or 14 days. There
is usually no elimination period for accidents, so benefits begin on the first day of disability.
By definition, STD benefit periods are short, generally six months or less. Some STD
policies pay for as long as 52 weeks, but overall, periods of 13 and 26 weeks are the most
common. Some insurers identify their short-term disability plans by numbers that describe
the elimination periods for accidents and for sickness as well as the benefit period. For
example, an STD plan referred to as a "1-8-13" plan is one that pays accident benefits
beginning on the first day of disability, sickness benefits beginning on the eighth day of
disability and, in both cases, for a 13-week benefit period.

Figure 6-1 illustrates how the probationary, elimination and benefit periods might apply. In
this example, the probationary period is three months, there is no elimination period for
disability from accidental injury and the benefit period is 13 weeks.

STD Benefits

The actual amount of the STD benefit is based on weekly income, rather than monthly
income and there is wide variation in the percentage of income paid for the short term. While
662/3% is common, the range is from 50% to 70% and even 100% in some cases. Following
are several ways STD benefits are handled.

Some employers provide a STD policy that pays a certain percentage of the employee's gross
weekly earnings and the employer bears the balance, so the employee actually receives 100%
of earnings in the form of salary continuation or sick pay benefits. For example, let's say the
STD policy pays 60% and the employer pays the 40% balance. A certain employee earns
$700 per week. Here's how the plan works:


        STD Policy:                     $700 x .60 = $420 per week
        Employer:                       $700 x .40 = $280 per week
        Employee receives:                           $700 per week

You'll recall that disability income policies typically pay less than 100% of earnings.
However, when salary continuation or sick pay benefits are funded by a short-term disability
income policy, full income may be paid either through the STD policy itself or through a
combination of the employer's direct contribution plus a percentage of income provided by
the disability policy as illustrated above.

Some STD plans provide two different percentages of earnings, depending on the income
level. For example, a higher percentage, perhaps 70%, might apply to weekly earnings up to
$999 and a lower
                                            110
                                        Figure 6-1
                                      STD Application




percentage, 50% perhaps, to weekly earnings of $1,000 and over. Then, a maximum weekly
benefit is likely to apply to all levels, such as $1,000 per week regardless of actual income.
Here's an example:

       Weekly                          STD            Weekly
       Earning                                        Benefit
       $3,000                          50%            $1,000
       $1,200                          50%            $ 600
       $ 500                           70%            $ 350

In the first example, notice that although a 50% benefit would equal $1,500, the $1,000
weekly maximum applies. Usually, the policy also stipulates a minimum weekly benefit of
perhaps $100.

Still another method for paying STD benefits is to pay 100% of weekly earnings for a certain
period-four to six weeks are common-followed by 70% or some other percentage for the
duration of the STD benefit period. Here's a comparison of the total STD benefits paid under
this arrangement versus two other, lower percentages paid uniformly for the same period.
We're assuming weekly earnings of $500, 12 weeks of benefits with 100% of wages paid for
six weeks in the first example.

       $500 @ 100% = $500 x 6 weeks =                    $3,000
       $500 @ 70% = $350 x 6 weeks =                     $2,100
                        Total Benefits =                 $5,100

       $500 @       70% = $350 x 12 weeks =              $4,200
       $500 @       66% = $333.50 x 12 weeks =           $4,002

These are some of the more common ways percentages of earnings and duration of benefits
may be applied. You will want to determine the details of the STD plans you sell.

                                             111
Definition of Disability

Most STD policies use the liberal "own occupation" definition of total disability to trigger
benefit payments. This means the insured is unable to perform the substantial and material
duties of his or her own occupation. A few STD policies still include the more restrictive
definition, requiring the inability to work in any gainful occupation, but these policies are
rare.

The federal Pregnancy Disability Act requires businesses that offer disability plans to
employees to treat pregnancy and childbirth as a sickness under disability income policies,
triggering benefits on the same terms as any other sickness. A few states have even more
stringent laws concerning pregnancy disability benefits, so you will want to be familiar with
the exact requirements where you do business.

STD and Major Medical Plans

Today, some employers are including STD benefits as a standard part of employee health
plans, right along with major medical expense coverages. Other employers offer STD
coverage separately as an option the employee may choose or not. In whatever form, many
employers offer STD benefits at every income and occupational level within their companies.
As you will see in the next section, long-term disability benefits may be offered differently.

Long-Term Disability (LTD) Plans

After the short-term disability benefit period ends, many group plans provide long-term
disability benefits when the employee is still disabled. However, LTD benefits, unlike STD,
are sometimes made available only to higher-income, usually salaried, personnel rather than
to both salaried and hourly employees. For example, the LTD plan might be available only
for employees earning $30,000 or more annually. There are two reasons for this. First, lower-
income earners are often covered adequately by social insurance programs. Second, because
insurance company experience shows that lower-income and hourly employees as a group
incur greater claim costs, the risk is less desirable from the insurer's point of view.

Probationary Period

Different LTD and STD plans might have probationary periods as short as three months
before the employee is eligible to enroll. On the other hand, some LTD group policies require
an employee to be continuously employed for as long as one year before becoming eligible.

Some LTD plans also require the employee to be actively at work for a specified period-30
days, typically-without illness or injury in order to enroll. For example, suppose the three-
month required probationary period has passed for a certain employee, but the employee has

                                             112
been ill for the final four days of the last month of the probationary period. This person
would be ineligible to enroll until 30 more days have passed during which the individual was
at work full time, with no intervening illness.

Elimination Period

Insurance companies offer a wide range of elimination periods for group LTD plans, from
as few as seven days to as long as one year. In between, 30, 90 and 180-day periods are
generally available, with the 180-day, or six-month, period most common. Unlike STD plans,
LTD plans do not usually specify different elimination periods for injury and sickness. Many
employers offer STD benefits or salary continuation for the full span of the LTD elimination
period. For example, if the LTD elimination period is 90 days, the employer has a salary
continuation plan that allows the employee to receive full salary for the first 90 days of
disability before LTD benefits become available.

Figure 6-2 (on page 114) combines several of the features we've been discussing. Refer to
this figure as you read the paragraphs following.

In this application, the probationary period extends for 90 days after a new employee begins
work, but because this employee was sick and off work during the last several days of the
probationary period, he is not eligible to enroll until 30 more days of continuous
employment. When this requirement is fulfilled, he enrolls and is eligible for LTD benefits.
The employee works for some indefinite time, then suffers an accidental injury that leaves
him disabled. His group LTD plan has a 90-day elimination period, but the employer
provides salary continuation through a STD policy that has no elimination period for
disability from accidents. At the end of the 90-day elimination period, the STD benefits stop
and, since the individual is still disabled, LTD benefits begin.

This is just one way STD or salary continuation benefits and long-term disability benefits
might be combined to provide significant income replacement under a group disability plan.
As usual, you must be fully aware of the types and duration of benefits available from the
insurers you represent in order to offer options that will meet the needs and desires of
different group sponsors.

Benefit Period

By definition, the benefit periods for LTD are longer as compared to short-term disability
plans, but some LTD plans pay benefits for no more than two or five years. Of the longer
periods available, two of the most popular are benefits paid to age 65 and lifetime benefits.

Lifetime Restrictions

When a long-term disability plan pays benefits for a lifetime, insurers usually impose
                                          113
additional restrictions. Some policies stipulate an upper age before which the coverage must
be purchased. As an example, if an individual is covered by the LTD plan before age 45, the
lifetime benefit period applies. For those age 45 and older when the plan becomes effective,
the benefit period is restricted to age 65.

Other LTD plans specify an age before which disability must begin in order for lifetime
benefits to be paid. For example, a person age 50 or younger when disability begins receives
lifetime benefits, while a disability that begins at a person 5 age 51 or older pays benefits
only to age 65.
                                          Figure 6-2
                   Application of Salary Continuation and LTD Benefits




Age Discrimination in Employment Act

While insurers and employers may place some restrictions on lifetime benefits, they also
must consider the requirements of the Age Discrimination in Employment Act. Under this
law, the upper age limits must be adjusted in some cases. The general requirements include:

       *Extending benefits to age 70 when disability occurs before that age.

       *Paying benefits for disability that occurs after age 70, tempered by a shorter
        benefit period than if disability had occurred earlier.

As an example of how the shorter benefit period might apply, the plan could be written in
such a way that any disability occurring at age 70 or earlier calls for a benefit period of 18
months. However, if the individual is age 71 or greater, the benefit period is shortened to 12
months.

Benefit Amount

The monthly benefits paid under group LTD policies are determined in various ways, with

                                             114
a percentage of gross earnings being the most typical method. While options range from 50%
to 70%, 60% or 66 % are common. An upper limit generally applies to the amount of
monthly benefits available-such as $6,000 or $8,000 per month. In other words, the benefit
paid is the lesser of the dollar maximum or the specified percentage of earnings. Different
maximums apply at different income levels in order to retain the incentive to return to work
and avoid overinsuring. As is true for STD policies, different percentages maybe used at
different income levels: higher percentages for lower incomes, lower percentages for higher
incomes. Similarly, LTD plans specify monthly minimum benefit amounts as well.

Some plans use different percentages for the same individual's income, paying a higher
percentage for income up to a certain dollar amount and a lower percentage for all income
that exceeds that amount. Suppose Rosanne O'Malley earns $7,000 per month. The LTD plan
her employer provides pays 66 % of earnings up to $5,000 and 40% of amounts from $5,001
up. O'Malley's monthly benefit is determined like this:

                       $5,000 x .667 = $3,335
                       $2,000 x .40 = $ 800
                                       $4,135        Total Monthly Benefit

The actual percentages that apply when this split percentage arrangement is used vary from
insurer to insurer.

Rehabilitation Benefit

Because of the good experience insurers have had in providing payments for rehabilitative
services for disabled insureds, more and more group LTD plans today pay some form of
rehabilitation benefits as discussed in Chapter Three.

While the specific details vary from plan to plan, it is typical to as encourage a disabled
employee to return to work by paying a reduced benefit during a “trial” work period. Instead
of discontinuing benefits as soon as the employee returns to work, the insurer pays the
smaller benefit for a short period during which the employee determines whether he or she
will be able to be gainfully employed.

During the trial period, the employee receives both the reduced DI benefit and current
income. The amount of the rehabilitation benefit is generally determined by reducing the
total disability monthly benefit by a certain percentage of current earnings-usually from 50%
to 80%. Let’s say employee Trevor Brandt has been receiving a $2,000 per month disability
benefit. He returns to work part time for a trial period during which he earns $1,400 per
month. This particu1ar insurer pays a rehabilitation benefit that is the disability benefit
reduced by 70% of current income.


                                            115
       Current earnings of $1,400 x .70          =     $ 980

       Monthly total DI benefit                  =     $2,000
       Minus earnings reduction                  =       -980

       Rehabilitation benefit                    =     $1,020
       Plus current earnings                     =     $1,400

       Income during trial period                =     $2,420

Thus, the rehabilitation benefit allows the disabled employee to return to work gradually,
possibly improving the changes the individual will be able to return to full time gainful
employment. The reduced DI benefit supplements the income so the individual is not
discouraged from returning to work at a lower income than before the disability occurred
since current income and the rehabilitation benefit combined provide more income that the
total DI benefit alone.

After the trial period, the individual would norma1ly either return to work full time and DI
benefits would stop, or, if the trail employment indicates that the individual is unable to
continue working, the full DI benefits would be reinstated without requiring a new
elimination period.

Remember, too, that many insurers pay rehabilitation benefits in the form of payments for
vocational rehabilitation or medical rehabilitative services, whether or not such benefits are
specifically mentioned in the policy. Insurers recognize that helping disabled insureds in this
way can reduce the insurance company's outlay in the long run by making it possible for the
individual to become employable again, rather than continuing to receive DI benefits.

Residual Disability Benefit

Another partial benefit that goes hand in hand with rehabilitation is the residual disability
benefit discussed at length in Chapter Two. When residual disability is covered in a group
LTD plan, the insurer may agree that, if the individual's post-disability earnings are at least
20% less than pre-disability earnings, a proportionate residual benefit will be paid.

For example, suppose a disabled employee was receiving $2,000 in DI benefits each month.
He returns to work, but earns 30% less than his pre-disability earnings. The insurer pays a
residual benefit equal to 30% of $2,000 or $600 per month to this insured. A time limit is
placed on the period for which the residual benefit will be paid, often up to two years as long
as the post-disability earnings are reduced. Like the rehabilitation benefit, a residual benefit
encourages the insured to attempt to return to gainful employment.


                                             116
Some LTD policies call this a partial benefit rather than residual benefit, although it does not
operate like a true partial disability benefit. These partial or residual benefits are often found
in-group LTD plans for the best classes of risks-professionals and a few other high-income
earners.

Definition of Disability

Group LTD policies often use a dual definition of total disability. The "own occupation"
definition probably applies for a period ranging from one to five years, with 24 or 36 months
the most commonly used time. If the insured is still disabled after the stipulated period, the
"own occupation" definition Is then replaced with the "any occupation" definition. This
requires the insured to be unable to engage in any gainful employment for which he or she is
reasonably suited by training, education or experience.

Some group LTD policies include a presumptive disability benefit that is paid when the
insured suffers loss of limb or eyesight. The elimination period is typically waived for
presumptive disability and monthly benefits begin at once.

Benefit Coordination

Avery few group LTD policies provide coverage for both occupational and nonoccupational
injury and sickness, rather than just non-occupational disability. Even so, the benefits must
be coordinated with any other DI benefits from programs such as workers compensation.

Additionally, group LTD benefits will always be coordinated with any other potential or
existing DI benefits such as Social Security, state cash sickness temporary benefits or other
government-sponsored benefits. Other possibilities include any STD or sick pay plan the
employer provides, pension benefits that might be available earlier than retirement age
because of the disability, and any individual disability income policies the individual owns.

Survivor Benefits

Some group LTD policies pay survivor benefits when a disabled insured dies after having
received DI benefits from the policy. Typically, the survivor benefit is paid only if the
deceased received benefits for a certain length of time, such as six months. The LTD policy
specifies who are “survivors” for purposes of receiving the benefit. Survivors generally
include a spouse or children younger than age 25 or 21, depending on the policy. If the
deceased has no such survivors, the benefits are paid to the estate.

There are at least two different ways survivor benefits might be paid. Under some policies,
the survivors receive a reduced monthly benefit for a short period or up to as long as two
years. Other policies pay survivors a single lump sum equal to two or three times the monthly

                                              117
benefit the disabled person was receiving before death. Both of these methods are illustrated
in Figure 6-3.

                                       Figure 6-3
                            Payment of LTD Survivor Benefits




Exclusions in Group DI Plans

Exclusions most frequently written into group disability income plans include these:

       *Disability resulting from acts of war.
       *Disability resulting from participating in criminal activities.
       *Disability resulting from self-inflicted injury and/or attempted suicide.
       *Disability resulting from certain mental conditions and substance abuse, although
      these may be covered for limited periods.
       *Periods during which the individual is not under a physician's care.
       *Disability that began before the individual was covered under the group plan.
       *Employment of the insured in any gainful occupation.
       *Disability from pre-existing conditions as defined in the policy.

Remember, however, that pre-existing conditions for certain individuals must be covered
when a group plan replaces another group plan under which the requirements for pre-existing
conditions had already been met.

Opportunities in the Group Market

The group disability income insurance market is a large, potentially lucrative source of new
business for you. Although many businesses already have group health and life insurance
plans, fewer plans include group DI insurance. The less stringent underwriting and lower
individual cost that characterize group disability plans are just two features that make this


                                            118
coverage attractive to both employers and employees. The trade-offs in benefit restrictions as
compared to individual policies are often worth the difference in price and availability to
more people.

Because only a small percentage of people have individua1 disability income policies, group
DI coverage fulfills a genuine societal need. Group DI is the only income protection that
some people have, barring catastrophic disabilities that qualify them for government DI
benefits. And, people whose incomes fall in the lower range and who are therefore not good
candidates for individual policies are usually eligible for group DI.

Finally, group DI can be incorporated into an employer's benefit package at very little cost to
the employer since there are tax advantages to having premiums paid by the employees
themselves rather than by the employer. These are some of the advantages you are in a
position to promote with employers and other groups as you work in this market.




Chapter 6 Review Questions

1.     Which of the following are typical employee requirements for being included in a
       group disability income insurance plan with little or no medical underwriting?

       a.    Serving a probationary period, often 90 days.
       b.    Full-time employment, usually 30 or more hours per week.
       c.    Enrolling within a specified enrollment period, usually within 30 or 31 days
             after becoming eligible.
       d.    All of the above.



2.     When monthly benefits are paid to an employee under a group DI plan. the benefits
       are not taxed as current income when the premiums have been paid by (the
       employee/the employer/either the employee or the employer).



3.    The term "weekly indemnity insurance is sometimes used to refer to (short-term
      disability plans/long-term disability plans/both of the preceding).



                                             119
4.   Which of the following correctly describes a common way for the STD elimination
     period to apply?

     a.   No elimination period for sickness and seven or 14 days for accidents.
     b.   No elimination period for accidents and seven or 14 days for sickness.
     c.   Seven or 14-day elimination period for disability from any cause.
     d.   Thirteen or 26 weeks' elimination period for disability from any cause.



5.   While STD plans vary in the percentages of income actually paid to a disabled
     employee, STD plans are generally based on (weekly/monthly) income.



6.   At least at the beginning of a disability, both STD and LTD plans most frequently use
     what definition of total disability? (own occupation/any occupation)



7.   Under group LTD plans. the elimination periods for accidents and for sickness are
     usually (different/the same/seven days apart).



8.   When group LTD plans provide a lifetime benefit and a certain employee enrolls at
     age 50, the benefit period for this specific person might be (limited to age
     65/extended to age 70).



9.   Under its group LTD plan, a certain employer wants to pay a monthly benefit that is
     the total of 70% of employees' monthly earnings up to $4,000 and 60% of all
     earnings over $4,000. This arrangement is (illegal/legal for all employees/legal only
     for employees earning more than $5,000 per month).




                                         120
10.   A certain insurer agrees to pay a rehabilitation benefit under a group LTD plan for a
      disabled insured who is returning to work on a trial basis. This particular insurer
      determines the amount of the rehabilitation benefit by reducing the benefit for total
      disability by 80% of monthly earnings during the trial period. The monthly benefit for
      total disability is $3,000. The monthly earnings during the trial period equal $2,000.
      The amount of the rehabilitation benefit is ($600/$1,400/$1,600/$2,400).



11.   When a group LTD plan pays a residual benefit, this benefit is generally paid only
      when the individual's post-disability earnings are at least how much less than pre-
      disability earnings?(20%/50%/80%)



13.   A person who was receiving group LTD monthly benefits dies before the benefit
      period ends. This particular insurer continues paying the monthly benefit to the
      deceased person's spouse for three months. This type of benefit is called a
      (partial/residual/survivor/STD) benefit.




                     Answers
                     1.              d is correct
                     2.              the employee
                     3.              short-term disability plans
                     4.              b is correct
                     5.              weekly
                     6.              own occupation
                     7.              the same
                     8.              limited to age 65
                     9.              legal for all employees
                     10.             $1,400 determined like this: 80% of $2,000 = $1,600
                     11.             20%
                     12.             survivor




                                           121
                           Chapter Seven
                   Determining the Monthly Benefit
Introduction

At several points in this text we have mentioned the need to coordinate disability income
policy monthly benefits with other DI benefits that are actually or potentially available to an
insured. The goal of such coordination is twofold: To provide the insured with an adequate
level of replacement income during disability and to avoid over insurance that leads to a
disincentive to return to work. This chapter will help you understand how to determine the
maximum monthly DI benefit for which an applicant is eligible under the individual
disability income policies you offer. The primary considerations are these:

       *The applicant's current income level, either actual or averaged
        when Income fluctuates.

       *Other DI benefits actually or potentially available.

       *The insurers issue limits.

An insurance company's issue limits represent the maximum dollar monthly benefit for
which an insured is eligible from that insurer, based on earnings and coordinated with
potential Social Security benefits. The companies you represent will provide you with tables
that stipulate issue limits and how to apply them in different situations.

What Income is Replaceable?

Disability income insurance is designed to replace only earned income. The key to
differentiating earned, and therefore insurable, income from unearned income is whether the
income will stop if the insured becomes disabled and is no longer able to do the work that
generates income.

Examples of unearned income, which is not insurable under a DI policy, include:

       *Rents paid to an insured who owns rental properties.
       *Pension income.
       *Interest or dividends from investments.
       *Any other type of income that is not dependent on the insureds ability to work.

For the vast majority of people who are employed by a business and who earn a salary or an


                                             122
hourly wage, determining earned income is easy. Earned income is shown on paycheck stubs
and W-2 forms. More difficult to determine is the income earned by self-employed people
and by either employed or self-employed people who receive commissions and performance
bonuses or other income that is riot fixed.

Fluctuating Incomes

To deal with fluctuating incomes, insurers generally look at earnings not just for the current
year, but also for the proceeding two or more years. When you take an application from an
individual whose income varies, you can use financial information from prior years to
estimate your client's average insurable income. However, your insurer's underwriting
department probably requires a financial statement from the applicant in order to more
accurately arrive at insurable income. In fact, for applicants at higher income levels, a
financial statement is probably required whether income is relatively stable or not. You'll
learn more about specific financial information requirements in the underwriting chapter. It is
important for you to be aware of the circumstances under which an applicant must provide
more data. This allows you to advise your customers in advance that more information will
be needed and to caution them that the figures you are working with at the point of sale are
estimates.

Special Needs of Self-Employeds

Particularly for people who are self-employed, it is important to differentiate between the
income the business earns and the wages the self-employed person pays him or herself. An
individual, personal disability income policy is designed to cover only the personal income,
not the entire business earnings. For example, let's say a small business owner generates
$12,000 monthly income in his business. He pays himself a salary of $8,000 per month. An
individual DI policy that pays benefits at a level of 70% of income will replace 70% of
$8,000 or $5,600 for this person. Of the $12,000 the business generates, only the $8,000 paid
as salary is substantially replaced. Remember, however, that income generated by the
business to pay ongoing business expenses can be protected with the business overhead
expense policy discussed in Chapter Five. That's how this person could replace the $4,000 of
income not accounted for under the individual DI policy.

Minimum and Maximum Income Levels

Insurance companies typically specify both minimum and maximum incomes that qualify for
individual disability income policies. The annual minimum is usually from $20,000 to
$30,000. As we have indicated elsewhere, people whose incomes are below these levels can
generally be covered adequately during disability by social insurance programs such as
workers compensation or Social Security. By setting minimums at this level, insurers
effectively eliminate the problem of coordinating individual DI policy benefits with the
benefits of those programs.
                                           123
Insurers also may stipulate a maximum income level from $300,000 to $400,000 annually,
or about $25,000 to $33,000 per month. Alternately, an insurance company might allow a DI
policy to be written for people with higher incomes, but place a cap on the monthly benefit.
For example, the insurer stipulates that the monthly benefit will be no more than $20,000,
regardless of the individuals actual earned income. On the other hand, insurers catering to
high-income professionals are likely to take a more liberal approach and will insure a higher
monthly benefit.

Another consideration is the amount of an individual's unearned income. When sources other
than the person's occupation provide a high level of unearned income, the insurance company
takes a close look at the individual's net worth-the amount remaining when total liabilities are
deducted from total assets. Insurers sometimes refuse to write personal DI coverage when net
worth exceeds a certain level, perhaps $3 million or $4 million. The reasoning is that a
person with a very high net worth probably has assets, other than earned income, that are
adequate to support the person comfortably if disability occurs, so there is no need for
insurance coverage.

The companies you represent will provide you with guidelines for your high-income
prospects. However, even when you submit applications that seem to fit the guidelines, you
should know that the underwriting process would include careful scrutiny of earned and
unearned income and net worth. The dollar minimums and maximums included in this
section are representative figures only. Actual figures differ from insurer to insurer and are
subject to change.

The Replacement Percentage

You know that the purpose of disability income insurance is to help the insured manage
financially during a disability, but to replace less than 100% of pre-disability earnings in
order to keep the insured motivated to return to work. Therefore, DI policies stipulate a
benefit equal to a percentage of monthly earnings.

Some insurers use gross earnings before taxes as the base and offer a benefit from 60% to
70% of gross monthly earnings, with 66 % being the most common. Other insurers work
with net or after-tax earnings rather than gross. In this case, the replacement percentage is
likely to range from 70% to 90%, with 75% or 80% most commonly used. The following
examples show the differences in monthly benefits based on various means of figuring the
benefits.

Percentage             Of Gross   Benefit              Of Net          Benefit
  70%            x       $4,000 = $2.800               $3,000     =    $2,100
66 %             x       $4,000 = $2,668               $3,000     =    $2,000
  75%            x         N/A      N/A                $3,000     =    $2,250
  80%            x         N/A      N/A                $3,000     =    $2,400
                                       124
You'll also recall that lower percentages are typically used with higher income levels and
higher percentages with lower income levels. The insurers you represent will provide the
exact information for your use.

Integration with Other DI Benefits

Social Insurance Benefits

Earlier we mentioned the dilemma faced by both the insurer and the insured in regard to the
potential for receiving disability income benefits from the Social Security program. In spite
of the difficulty in qualifying for Social Security disability benefits, insurers must take this
possibility into consideration to avoid overinsuring. Here is an example of what could
happen if the potential Social Security benefit is ignored by the insurer and the insured
ultimately receives benefits from both Social Security and an individual DI policy.

Suppose an individual earns $2,000 per month and qualifies under the insurer's guidelines for
a monthly benefit of 66 % or $1,334. The insurer writes the individual DI policy for the full
$1,334 monthly benefit, ignoring Social Security. If the individual is able to receive Social
Security DI benefits, they will total $800 per month. Let's add up the benefits:

                        DI Policy                      $1,334
                        Social Security                   800
                        Total                          $2,134

You can see the problem. This individual, who was earning $2,000 per month on the job,
now receives $134 more each month by virtue of being disabled. Although not a huge
amount, an additional $134 of tax-free income could make it more difficult for this person to
"recover" from the disability.

One way insurers handled this situation in the past was simply to deduct the potential Social
Security benefit from the amount of DI insurance the person would otherwise qualify for and
write the policy for the difference.

                        DI Policy                      $1,334
                        Minus Social Security            -800
                        Reduced DI Policy              $ 534

Writing the policy without regard for whether the insured will actually qualify for Social
Security benefits eliminates the overinsurance problem, but if the individual does not qualify
for Social Security. the results can be devastating. The individual now receives only $534 per
month compared to former earnings of $2,000-a 73% loss of income! Said another way, the
DI policy, which intends to replace from 60% to 70% of income, in this case replaces only
27%.
                                              125
Using the Social Insurance Offset Rider

Situations such as that described above, you'll recall, were the inspiration for development of
the Social Security offset rider and the subsequent social insurance offset rider. The latter
addresses not just Social Security, but other types of social insurance as well, including
workers compensation and state temporary DI benefits plus other government-sponsored
disability programs. Let's review from Chapter Three how you can use the social insurance
offset rider to coordinate all DI benefits. Three different applications are common.

Dollar-for-Dollar Offset

One method is a dollar-for-dollar offset, where the benefit dollars received from a social
insurance program are deducted from the DI policy monthly benefit. In other words, the DI
policy is written for the monthly benefit the insured otherwise qualifies for, but the policy
actually pays only the difference between the specified monthly benefit and any other DI
benefits paid from social programs. Here is an example based on the previous situation. The
insured earns $2,000 per month and qualifies for a monthly DI benefit of $1,334. The DI
policy is written for this amount and the social insurance rider is attached, providing a dollar-
for-dollar offset. Here is the result:

                Specified DI policy benefit             $1,334
                Benefit insured receives from
                a social insurance program                -500

                DI policy pays                          $ 834

The social insurance offset rider has solved both potential problems. The insured is neither
overinsured nor underinsured. Instead, the insured receives 66 % of pre-disability income,
which both adequately compensates him or her during disability and encourages returning to
work.

Percentage Offset

The percentage offset method reduces the DI benefit by a specified percentage depending on
the type and amount of social insurance benefits the insured receives. One of two different
percentages applies, according to the circumstances.

The rider stipulates that the DI benefit will be reduced by a smaller percentage-let's say 30%
if the insured receives the Social Security benefit known as the primary insurance amount
(PIA). The PIA is determined by means of a formula applied to the individual's lifetime
earnings and is also the amount a person receives from Social Security at retirement. This
calculation is complex and we will not discuss it further here. If the insured receives either
                                            126
the PIA or a DI benefit from any other social insurance program, the rider makes the 30%
reduction (or other percentage the insurer stipulates). Here's an example.

Vince Venezia's DI policy pays a $2,000 monthly benefit, but he qualifies for the Social
Security PIA, triggering the 30% social insurance offset rider reduction.

                       $2,000      x    .30    =     $600

                                                     $2,000
                                                   - $ 600
                       DI policy pays                $1,400

The result is that Venezia receives $1,400 from the DI policy plus the PIA from Social
Security. The same application would be made if he had received a DI benefit from some
social insurance plan other than Social Security

But suppose Venezia receives the Social Security PIA plus a disability benefit from another
social insurance program. In this case, the rider specifies that the DI policy's monthly benefit
must be reduced by the larger percentage specified-let's say 90% for this particular rider:

                       $2,000      x    .90    =        $1,800
                                                        $2,000
                                                       -$1,800

                       DI policy pays                    $ 200

Now Venezia receives $200 from the DI policy plus the other two social insurance benefits.
Some offset riders specify that, if the insured receives two or more social insurance DI
benefits, no benefits are paid from the DI policy-in other words, a 100% reduction.

As you can see, under the percentage reduction method, the actual dollar amounts the insured
receives from social insurance programs are not considered. The fact that the insured does
receive other disability benefits triggers the reduction in the DI policy benefit.

Total Offset

The third method for applying the social insurance rider, total offset, also ignores the actual
dollar amounts received from other sources. If the insured receives any social insurance
disability benefit, the DI policy pays no benefits: it's that simple. If this method applied to
Venezia's $2,000 monthly benefit DI policy and Venezia received $300 from any social
insurance program, he would receive nothing from the DI policy. If Venezia received no
social insurance benefits at all, the DI policy would pay the full $2,000.
                                             127
Remember that these offsets can be critically important at the lower income levels where
government benefits alone might be adequate to replace a significant portion of lost income.
By contrast, social insurance benefits replace a much smaller proportion of higher incomes.

From the insureds point of view, the dollar-for-dollar offset is probably the most attractive.
Knowing how your companies apply the rider will guide you in integrating policy benefits
with social insurance benefits.

Social Security Supplement

Another method for coordinating benefits that you learned about in Chapter Three is a
supplemental Social Security rider that increases the DI policy monthly benefit for the first
year only. This rider takes into consideration the five-month waiting period for Social
Security benefits plus additional time for approval before any Social Security benefits would
be paid. The rider increases the DI policy benefit for that period.

As an example, suppose Mae North's income qualifies her for a $3,000 monthly benefit if no
other benefits apply. Since she potentially qualifies for a $900 monthly Social Security DI
benefit, the insurer reduces the DI policy benefit to $2,100 ($3,000- $900). Adding the Social
Security supplement rider, however, gives back the $900 until the end of the first 12 months
of disability. If North's policy has a 60-day (two-month) elimination period, she will receive
$3,000 monthly for 10 months. If she is still disabled after that, the DI policy benefit drops
down to $2,100 monthly, whether or not she actually receives the Social Security benefits.

Depending on which riders are offered by the Insurers you represent you maybe able to offer
a combination of the Social Security supplement and the social insurance offset rider. Using
either or both of these riders to integrate your policy's benefits with social insurance benefits
allows you to offer the most advantageous monthly benefit without overinsuring.

Other Benefits

Any individual DI policy you sell must also take into consideration other sources of disability
income, such as salary continuation plans, any other individual DI policies the applicant
already owns, and group disability coverage.

Salary Continuation

Let's first see how you can coordinate benefits when you must consider a salary continuation
plan and potential Social Security benefits. The applicant, Sarah Gordon, earns $4,000 per
month and your insurer would insure this amount at 70% or $2,800 per month. If Gordon


                                              128
qualifies, Social Security will pay her a DI benefit of $1,000 per month. Gordon's employer
has a salary continuation plan that pays 100% of earnings for the first 30 days.

You can offer a DI policy with a 30-day elimination period so the policy's benefits start when
the salary continuation plan ends. Gordon is assured of full income replacement from her
employer for 30 days. Although the insurer's normal issue limits for Gordon's income are
$2,800 monthly, you must consider the potential $1,000 from Social Security. You can use a
social insurance offset rider to provide a dollar-for-dollar offset. The rider is for $1,000 and
the DI policy benefit is $1,800. As long as Gordon does not receive anything from Social
Security, the DI policy pays $2,800 monthly following the elimination period.

Let's suppose, however, that Gordon is approved for Social Security DI, but the $1,000
estimate was wrong and she receives only $800. Here are Gordon's total benefits from all
sources:

               DI Policy                               $1,800
               Rider                                      200    ($1,000 - 800 offset)
                                                       $2,000
               Social Security Total Benefits             800
               Total Benefits                          $2,800

If Gordon is also eligible for other social insurance benefits, such as workers compensation,
the dollar-for-dollar offset would apply to those benefits as well. Remember, though, if the
insurer you are working with uses another method to offset social insurance benefits, the
figures will be different.

Another Individual DI Policy

Another possibility is that the applicant has another individual DI policy in place. This
applicant, Sam Wong, earns $6,000 per month and would otherwise qualify for $4,000
monthly benefits under your policy. However, his existing policy provides a monthly benefit
of $1,500 and an additional $1,100 might be available from Social Security.

Since $1,500 per month is already available to Wong, you must first subtract this amount
from your insurer's issue limits.

       Issue limits                    $4,000
       Existing policy                 -1,500
       New limits                      $2,500

But you still need to consider the potential Social Security benefits of $1,100. Again, you can
use the social insurance offset rider to provide the $1,100 representing potential Social

                                             129
Security benefits and the balance of $1,400 as the monthly benefit from the new DI policy.

        New issue limits               $2,500
        Offset rider                   -1,100 (potential 55 benefits)
        New DI Policy                  $1,400

As was the case with Gordon, if Wong qualifies for any other social insurance benefits,
those, too, will be offset by the rider.

Group DI coverage

Insurers often use a different arrangement when an applicant already has group DI coverage
by increasing the issue limits before reducing that amount by the group monthly benefit. For
example, assume the applicant, Justin Hackley, has group insurance that would provide him a
$2,000 monthly benefit if he became disabled currently. Under your DI policy, Hackley's
issue limits would normally be $3,500. Taking into consideration the $2,000 group benefit
normally leaves this result:

        Issue limits                   $3,500
        Less group benefit              -2,000
        New issue limits               $1,500

However, since the other benefit comes from group insurance, the insurer might increase the
original issue limits slightly, let's say by $500 in this case. Now, instead of purchasing a new
policy with a benefit of only $1,500, Hackley may purchase a $2,000 benefit:

        Increased issue limits         $4,000
        Less group benefit              -2,000
        New issue limits               $2,000

There are two basic reasons insurers offer this increase when the other coverage is group DI:

   1.   Group coverage might be canceled for the group or the covered individual might
        leave the group; in either case, the DI benefit terminates.

   2.   If the employer pays all or part of the group premium, all or part of the benefit is
        taxable to the employee; the larger individual DI policy benefit can help pay taxes
        due on the group benefit.

Unearned Income and the Monthly Benefit

In some cases, determining the monthly benefit requires consideration of the applicant's

                                             130
unearned income. When an applicant has significant unearned income, but not so much that
he or she is ineligible for DI coverage, insurers typically use one of two methods to calculate
a benefit that provides adequate protection while recognizing the potential impact of
unearned income.

Under one method, the insurer specifies a dollar amount of unearned income that will
essentially be ignored for purposes of determining the monthly DI benefit. This will be a
relatively small amount, such as $2,000 per month. Then the insurer stipulates that, if the
insureds unearned income exceeds that limit, the policy's monthly benefit will be reduced by
a certain percentage of the excess. Let's look at how this works, using the $2,000 limit and a
reduction equal to 50% of unearned income over $2,000.

Assume the insured, Willa Ellis, qualifies for a $4,000 monthly DI benefit based on her
earned income. This must be reduced, however, because she has unearned income of $3,000
monthly-$l,000 more than the limit her insurer imposes.

       Unearned income                                 $3,000
       Unearned income limit                           -2,000

       Excess unearned income                          $1,000

       $1,000      x    50             =               $   500

       Monthly DI benefit                               $4,000
       Less reduction for excess
       unearned income                                 - 500

       Monthly DI benefit payable                      $3,500

How does Ellis fare in terms of income replacement? We know she'll receive $6,500
monthly-$3,000 of unearned income plus the $3,500 DI benefit. In order to qualify for the
$4,000 issue limits originally, Ellis probably had earned income of about $6,700 per month,
based on a replacement percentage of 60% of earned income:

       $6,700      x    .60    =    $4,020 ($4,000 issue limits)

Ellis also has $3,000 unearned income, so her total monthly income is:

       Earned                          $6,700
       Unearned                         3,000
       Total                           $9,700


                                             131
To determine what percentage of her income is replaced by the DI benefit and unearned
income totaling $6,500, divide this figure by her former income:

       $6,500          $9,700     =    67%

So, even by reducing the DI policy's monthly benefit in response to Ellis' unearned income,
her income during disability is still two-thirds of pre-disability income, which is a common
replacement ratio.

The second method involves a rather complicated series of steps that take into account:

       *The amount of earned income,
       *The amount of unearned income, and
       *The relative values of each.

The insurer then apples different percentages by which the monthly benefit will be reduced
based on all of those values.

For example, the insurer might specify that if the insureds earned income is greater than
$200,000 and unearned income equals more than 10% of earned income, the benefit is
reduced by 5% of all unearned income that exceeds the 10% limit. Different figures might
apply to different income ranges. These figures, of course, are examples only and the insurers
you do business with might have different limits and apply different percentages.

As usual, the examples used here may not represent the procedures used by insurers you
represent, so you must customize your approach to clients based on the particular situation.

A Final Application

We'll conclude this chapter with a final example of determining the monthly DI benefit for
which an applicant is eligible based on disability benefits that are known to be available or
are potentially available.

       Data Required

       The Insured: Bruce Boswell

       Monthly Income: $7,000

       Proposed DI Policy Issue Limits: $4,670 (66 %)

       Potential Social Security: $800/month

                                             132
       Potential Workers Comp: $690/month

       Salary Continuation: 100% for 60 days

Group DI Plan, 60-day elimination period, @ 60% of earnings up to $3,000/month
maximum, lifetime benefit period.

Notice that Boswell's own earnings are not covered at the 60% level because of the group
plan's maximum benefit.

Adjustment Required
The presence of the group DI plan requires that the monthly benefit of your policy be
reduced by the group plan's monthly benefit. Let's say that under your policy the insurer
raises the normal $4,670 issue limits to $4,800 when a group plan is in place. The result:

       DI policy issue limits                         $4,800
       Minus group benefit                             -3.000
       DI policy benefit                              $1,800

To accommodate the potential Social Security and workers compensation benefits, you can
write this policy with a monthly benefit of$1,000 and $800 on the social insurance offset
rider. The elimination period can be 60 days to correspond to the end of the salary
continuation plan benefit period. At that point, Boswell will theoretically receive a monthly
income of $4,800 if no social insurance benefits are paid:

       Group DI benefit                               $3,000
       DI policy benefit                              $1,000
       Rider benefit                                  $ 800
       Total monthly benefit                          $4,800

This $4,800 replaces about 69% of Boswell's pre-disability income. If Boswell does receive
social insurance benefits, of course, the $800 benefit under the rider will be reduced in
whatever manner the insurance company specifies. Typically, a group plan's DI benefit is
also reduced dollar-for-dollar by social insurance benefits.

As we conclude, remember that this chapter has presented, in general, various ways multiple
benefits might be treated, but the procedures established by the companies you represent are
really the only guidelines that matter when you prepare an application for disability income
insurance.



                                            133
Chapter 7 Review Question

1.    Which of these represents insurable income under a disability income policy? (rental
      income/self-employment income/savings account interest)



2.    Atypical minimum annual income that qualifies an individual for a DI policy is
      ($15,000/$25,000/$100,000).



3.    When gross earnings are the basis for income replacement. a common replacement
      percentage is (66 %/75%/90%).




4.    A certain insurer's social insurance offset rider stipulates that the policy benefit will
      be reduced by the same number of dollars the insured receives from Social Security.
      This offset method is known as a (total/dollar-for-dollar/percentage) offset.




5.    Caldwell is applying for a DI policy. Her employer provides a salary continuation
      plan for 60 days during which Caldwell will receive 100% of her $4,000 monthly
      income. Caldwell wants the new DI policy to be written for the issue limits of $2,800
      with a 30-day elimination period and a lifetime benefit period. Select the best
      statement concerning this situation.

      a.    Because of the salary continuation plan, Caldwell is not eligible for a DI policy.
      b.    The insurance company will probably be happy to write the DI policy as
            Caldwell requested.
      c.    The policy probably may be written as requested except the benefit amount
            must be altered.
      d.    The policy probably may be written as requested except the elimination period
            must be extended to at least 60 days to avoid overinsuring




                                            134
6.   An applicant's income qualifies him for a monthly benefit of $5,500 according to the
     issue limits for the DI policy you are offering. He has an existing DI policy with
     another insurer for a monthly benefit of $2,000. Ignoring the possibility of social
     insurance benefits, for what monthly benefit may you request the policy?
     ($5,500/$3,500/$2,000/-0-)



7.   An insurer often will slightly increase the issue limits for an applicant who already
     has what type of DI coverage in place? (another individual DI policy/group DI
     coverage/salary continuation/any of the preceding)



8.   Which statement is correct concerning unearned income and the monthly benefit for
     which an applicant is eligible?

     a.   Unearned income has no effect on the amount of the benefit.
     b.   If unearned income is high, the insurer might reduce the monthly benefit based
          on a predetermined formula.
     c.   If unearned income exceeds a stipulated amount in the range of $2,000 to
          $4,000, the DI policy will not be written at all.




                       Answers
                       1.            self-employment income
                       2.            $25,000 – usually from $20,000 to $30,000 depending on the
                           insurer
                       3.            66 %
                       4.            dollar – for – dollar
                       5.            d is correct
                       6.            $3,500 – the issue limits minus the benefit already in place
                       7.            group DI coverage
                       8.            b is correct
                                             135
                                   Chapter Eight
                                   Underwriting

Why Underwriting Is Important to You

As you know, the underwriting function is primarily the responsibility of the insurance
company home office underwriting department. However, agents also perform preliminary
underwriting tasks that are commonly known as field underwriting. In the first part of this
chapter, we'll discuss the vital role agents fulfill through careful and complete field
underwriting techniques. After that, we will look at home office underwriting, including
techniques and tools plus the critical underwriting factors that result in a decision about
issuing the disability income policy. We'll conclude with a review of the concepts underlying
group insurance underwriting.

The quality of field underwriting you perform before submitting an application sets the stage
for what occurs at the home office level. Underwriters rely heavily on agents to screen out
obviously unacceptable applicants, to provide the insurer with complete and accurate
information, and to assist in obtaining additional data when needed to complete the
underwriting process. Your advance underwriting, coupled with the quality of information
available to the home office underwriter, is the key to underwriting approval and, ultimately,
the completion of your sales effort.

Field Underwriting

Pre-Qualifying the Applicant

As an experienced agent, you have certainly learned the importance of pre-qualifying
applicants for any type of insurance. You know that prospects must display certain
characteristics that suggest they are good candidates for the insurance policy you are offering.
The fundamentals of pre -qualifying applicants for disability income insurance are essentially
the same as for life insurance policies, with slightly more emphasis on certain characteristics
as explained in the following paragraphs.

Remember first of all the markets we've emphasized throughout this text. Professionals and
other high income earners and businesses comprise a large pool of prospects for disability
policies paying high monthly benefits. This pool represents prospects with the ability to pay
premiums and the potential for additional related insurance sales. From an underwriting
standpoint, individuals such as these are among the highest quality and lowest risk of all
                                            136
prospect groups. In general, you can count on the greatest number of home office approvals
for applicants from these markets.

You'll find the greatest numbers of potential applicants by extending your prospecting efforts
to include upper middle-income earners as well. Income alone, however, does not
adequately qualify good prospects for disability income insurance, so you must also identify,
to the best of your ability, characteristics such as:

       *Type of work-actual duties, degree of physical hazard, nonseasonal, full time.

       *Job stability-number of years in the same line of work, number of different
        employers, stability of current employer's business.

       *Financial condition-estimated income level and insurable income, apparent ability
        to pay premiums, perceived standard of living.

       *Lifestyle-hobbies, avocations, recreational interests, friends and associates.

       *Physical or medical conditions-absence of obvious problems that increase the
        chances of future disability.

Early in your prospecting efforts, some types of information are readily apparent, while other
information requires more inquiry on your part. Until a prospect actually agrees to hear your
sales presentation and/or apply for insurance coverage, he or she may be reluctant to divulge
a great deal of personal or financial information. Many facts become available to you only
when you are actually completing the application as discussed in the next section.

The Application for Insurance

After you pre-qualify a prospect, your complete and accurate completion of the application
for insurance is the most significant contribution you can make to the underwriting process.
For this reason, you should be fully aware of the information requested on the application by
having studied it carefully before the sales interview. And, while different insurers require
the same general types of data, you should also know the differences between various
insurers applications. Most importantly, fill out the application completely and accurately.
Every question has a purpose: otherwise it would not appear on the application. And to be
certain every item is complete and accurate, read carefully to determine the amount of detail
the insurer requires, then provide that depth of detail.
                                                137
General Information

Applications always ask for certain general information that includes name, home address,
and number of years at the residence, Social Security number, age, sex, weight and height.
This type of data, of course, helps identify the applicant and it also provides some
preliminary information about insurability as well as identifying areas that need further
investigation. These act as clues that can help focus the underwriter's evaluation.

For example, incongruent weight and height might indicate a health problem that increases
the risk of disability or the potential for disability to occur. Or, if the applicant's age indicates
he or she might be approaching retirement, the applicant may be ineligible for coverage or
require a modified policy. Even the applicant's history of changing residences can raise a flag
about stability as a factor that needs further investigation. Experienced underwriters are able
to use general information in the context of other data about an applicant to decide which
areas require additional underwriting attention.

Occupation Information

For disability income insurance underwriting, perhaps the most significant single item on the
application concerns the applicant's occupation. Earlier in the text, we've referred to the
occupational classes as being more or less risky and to the "best classes being eligible for the
most liberal DI policies. The occupational classification, then, ultimately determines:

        1.    Whether the policy will 'be issued and, if so.

        2.    At what price.

As the agent, you must be able to quote a premium for the policy at the point of sale, which
means you have to determine the occupational class. Insurance companies provide guides or
schedules with detailed job descriptions to help agents and underwriters determine the
correct occupational class. You must be familiar enough with these guidelines to complete
the application and quote an estimated premium. Additionally, you should know the
guidelines well enough to terminate a sales interview if you discover the individual's
occupation makes him or her ineligible for coverage.

The information about the occupation that you obtain from the applicant and include in the
DI insurance application determines the initial classification. We say "initial" because the
classification could be changed at the home office if the information is not complete and
accurate enough to precisely classify the occupation. In this case, the underwriter would be
required to contact you or the applicant for additional information, then decide whether the
classification is correct or perhaps the occupation must be reclassified. While this is not a
                                           138
major problem, your client might be unhappy if the reclassification causes an increase in the
premium you quoted. Two cautions are appropriate at this point. Be very careful about
classifying occupations and prepare your prospect for the possibility that the premium you're
quoting could change after the underwriting process is complete. It's safest to indicate that
you are providing an estimated premium, since many variables in addition to the
occupational class can cause a policy to be modified in some way. We'll have more to say
about modifications in the sect ion on home office underwriting.

The home office underwriting section also gives you more information about specific
occupational classifications that many insurers use. However, you must use the specific
classifications provided by the insurers you do business with in order to complete the
application accurately for any particular insurance company.

At this point, we'll give you some examples of different ways to identify occupations on
applications and point out why some are complete and accurate and others are not. Suppose
your applicant, Carl Smathers, identifies his own job as "vice president of production for
Pudley Printing." The title has a "white collar executive" ring to it, but don't assume that's the
case. Maybe Pudley is a large printing operation and maybe Smathers performs his duties far
from the floor of the printing presses. On the other hand, maybe Pudley is a very small
printer, Smathers is an employee/owner, and he personally operates high-speed presses and
other printing equipment every day to contain personnel expenses while the business is
growing. The job title tells you none of this, so a title alone is incomplete. A more accurate
description states the title, then describes precisely what functions Smathers performs, such
as "operates high-speed presses, feeders, folding machines, and similar printing equipment."

Another applicant, Eloise Poston, tells you she works in "assembly" at Shortberger Basket
Manufacturing, you might visualize Poston poised tensely at the perimeter of a long,
mechanized assembly line, glue gun or stapler in hand, reaching into the midst of clattering,
rapidly moving machinery to apply a critical fastener while baskets zoom toward the next
station. Upon further questioning, though, you discover that Poston is a skilled weaver, hand-
weaving baskets in an environment more akin to a quilting bee than to a manufacturing plant.
Whereas you might first have described Poston's occupation as "assembly line worker." now
you can say she "weaves baskets by hand, no exposure to machinery nor to hazardous
working conditions" or similar wording as required by your insurer's guidelines.

These examples should help you see how much differently the risks of disability can be
perceived when an application completely and accurately describes the actual duties
associated with an occupation, rather than simply stating a general title.
                                             139
Financial Information

Deciding whether a prospect's income falls within the minimum and maximum income levels
established by the insurer requires the acquisition of financial information. As much as
possible, you will make an "educated guess" about an individual's finances during the pre-
qualifying phase of your prospecting. However, you're likely to find people reluctant to
divulge a great deal of information until you are engaged in a sales interview. At that time, if
you acquire information that strongly suggests the prospect income does not meet your
insurer's requirements, you can terminate the interview before completing the application.
Usually, your pre-qualification efforts will lead you to the point of completing applications
only with those whose finances support the need for DI insurance.

The application typically asks for data about both earned and unearned income as well as
income generated by any business the applicant owns. Even when disability insurance for
business needs is not the purpose of your interview, gathering such information can be the
first step toward your next sales interview with this individual-to offer one or more of the
business policies discussed previously.

The financial data you gather will be carefully examined during home office underwriting,
but remember that you also need this information in order to differentiate between earned and
unearned income for purposes of identifying insurable income. Once you know the amount
that is insurable, you're able to suggest a monthly disability benefit and estimate the
premium. Additionally, applications request sufficient financial information to allow the
home office underwriter to estimate the individual's net worth. You'll recall that net worth
may become an issue when an individual has a great deal of unearned income or other assets.
When net worth is high, insurers usually decline to write the policy since the individual
probably has sufficient income from sources other than earnings.

Medical Information

Applications for Dl insurance request medical Information similar to that required for life
insurance applications. For disability income insurance, the significance of answers to
medical questions is even greater since health problems are more likely to result in
disabilities than in early death.

Questions take the form of a brief medical history, asking short, uncomplicated questions that
usually begin, “Have you ever been treated for any of the following?" All "yes" answers
require a short explanation on the application. The home office underwriters scrutinize these
questions and answers for situations that require close attention in considering whether to
issue the policy. As you record these answers, you may become aware of medical conditions
that could result in the policy being offered differently than requested. For example, you'll
                                            140
learn that certain medical problems do not preclude coverage, but normally require the policy
to be issued at additional cost or with an exclusionary rider. You will learn this type of
information as you gain experience with the insurance companies you represent.

Recording the answers to medical questions provides the opening for you to inform an
applicant about the medical examination that your insurer requires. Disability income
insurance applicants, almost without exception, must have a physical examination by a
physician the insurer selects. The insurer pays for this exam.

Finally, the medical history discussion leads to your informing applicants that the insurer will
request medical information from the Medical Information Bureau (MIB). See the home
office underwriting section of this chapter for complete information about MIB.

Miscellany

As you study your insurers' applications, you'll notice other questions that allow underwriters
to further develop a profile of the applicant. Several questions address other insurance the
applicant currently has, has had in the past, or has applied for but was declined. Here are
some examples of the content of these questions:

       *Whether the individual has previously been refused insurance by any other insurer
       and, if so, why.

       *Whether the applicant has ever been issued a policy that rated the individual as an
       above-average risk and, if so, to describe the circumstances.

       *Whether any other insurer has ever canceled a policy with the applicant and, if so,
       why.

       *Whether the applicant has other DI insurance in force and, if so, what types, with
       what insurers and for what amounts.

Other questions typically asked on an application address personal and moral issues such as
hobbies, avocations, leisure and sport activities, family life, friends and business associates,
use of alcohol and other often-abused drugs, and similar items that fill in the details of an
applicant's lifestyle.

Questions of the types described here are used in the context of other data on the application
to identify factors that might contribute to an individual's becoming disabled and/or being
reluctant to recover from a disability and return to work.
                                               141
We hope you can see how important a fully and accurately completed application is as an
underwriting tool for both you and the home office underwriter. Once you've completed the
application, you might be responsible for initiating the details of the medical examination
that will occur or at least to inform the applicant that someone at the home office will arrange
the exam in cooperation with the applicant. This is also a good time for you to mention the
possibility of other investigations the insurer might conduct, such as interviews with family
members, neighbors and/or business associates. Telling the applicant about such
investigations in advance eliminates any unpleasant surprise that could occur if the applicant
first learns of the investigation from someone who has been interviewed.

Agent’s Statement

Many insurance companies include a section on the application for an agent's statement that
is completed privately after the agent has filled out the remainder of the application with the
prospect. The agent's statement permits you to comment on anything you know about the
applicant that will help the underwriting process. For example, you can describe any pre-
qualifying information that does not appear elsewhere on the application, such as information
about the individual's character, community standing, lifestyle, or other data that helps
establish the applicant as one who meets the insurer's standards.

Home Office Underwriting

When the home office underwriter receives the application you have carefully completed. the
underwriting process begins in earnest. The information on the application suggests avenues
for the underwriter to explore more fully before making a final decision about whether or not
to issue the policy and, if so, on what basis. While the underwriter begins this process, the
medical examination typically occurs at about the same time.

Medical Examination

The medical examination required for a disability income insurance policy follows a fairly
standard routine required for all types of insurance. In addition, because disability can result
from many different health conditions, insurers might request specific testing or medical
examination related to a particular condition the applicant disclosed in the medical history
section of the application. The routine examination typically calls for information such as:

       *Age, weight and height.
       *Blood pressure readings.
       *Physical condition in general.
       *Blood testing for various results including HIV,
        cholesterol, triglycerides, and others.
       *Urine testing for various results including nicotine and drug use and others.
                                             142
Based on information from the application, the underwriter might request special testing,
such as examination of the skeletal system, cardiac or respiratory tests, chest x-rays,
additional laboratory tests and others. Exactly what tests and reports are required varies
according to the insurer's requirements and the circumstances of the particular applicant's
health or physical condition. All of the requested information is eventually compiled into a
report that reaches the home office underwriter. Sometimes the report suggests that even
further medical testing is required.

Attending Physician Statement (APS)

An applicant's answers to medical questions sometimes prompt the underwriter to request an
Attending Physician Statement (APS) from physicians the applicant has consulted in the past.
Underwriters often want more specific information than the applicant is able to provide. The
APS, requested directly by the underwriter, can provide the details about a particular
condition, what treatment was prescribed, how many times the insured consulted the
physician for the condition, and the date of its onset.

The APS serves several purposes in providing a complete and accurate picture of the
applicant's health. Applicants can and do forget how often the condition required medical
treatment. More than one consultation for the same purpose can reflect a recurring condition,
one that may result in disability in the future. In this case, the risk to the insurer is greater
than for a condition from which the applicant has fully recovered and that is not likely to
happen again.

Most applicants lack medical training, which means they are unable to be as precise as a
physician in describing medical conditions. For example, an applicant who reports his blood
pressure is "a little bit higher than normal" might actually have very high blood pressure from
the physician's perspective. Physicians can provide more complete, specific, and objective
information because their medical training enables them to classify and codify illness more
thoroughly.

Like the medical exam report, the APS can suggest further areas of inquiry or medical testing
that the underwriter wants to pursue before making a decision about issuing the policy.

Medical Information Bureau (MIB)

Another source of medical information about insurance applicants is the Medical
Information Bureau (MIB), which is a clearinghouse for medical information previously
reported to insurers. Insurance companies that are members of the MIB both report and
receive data from this organization. Applications for life, health and disability income
insurance include a form disclosing to the applicant that the insurer might request
                                             143
information from the MID. Insurance applicants must read and sign the form, giving the
insurer permission to request data and to report data about the applicant. This notice also
informs applicants about their right to know what information the MID has on file and
reports about them. These rights are covered by the Fair Credit Reporting Act, described later
in this chapter. MID discloses the contents of its files only to member insurers and, upon
request, to a certain individual's physician. The physician then discusses the data with the
individual.

Disability Income Record System (DIRS)

Of particular interest to insurers writing disability income policies is a service of MID known
as the Disability Income Record System (DIRS). DIRS is a record of applications for
disability income insurance that request lengthy benefit periods and/or monthly benefits that
exceed a certain dollar amount. This information is reported to MID by member companies
and may be requested by member companies when the underwriting of a DI application is
underway. The information is kept on file for five years. The purpose of DIRS is to provide
another safeguard against overinsurance.

Financial Information

In the section on field underwriting, we stressed the reasons that accurate financial
information is vital to disability income insurance underwriting. The insurer must have a
complete picture of the applicant's earned and unearned income, other potential sources of
disability income benefits and, when income from all sources appears to be significant, the
individual's net worth. Much of the required financial information comes directly from the
application, but when there appears to be significant wealth, underwriters sometimes request
additional financial statements from the applicant. Financial statements typically include
disclosure of all assets and earned and unearned income, both currently and for the recent
past-perhaps for two or three years.

The goal of seeking financial information is to determine that the applicant's income is within
the limits imposed by the insurance company and to establish an appropriate monthly benefit
without overinsuring. Another source of financial information (and other information as
well) is a report from an investigatory agency.

Investigation/Inspection

An underwriter who wants more information about an applicant's finances-or almost any
other issue-may request further investigation or inspection, as it is sometimes called in the
insurance business. Many insurers have in-house staff trained to verify information on an
application, while others use outside consumer investigative agencies. For disability income
                                              144
insurance, the investigation often is directed primarily towards verifying information about
the applicant's income and occupation and in identifying past instances of disability. Other
types of information available through investigations address the applicant's lifestyle, habits,
associates and other personal and moral factors.

Fair Credit Reporting Act

Consumer investigative agencies such as those utilized by insurance companies are subject to
the federal Fair Credit Reporting Act. This consumer protection law requires investigatory
agencies to verify the accuracy, completeness and currency of information maintained on file
about consumers. All who use these agencies, including insurance companies, must notify
consumers in advance that a request for information will be made. This notification must tell
the consumer how to acquire information about the nature of the data on file with the
investigative agency and what the consumer's rights are.

Summary of Consumer Rights

Here is a summary of consumer rights under the Fair Credit Reporting Act. Consumers have
the right to:

       *Receive the name and address of the reporting agency that prepared the report if the
         report was used to deny insurance, credit or employment or, for insurance or credit,
        to cause a higher cost to be imposed.

       *Learn what information is in the file a reporting agency has compiled on the
        particular consumer.

       *Receive, within 30 days. a free copy of the information on file when that
        information caused denial of insurance, credit or employment. A file requested
        for other reasons or at other times can incur a small fee.

       *Have misleading or incorrect information removed from the file.

       *Require the reporting agency to notify those who received incorrect information that
        the information was incorrect and has been removed from the consumer's file.

       *Place in their files their own written version of any issue that is in dispute-
        conflicting information the reporting agency cannot verify as being either correct
        or incorrect. The consumer's version of events must accompany any future reports.
                                           145
       *Require the reporting agency to send the consumer's version, within 30 days, to
        businesses that previously used the report to deny or charge more for credit or
        insurance or to deny employment.

       *Sue the reporting agency for damages, attorney fees and court costs if the agency
       violates the provisions of the Act.

       *Demand that the reporting agency not provide information about the consumer to
       anyone who does not have a legitimate business need.

       *Require removal from the file of negative information that is more than seven years
        old, except bankruptcy data, which may be retained for 14 years.

       *Be notified by a company that it intends to ask for a report from an investigatory
       agency.

       *Request additional information from the company seeking the report about what
       information they are looking for and why.

       *Learn what information was gathered that resulted in the report, but not the sources
        of that information.

The rights summarized here, as well as all other sections of the Fair Credit Reporting Act,
apply not only to insurance, but to all business transactions that require investigation of and
reporting about consumers.

Occupational Classification

We come now to what is probably the single most important consideration in the disability
income insurance underwriting process, the occupational classification. An underwriter
evaluates essentially every other piece of information about the applicant in the context of the
applicant's occupation and actual duties. As an example, consider a physical condition such
as recurring backaches. Back problems are likely to have considerably less impact on an
individual's ability to work if the individual is an executive who spends most working hours
in a business office, as opposed to an emergency medical technician whose responsibilities
include lifting or moving injured people.

Classification Systems

Unfortunately, there is not a single classification system that all insurers use. Insurance
companies have a variety of systems that identify occupations by different codes or classes.
                                               146
For some insurers, the best class of risk, eligible for the best rates and most liberal benefits, is
called Class 1; another insurer might use high numbers rather than low numbers to signify
the best risk, perhaps Class 5. Still others classify the best risk as Preferred or Class P or a
letter system such as Class AAA, AA, BB and so forth.

Depending on the insurer, the number of occupational classifications may range from four to
six-in which case the fourth or sixth could be either the best risk or the most risky one.
Obviously, you must become acquainted with the systems of insurers with whom you do
business.

Classification Example

The following table is an example of just one way occupations might be grouped in various
classifications. For purposes of this example, Class 1 represents the best occupational risks
and each class becomes more risky as the class numbers increase.

In all classes, the table shows a sampling of the types of occupations included. Many other
jobs are actually included in each insurer's classifications and the exact job duties will be
spelled out. Insurers also

                           Occupational Classifications Example

                                               rates        higher rates      restricted, higher
                                                                                    rates
Class 1*                   Class 2            Class 3          Class 4            Class 5+
Professional, high
Income, highly          White collar,   White collar,     Blue collar,
  Educated              middle income lower income & skilled & semi              Manual labor
                                      blue collar, higher    skilled
                                            income
Low hazard
                        Low hazard         Slight hazard
   Physicians &                                           Possible hazard Inherent hazard
   other highly        Managers and      Factory managers
educated medical        supervisors,      & supervisors,    Electricians,  Truck drivers,
& health profes       school teachers,   retail exposed to mechanics.     heavy equipment
sionals, psycholo      clerical, sales    heavy lifting & plumbers, hair operators, roofers,
gists, executives,       personnel        other hazards, dressers, mainte    firefighters
 lawyers, archi                           physical thera nance workers,
    tects                                  pists, outside    restaurant
                                         sales exposed to    wait staff
                                            travel risks
                                           147
Liberal benefits,   Liberal benefits, Benefits slightly
   best rates       slightly higher restricted, slightly Benefits more Most limited
                                                                         benefits,
                                                                        highest rates
           *with some exceptions, personal services are the primary source of income.
             +Occupations may be divided into two classes, e.g.. Class 5 and Class 6;
            certain occupations listed may be uninsurable with some insurers.

indicate occupations that are uninsurable by that particular insurance company. Some of
these include certain jobs listed under Class 5 above. A few occupations are considered
uninsurable by the majority of DI insurers. These include extremely hazardous jobs in which
the likelihood of accidental injury is great, such as mining and high-rise construction and
possibly firefighters and police.

You also need to know how the insurers you do business with handle hazardous hobbies or
leisure activities, such as sky diving, scuba diving, amateur auto racing, parachuting and
similar activities. For example, a highly compensated executive in a job with no apparent
physical hazards typically qualifies for the best classification. However, if this individual is
licensed to pilot the small plane he owns, the insurer takes that activity into consideration as
well.

Additionally, recent changes in U.S. society have resulted in some increase in hazards-
particularly physical violence-for the medical and legal professions especially. Exactly how
these hazards will affect occupational classifications for DI insurance is not yet clear, but you
will want to watch how events unfold and be aware of any changes insurers make in
response.

Importance of Classification

We cannot overemphasize the importance of your determining the correct classification to
the best of your ability when you are completing the application. Because disability income
insurance underwriting is generally more exacting than underwriting any other type of
insurance, a misclassification isn't likely to go unnoticed. Reclassifying an occupation at the
home office level can result in the applicant's job being classified as more risky, which in
turn means the DI policy will cost more and possibly provide less liberal benefits than
requested on the application. This situation can place you in the position of reselling the DI
policy with more restrictive benefits at a higher premium to an applicant who is less willing
to purchase the policy on that basis.

Having classified the risk and gathered all of the necessary information described earlier in
this chapter, the underwriter is now prepared to evaluate the risk and decide whether to issue
the disability income insurance policy and, if so, on what basis.
                                             148
The Underwriting Decision

Compared to life insurance, the underwriting of disability income insurance results in a
relatively high number of rejected applications and substandard ratings that require premium
or benefit adjustments or other changes in the way the policy is written. Two factors are
largely responsible for stringent underwriting in the DI area:

       1.    Many medical and health conditions are more likely to contribute to disability
             rather than to death.
       2.    The nature of the applicant's occupation bears a closer relationship to the risk of
             loss from disability than to loss of life.

Figure 8-1 illustrates the contrasts between DI and life insurance in the percentages of
uninsurable applicants and policies issued with adjustments because of a substandard rating.

As illustrated, statistics indicate that from 5% to 10% of applicants for disability income
insurance are judged uninsurable, compared to 3% or less of life insurance applicants. As for
adjusting policy provisions for substandard conditions, 15% to 20% of DI policies require
such adjustments. Only 5% to 8% of life insurance policies require additional premium or
some other modification.

The final underwriting decision takes one of three basic forms:

       1.    Issue the policy as a standard risk that meets the insurer’s underwriting
             guidelines.
       2.    Decline to write the policy because the risk is uninsurable according to the
             insurer's guidelines.
       3.    Issue the policy as a substandard risk requiring one or more significant
             adjustments in order to make the risk acceptable according to the insurer's
             guidelines.
                                       Figure 8-1




                            DI vs. Life Insurance Underwriting
                                             149
Standard Risks

Most disability income insurance policies are issued on a standard basis, which means the
insured is believed to have an average risk of becoming disabled. Individuals who are
classified as standard risks pay the standard rates established for people with similar
characteristics and occupational classifications. Standard rates are those the insurer
established and filed for a particular classification when the DI policy was developed.

Classifying a risk as standard, however, doesn't necessarily mean the policy is issued exactly
as requested. Adjustments can result from inadvertent errors in classifying the occupation or
from information gathered during the underwriting process. For example, if the applicant's
occupational class is changed, the premium might be higher than originally estimated
because the standard rate for the different class is higher. Or perhaps the relationship of
earnings to insurance requires that the monthly benefit be slightly lower than requested. The
risk is still standard, as are the rates, but the benefit cannot be as high as the applicant
desired. Adjustments such as these do not mean the risk is substandard. Rather, the risk is
standard from the insurer's point of view, but on a somewhat different basis than anticipated
when the application was completed.

Uninsurable Risks

Some applicants pose more risk than the insurance company is willing to assume, so the
underwriting decision is to decline to write the policy. From the insurer's viewpoint, these are
uninsurable risks. We mentioned previously that certain extremely hazardous occupations are
uninsurable and what these are specifically differs from insurer to insurer. Other factors that
can result in rating an applicant as uninsurable are the insureds medical and financial
conditions and dangerous hobbies or leisure activities. Sometimes it is a combination of
factors, rather than a single thing, that results in the decision to reject the application.
However, while more DI policies are declined than are life insurance policies the number of
rejections is still a small proportion of all applications for disability income insurance.

Substandard Risks

An individual is rated as a substandard risk when one or more of the elements that are given
considerable weight in the underwriting process pose a problem that the insurer must resolve
before accepting the risk. In a case such as this, the insurer decides that, while the risk is
insurable, certain alterations in the terms of the policy must occur before the policy will be
issued. The following paragraphs address various adjustments that insurers commonly make
in order to issue the DI policy on a substandard basis.


                                             150
Increase the Premium

One method to make the risk more acceptable to the insurer is to increase the premium
while retaining all the benefits and provisions originally requested. This is an adjustment you
can present in a most positive light to the applicant. Certainly no one is thrilled to hear
something costs more than anticipated, but you can emphasize that the desired benefits
remain intact-the monthly benefit, the benefit period, the elimination period and all other
features are still available. Additionally, the insurers will review and consider adjusting the
premium in the future if their actual experience is good.

The extent to which a premium might be increased varies by insurer and according to the
particular factor that influenced the increase. Typical increases range from 10% to 50% of the
standard premium.

Add an Exclusion Rider

Adding an exclusion rider is another means used to write a substandard policy that is
acceptable to the insurance company. An exclusion rider specifies a particular condition or
situation that will not be covered as a cause of disability. The condition might be related to
the individual's health or physical condition. For example, if an insured has a history of back
problems associated with a herniated disk that prevented working in the past, the rider would
stipulate that coverage does not apply when disability results from anything related to the
herniated disk. You might be interested to know that back problems are among the most
common reasons for adding an exclusion rider to a DI policy.

An individual's leisure activities might be another source of concern that could be handled
with an exclusion rider. Earlier we mentioned an executive who is also a licensed pilot and
flies his own small airplane. In order to retain the highest classification and best insurance
rates for which this executive would otherwise be eligible, the insurer can exclude disability
resulting from any incident associated with his aviation activities.

Insurers also deal with certain conditions, especially those of a medical nature, by means of a
more limited exclusion rider. One way this might work is to defer paying benefits for the
specified condition during the first 90 days of disability. Then, if the insured is still disabled
after 90 days, benefits are payable for the full benefit period. Alternatively, the insurer might
limit not only the first days of coverage, but also the length of the benefit period for that
condition. For example, if the benefit period for all other disabilities under the policy is to
age 65, the insurer might limit the benefit period for disability associated with the particular
condition to three years.

Riders stipulating full or limited exclusions differ according to the insurer's rules, the specific

                                               151
condition or situation involved, and the insureds history. After you gain some experience
with an insurer, you will be able to describe to your clients the potential exclusions and how
they might work. In the meantime, be tuned in to any potentially hazardous situations or
conditions that might raise a red flag with underwriters. The best time to alert applicants to
the possibility of underwriting adjustments is when you're completing the application. It is far
better to return to an applicant and say that the condition caused no changes or minimal
changes than to return with a surprise exclusion or reduction in benefits.

Other Modifications

Finally, Insurers have the option to make other modifications to policy provisions in order to
issue the DI policy on a substandard basis. While the possibilities are many and varied, the
most common adjustments include:

       *Shortening the benefit period.
       *Extending the elimination period.
       *Reducing the amount of the monthly benefit.

Modifications may be applied Individually or in some combination, depending on the actual
circumstances. The primary advantage of this type of adjustment is avoiding a premium
increase or making an absolute exclusion for a medical condition or other situation. As an
example, suppose an insured has a history of short-term debilitating migraine headaches.
Rather than completely excluding coverage for disability associated with migraine
headaches, the insurer could specify a longer elimination period for this condition, whereas
the elimination period for other conditions is shorter.

Insurers often use various combinations of the three major ways to handle substandard risks
described above in order to issue the DI policy on some basis rather than rejecting the
application completely. From the applicant's viewpoint, adjustments are preferable to the
only other alternative-not issuing the DI policy in any form. The stringency of DI
underwriting can understandably be a source of frustration for agents, but most underwriters
make every effort to find a creative solution to underwriting problems. It is important for you
to cooperate with underwriters to find solutions and to present the positive aspects of policy
modifications to your clients.

Group Underwriting

Some of the basic principles of group disability income insurance underwriting were
presented in Chapter Six. These dealt with group eligibility, the savings associated with large
numbers of insureds that result in lower costs, the absence of significant medical and
financial underwriting and similar principles. If you need to review any of these underwriting

                                             152
considerations, please see Chapter Six. In the remainder of this chapter, we will look at other
factors of concern in group underwriting.

The Group Sponsor

In deciding whether to provide disability Income insurance for a specific group, underwriters
must evaluate the group sponsor, which is often a business. The underwriter investigates the
company's financial stability, its standing in the marketplace, the stability of its product or
service, the presence of any hazardous occupations, the company's management practices,
size and geographic location. Some indications of good group sponsors include:

       *Good reputation in the marketplace and in the community.
       *A history of successful operations.
       *Demonstrated flexibility to adjust to change.
       *Products or services that fill stable needs or demands.
       *Not unduly affected by economic conditions.
       *Physically located in an economically stable area.

Poor indicators include:

       *Short and/or poor business history
       *An industry subject to financial peaks and valleys.
       *Inherently hazardous occupations.
       *Questionable need for products or services offered.
       *Physically located in an economically depressed area.

These are just a few examples. As is always true of the underwriting process, the underwriter
looks at the group sponsor's characteristics in the context of every other underwriting
consideration.

History of the Group

Underwriters also look at the insurance history of the group itself, primarily in terms of
claim experience and employee turnover. A history of high and/or frequent claims doesn't
necessarily mean the trend will continue, but such a history requires the underwriter to look
for causes. For example, if the claims experience results from the particular type of business
operations, the trend probably will continue. However, if the claims were due to unusual
circumstances that aren't likely to be repeated, that's another matter. As an example, suppose
two highly compensated executives who were members of the group were badly injured
when they were traveling together in a commercial airplane that crashed. Both suffered long-
term disabilities that resulted in high monthly benefit payments for extended periods. The

                                             153
likelihood of such an event recurring is slight.

High employee turnover can also be a concern because the insurance company incurs
administrative costs when employees are hired and added to the plan and when they are
terminated from the plan. Some turnover, of course, is desirable to avoid an ever-aging group
that is more likely to become disabled as the years pass.

The group's history with other insurers is also important. Underwriters need to discover
whether the group has been canceled and, if so, why. If the group sponsor frequently cancels
one plan and initiates a new plan with a different insurer, the underwriter also must wonder
why. A group that is constantly price shopping, for example, can cost the insurer significant
administrative expense. In addition, insurers must be aware of the significance of pre-
existing condition provisions that have been fulfilled in previous DI insurance plans in order
to weigh its risk in underwriting a group where that provision cannot be enforced.

Establishing the Plan

Underwriters are also concerned with and must be consulted about the details of establishing
a new group DI plan, including:

       *Approving the plan's provisions: What are the basic provisions? What optional
        provisions are Included-presumptive benefits? Rehabilitation benefits? Survivor
       benefits? Other provisions?

       *Terms under which the plan will be installed: What is the minimum number of
        participants? What are the group sponsor's responsibilities? The insurer's
        responsibilities?

       *Determining individual eligibility: What employees will be covered? How long
       must they be employed?

       *Establishing the benefit amounts and benefit periods: Is there a formula for
        differentiating between income levels? Does a flat percentage apply across all
        income levels? Are all income levels eligible for the same benefit period? Do
        all provisions comply with federal nondiscrimination requirements?

       *Deciding who will pay the premiums: Does the employee pay all or part of the
       premium? Do the employees and the sponsor understand the tax consequences?

       *Establishing a method to collect premiums when participants contribute: Will
        the existing payroll deduction system be used? If not, what system will be

                                             154
        established? Does the sponsor understand its responsibilities to collect and remit
       premiums?

       *Developing administrative guidelines: Who will explain the plan to employees?
       Who will enroll participants and how? Who will assist with claims filing and
        answer participant questions? Who will maintain plan records and perform other
       administrative responsibilities?

All of these are issues with which the underwriter must be involved since covering a group
obligates the insurance company to a number of services not associated with individual
plans. The underwriter must be convinced that all of the details can be handled by both the
group sponsor and the insurance company before the group plan will be profitable and,
therefore, an acceptable risk for the insurer.

Whether installing a group plan or proposing an individual disability income policy, the
agent is always the front-line person in the initial underwriting process. Now that you've read
in some depth about the underwriting concerns and responsibilities associated with disability
income insurance, you're in a better position to do an outstanding job of pre-qualifying all of
the applicants you ask your insurers to consider.




Chapter 8 Review Questions

1.     The text suggests that you begin your pre-qualifying efforts by prospecting among
       (professionals/high -income earners/businesses/all of the preceding).




2.     For DI insurance, the key piece of information for deciding whether a policy will be
       issued and at what cost is the applicant's (medical history/financial
       status/occupation).




                                             155
3.   From the job descriptions below, select the one that best illustrates the type of
     information you should provide on an application for DI insurance.

     a.   President and sole proprietor of A&M Construction Company
     b.   President and sole proprietor of A&M Construction Company; master carpenter
          skilled in all aspects of carpentry for residential renovations and additions;
          work performed by applicant and one employee; no electrical, mechanical or
          plumbing work.



4.   An applicant is age 35 and apparently healthy. What type of medical data is probably
     required? (medical history on the application/medical examination/both the medical
     history and the medical exam)




5.   When the underwriter wants information from an applicant's doctor about a specific
     medical condition for which the doctor treated the applicant, the underwriter requests
     which of these? (Attending Physician Statement/medical examination by a physician
     of the insurer's choice/MIB report)




6.   What is the name of the specific service that provides insurers with records of
     applications for disability income insurance during the past five years?
     (MIB/DIRS/APS)



7.   Based on information in the text concerning occupational classifications, which of
     the following is likely to be classified as a better risk, eligible for more liberal
     benefits? (electrician/school teacher/physical therapist)



8.   Typically considered among the best occupational risks are people whose source of
     income is (personal professional services/educational professions/retail occupations).


                                          156
9.    According to the text, declined or rated applications are more likely to occur in what
      field? (disability income insurance/life insurance/neither; they're about equally likely
      to be declined or rated)


10.   Most DI policies are issued as (standard/substandard) risks.



11.   Which of the following methods might an underwriter use to write a DI policy that
      would otherwise be declined?

      a.   Retain all provisions as requested, but increase the premium.
      b.   Reduce the benefit period, but retain other provisions as requested.
      c.   Exclude a particular condition from coverage, retaining other provisions as
           requested.
      d.   All of the above



12.   Group underwriting requires the underwriter to look at the history of (the group
      sponsor/the particular group/both the sponsor and the particular group)



                                     Answers
                                     1.     all of the preceding
                                     2.     occupation
                                     3.     b is correct
                                     4.     both the medical history and the medical exam
                                     5.     attending Physician Statement
                                     6.     DIRS – Disability Income Record System, white is
                                            maintained by the Medical Information Bureau (MIB)
                                     7.     school teacher
                                     8.     personal professional services
                                     9.     disability income insurance
                                     10.    standard
                                     11.    d is correct
                                     12.    both the sponsor and the particular group




                                           157
                                   Chapter Nine
                                      Taxes

General Tax Rules

In this chapter, we will describe, in genera1, the tax rules that currently apply to paying
premiums for disability insurance and receiving benefits from disability policies. While many
variables can affect the taxes of any one person, the goal of this chapter is only to provide
you with the basic tax information you need to serve your clients. When clients want precise
details about the impact of disability insurance purchases or benefit payments on their
particular situations, they must consult legal or tax professionals. The information in this
textbook does not represent legal or professional advice of any kind.

Policies Purchased by Individuals

When an Individual purchases and pays the premiums for an individual disability income
insurance policy, the premium paid does not qualify for a tax deduction. Some people may be
confused about this because DI insurance is considered a health or medical insurance
coverage and some medical expense insurance premiums are tax deductible to the extent they
meet percentage requirements specified in the tax code. Individually-paid DI insurance
premiums are not deductible.

The advantage of non-deductible premiums, however, is that if the insured becomes disabled
and receives disability income benefits, the benefits are not taxed as current income. They are
received entirely income tax free.

Group Policies

With few exceptions today, premiums for group disability income insurance are paid for
wholly or partially by the insureds-often the employees of a business group sponsor-in order
to retain the tax-free receipt of benefits. Just as is true for individual policies, group DI
benefits are free of taxation as long as the insured person pays the premiums. On the other
hand, if the group sponsor pays the premiums. DI insurance benefits are taxed as current
income when the insured receives them and the group sponsor may deduct the premiums as a
business expense.

Sometimes the employer or other group sponsor shares the cost of group DI insurance
premiums with the employee. This action gives the employer a tax deduction and the


                                             158
employee does not have to report as income the amount of the premium the employer paid on
his or her behalf.

However, employer-paid premiums subject the insureds benefits to income taxation to the
extent the employer paid the premium. For example, if the employer and the employee each
pays 50% of the premium, 50% of any benefits paid are taxed as current income, while no
taxes are assessed on the 50% attributable to employee-paid premiums.

Salary Continuation Funded by Insurance

While not all salary continuation plans are funded by insurance, when insurance funding is
used and the plan has been formalized in writing, premiums paid by the employer are
generally tax deductible as a business expense. However, with salary continuation plans,
there is an exception to the general tax deductibility rule. Premiums paid for non-owner
employees are deductible, but no deduction is permitted when premiums are paid for any
employee who is also:

        *The working sole proprietor of the business.
        *A working partner/owner of the business.
        *A working owner of a Subchapter S corporation.

When premiums are paid by the employer for regular employees, the business normally takes
a tax deduction. This means that the salary continuation parents made during the employee's
disability are taxable income to the employee. And. because these are not considered true
disability income benefits, the salary paid during disability is subject to all applicable federal
income taxes, just as lithe employee were actively at work earning the income.
Unfortunately, though, if the employer insures the plan and the proceeds are paid directly to
the employer from the insurance company, the employer loses the tax deduction, so this
arrangement is not preferred by employers.

To retain the tax benefits for the employer, a salary continuation plan may be set up so the
insurance company pays benefits directly to the employee, rather than passing the funds
through the employer. Alternately, the insurer may deposit the benefits into a trust, which
then pays the funds directly to the employee, but the trust arrangement is rarely used today. In
either case, the employee must eventually report the income on his or her tax return.
However, the employee must pay two types of taxes for a short time while receiving the
salary continuation benefits.

Social Security and federal unemployment tax IFUTA) withholding is required for the last
calendar month the disabled person was working and for the six months of disability-a total
of seven months-after which withholding is waived if the individual is still disabled. Figure
9-1 (on page 160) illustrates this withholding rule.
                                            159
Key Person DI

With key person insurance, there are neither tax advantages nor disadvantages to the key
person personally, since any benefits are paid to the business. The business both pays the
premiums and receives the benefits, but no tax deduction is permitted for premium payments.
On the other hand, if benefits are paid to the business because the key person becomes
disabled, the benefits are not taxed.

Executive Bonus DI

We'll remind you of how executive bonus plans work so you can understand the tax
principles. The employer pays a bonus to the executive, who uses the bonus monies to
purchase an individual disability income policy. The employer may deduct the bonus as a
business expense.

The executive must pay current income taxes on the bonus and may not deduct the premium
from taxes, as is the case with any other individual DI policy premium. However, any
benefits paid to the executive because of disability are received tax-free.

Business Overhead Expense

The premiums for a business overhead expense (BOE) policy may be paid by the individual
owners, who may be sole proprietors, partners or stockholders of a corporation, or by the
business entity itself. In all cases, premiums are deductible as a business expense.

If DOE reimbursement benefits are paid to the business, the amount of benefits must be
reported as taxable income. This income is, of course, offset by the business expense
deduction the company is entitled to take.

                                       Figure 9-1
                                  Salary Continuation
                         Social Security and FUTA Withholding




                                           160
Disability Buyout

Premiums paid for an insurance policy that funds a disability buyout agreement are not tax
deductible. Neither are the proceeds paid to the remaining owners taxable when the buyout is
triggered. However, the disabled owner who is selling his or her interest under the agreement
is probably subject to capital gains taxation. The exact tax consequences depend upon the
type of business and the precise parties involved as we will describe shortly. First, let's
briefly review the broad concept of capital gains taxes.

Capital gains refer to profits from the sale of capital assets such as real estate, stocks or a
business. The capital gains tax advantage results from tax regulations that permit the
taxpayer to deduct any capital losses from any capital gains for the year and report only the
excess as income. This excess is then included in gross income and taxed at the individual's
regular tax rates up to 28%. If you need more information about capital transactions and
capital gains taxation before you continue this section, please consult a basic tax text.

Close Corporation

When the business is a close corporation and the buyout occurs between a disabled
stockholder and either the corporation as an entity or the other stockholders, the buyout is
treated as a capital transaction-the sale of a capital asset. This means the proceeds paid to the
disabled stockholder are treated as a capital gain (or loss if that is the case) according to the
Internal Revenue Code rules for such transactions.

Partnership Entity

When the business is a partnership, the tax rules differ depending on whether the purchasing
party is an individual or the business entity. Let's first consider buyout by the partnership
entity. In this case, the disabled partner's proceeds are taxed according to the rules for the
liquidation-not sale-of a partner's interest. The primary difference between a liquidation and
a sale (see the section following headed "Individual Partners") concerns the value of
"goodwill," a somewhat vague term referring generally to the value of the reputation a
business enjoys within the community and among competitors.

The taxing procedure can become complex in terms of valuing the partnership's goodwill and
whether or not the value of goodwill had been stipulated in the buy-sell agreement. Typically,
the value of a company's goodwill is treated as ordinary income unless the buy-sell
agreement stipulates that goodwill is to be treated as capital. In the latter case, the value of
the disabled partner's share of goodwill is subject to capital gains rules. The portion of the
liquidated business interest that is not considered to be the value of goodwill is always
treated as ordinary income.

                                              161
Individual Partners

If the buyout is between the individual partners, rather than between the disabled partner and
the partnership entity, taxation occurs according to the rules for the sa1e-not liquidation-of a
partner's interest. In this case, the entire transaction, including the value of goodwill, is
considered a capital transaction. This means all proceeds are subject to capital gains taxation,
with no option for the disabled partner to consider any part of the transaction as ordinary
income.

Other Tax Rules

Constructive Receipt

When the disabled seller realizes a gain, rather than a loss, on the sale of the business
interest, the gain as determined by capital gains regulations, is subject to current taxation In
the year it is actually or constructively received. Constructive receipt refers to the time the
individual first could have received the gain, whether or not it was actually received.

Because a business buyout involves a large sum of money, the disabled person might want to
defer part of the buyout funds to another year in order to avoid a large tax hit. However, he or
she cannot simply have a lump-sum insurance payment deposited somewhere and not draw
on it all at once because this action would be considered constructive receipt and the gain
would be taxed all at once. The disabled person may, however, have the funds deposited into
a trust from which he or she receives installment payments. Since the trust is set up to make
periodic payments only and the individual no longer has unlimited access to the full amount,
the funds are no longer considered to have been constructively received. The disabled person
now pays taxes only on the payments actually received from the trust as they are received.

Installment Sale

Some disability buyout policies pay benefits in installments instead of in a lump sum. In this
case, the sale might qualify as an installment sale, subject to slightly different rules.
Installment sales are taxed so that a certain part of each installment is considered a return of
investment and part is considered a capital gain. Only the proportion treated as a capital gain
is taxed each year as actually received.

Cash Value/Return of Premium Benefit

The cash value or return of premium feature included in some newer DI policies has not


                                            162
been addressed by any specific tax rulings as of this writing. It is assumed that the premium
returns will be treated the same as dividends paid under participating cash value life
insurance policies. If so, the transaction is considered to be a return of excess premiums to
the insured and, therefore, not taxable income.

Tax Credit for Totally Disabled Individuals

A federal tax credit may be available to certain people who are totally disabled, but this
credit is available only at very low-income levels. Eligibility for the credit requires the
individual to meet a strict “any substantial gainful employment” definition of total and
permanent disability.

We will not discuss this tax credit since people earning at the level described are not likely to
be those you are interviewing for DI policy sales. The credit is mentioned here only so you
can respond to prospects who might be aware that such a credit exists, but who are not
informed about its severe limitations. The credit is sometimes referred to as a Section 22
credit, after the pertinent portion of the Internal Revenue Code.

Caution

The information provided in this chapter is limited to the highlights of disability income
insurance taxation. Because tax laws are complex and must be considered in light of other
factors that impact any individual's financial situation, people who want tax information
specific to their personal circumstances must seek professional advice. While the information
included in this chapter is correct as of the time the textbook was produced tax rules have
always been and will continue to be subject to change.

Before you complete the review for this chapter, you can look over the table on page 165,
which is a summary of the tax rules we've highlighted.




                                            163
                            Disability Coverage Tax Highlights
Type of               Tax                If               Premiums         Who          Benefits                   Special Notes
Disability         Deduction for       Deduction           Paid by        Receives      Taxed
Coverage            Premiums            Applies,           Others,        Benefits
                       Paid           Who Gets It         Taxed as
                                                           Income

  Individual
  DI Policy             No               N/A                  N/A         Individual      No
 Purchased by
  Individual
                     Yes, if                        No                                   Yes, If         If premiums shared by employer and
 Group DI            employer           Employer               No         Individual    employer             employee, employee pays taxes on
                       pays.                                              Employee        pays.                proportion of benefits paid by
                      No, if               N/A                 No                        No, if                       employer only.
                    employee pays.
                                N/A                                                     Employee
                                                    Non
                                                                                          pays.

     Salary          Yes, except
  Continuation        premiums                                                                              If insurer pays to trust or direct to
   Funded by         paid for sole                                         Individual     Yes, and         Employee, employee may opt out of
   Insurance         proprietors,       Employer              No           Employee       Usually         withholding except Social Security and
                       partners,                                                         subject to             FUTA withheld for 7 months.
                        Sub S                                                           withholding
                       owners/
                     employees.

Key Person            No                  N/A N/AN          N/A          Employer         No
   DI

 Executive             Yes              Employer          Bonus taxed    Employee          No         Employee uses bonus to pay premium
  Bonus DI                                                as income to                                       for individual DI policy.
                                                           employee

 Business              Yes              Business             N/A          Business        Yes          Taxable benefit washed out by identical
 Overhead                                                                                                   business expense deduction.
  Expense

 Disability            No                 N/A                N/A          Business or     No                Disabled owner’s proceeds taxed as
   Buyout                                                                  owner(s)                        either capital gain or ordinary income,
                                                                                                                depending on circumstances.




              Chapter 9 Review Questions


              1.        It is generally preferable for an individual to pay his or her own premiums for a DI
                        policy rather than have them paid by an employer because in this case (premiums are
                        tax deductible/benefits are not taxed/both of the preceding are true).



                                                          164
              2.        An employer pays the premiums for a salary continuation plan funded by insurance.
                        Premiums are deductible as a business expense when they are paid for (non-owner
     employees/all employees).



3.   A business may not take a tax deduction for disability insurance premiums when the
     policy provides (executive bonus plan funding/key person insurance/ BQE
     reimbursement/any of the preceding).



4.   In a disability buyout situation, capital gains taxation is an issue for the business
     partner or stockholder involved in (buying/selling/either buying or selling) the
     business interest.


5.   Under current tax rules, the cash value return of premium under this feature is
     (taxable Income/not taxed).




                                   Answer

                                   1.       benefits are not taxed
                                   2.       non-owner employees
                                   3.       key person insurance
                                   4.       selling
                                   5.       not taxed




                                         165
                                 Chapter Ten
                             Looking to the Future

Directing Your Marketing Efforts

Now that you've studied the disability income insurance product, where do you want to go
with your new knowledge? Your next step is to decide where to focus your efforts-which
markets to explore and which markets to avoid. Once again we remind you that annual
income of about $25,000 is the minimum that offers any opportunity for you to place an
individual DI policy. Thai figure is higher in certain markets and, as time passes, the
minimums are likely to increase as cost of living adjustments are made to government-
sponsored programs that originally caused the deterioration of the DI market at lower income
levels.

Professional and Business Policies

Most analysts see professional DI policies and policies designed for business purposes as the
disability income profit-makers of the future. The professional market, encompassing
incomes of more than $100,000 annually, is highly competitive and has been penetrated
intensely in recent years. However, plenty of opportunities exist for agents who are willing to
challenge themselves to succeed in this market. Insurers continue to introduce innovative
product features that can open doors for both new and replacement policies that compete
successfully with existing policies. Examples include the HIV and assault benefits (Chapter
Three) and the malpractice liability rider (Chapter Five), all of which are of particular interest
to professionals.

The emergence of the professional corporation has changed the nature of certain segments of
the professional market by sharpening the line between professionals operating as owners
and professionals operating more like employees. Distinguishing between the business and
personal needs of the professional people involved will help you explore and explain their
dual needs for individual disability income policies and for policies designed to protect their
businesses specifically.

Small Business Opportunities

Small to medium-sized businesses that are less likely to self-insure provide a huge pool of
prospects for disability insurance sales. In fact, statistics indicate that the small business
market for disability “pie” shown in Figure 10-1 makes the point. Only about 25% of all


                                            166
small businesses in the United States have any type of disability insurance plan, individual or
group. Furthermore, only about half of all small businesses have a formal plan for continuing
the business in the event of an owner's death or disability.

Businesses in this group have a maximum of 50 employees, but many have high annual
earnings. Even smaller businesses with earnings of $100,000 and less annually can be a
prime prospecting pool for you since this group has been largely ignored by disability
insurance marketers. In general, all except the larger businesses represent fertile prospecting
ground for agents who are prepared to compete for placement of group and business-oriented
disability coverages.

Know What's Hot, What's Not and What's New

Agents who intend to survive and thrive in any line of insurance stay attuned to consumer
demands and new product developments. Insurers have learned from experience, with life
insurance products in particular, that consumers will take their money elsewhere if the
insurance industry fails to respond to their changing needs and demands. As is true for any
competitive business, creative products that answer consumer's insurance needs make the
difference between the companies that succeed and those that falter and sometimes fail.
Agent success goes hand-in-hand with the fortunes of insurers.

For you, this means taking an active role, being sensitive to your clients' requests and
shopping your insurers for the products that are in demand-an ever-changing landscape, by
the way. Consumers of financial products are becoming more sophisticated about their needs
and where to go to fulfill them. More and more, you'll find that your clients expect you to
demonstrate how a particular insurance product fits into their complete financial program.

                                       Figure 10-1
                             The Small Business Disability Pie



     Have Any Type----------------25%
     of Disability Insurance

                                                 50%-----------------Have a Business
                                                                     Continuation Plan




                                            167
Consumers also are more likely to have shopped your competition themselves and will
challenge you to prove the superiority of your product. Today, you must know what policies
compete with yours because, chances are, your prospects know. Educate yourself to be able
to fairly and accurately compare other policies to yours. This is not just sound advice, it's the
law-and most of your prospects know it.

The next several paragraphs briefly describe several developments in the disability income
insurance marketplace that are currently getting attention from both the insurance industry
and consumers.

Annually Renewable "Term" DI Insurance

This product, which we are calling annually renewable "term" disability income insurance,
may be identified by different names according to the insurer offering it. We use this
terminology because the product is similar to annually renewable term life insurance.

So-called term DI is used as a marketing tool to provide DI policies to individuals whose
incomes are expected to be significantly higher in the future than they are currently. Good
prospects include new physicians, lawyers and other professionals who are just starting in
business. The policy is written for a one-year period with a low initial premium that increases
each year that the policy is renewed as indicated in Figure 10-2.

At a specified point, the insurer expects to convert the renewable policy to a standard DI
policy with a higher, level premium. Most of these policies are noncancelable and guaranteed
renewable until age 65.

                                         Figure 10-2
                                     "Term" DI Insurance

                                              168




Step-Rate DI Insurance
Another product that has a life insurance counterpart is step-rate DI insurance. The disability
insured pays a lower than normal premium in the early years of the policy-perhaps for as long
as 10 years-after which the premium “steps-up” or increases significantly to an amount that
remains level for the duration of the policy Step-rate DI is illustrated in Figure 10-3.

Like the annually renewable policy, step-rate DI is aimed at younger professionals whose
incomes are likely to increase significantly over the years. This product is slightly less
competitive than the term product because of the pricing differences. Over many years, the
step-rate premiums are greater in total, while the annually renewable DI policy generally
costs less over the long term than a standard DI policy.

Life/Disability Insurance Combination Policy

One of the newer developments is a life/disability income insurance combination policy that
is not the same as a life policy with a disability income rider. The combination policy is
designed to allow the cash values of the life insurance portion to eventually pay the
premiums for the disability income insurance.

Insureds pay the life insurance premium for the entire policy period according to a pre-
established schedule and at a level that builds the necessary cash values. The term “vanishing
premium DI” has been applied to this concept since the insureds responsibility to pay the DI
premium theoretically vanishes when cash values are adequate to take

                                        Figure 10-3
                                   Step-Rate DI Insurance

                                         169




over the payment. At whatever point cash values are high enough as stipulated in the
contract, the portion of the premium covering the DI insurance is eliminated and the insured
pays only the life premium.

Long-Term Care Conversion

As an outgrowth of the accelerated or living benefit features being included in many newer
life insurance policies, some insurers now offer DI policies with long-term care conversion
features to meet similar needs.

Still a new concept, these policies permit insureds above a stipulated age, generally age 65, to
convert disability income policies to long-term care policies. The policies specify the
circumstances under which the policy may be converted, just as is true for life policies with
this type of benefit. Stay up to date with these policies, which are likely to become more
important to an aging population of U.S. consumers.

Lifetime Benefit Extension

While lifetime benefit periods are not new, such periods have traditionally been restricted
only to the highest risk classifications. Again because of the aging population, lifetime
benefit extensions are likely to become much in demand and are being offered to more
consumers. Such an extension continues the full DI benefit for the insureds lifetime if the
disability begins before a specified age, such as 65. Some policies offering this extension also
pay a reduced lifetime benefit if disability begins after the specified age.

The Evolving Future

The product developments we've discussed are still evolving and they deserve your watchful
attention as consumers respond to new features and insurers continue making improvements
that expand your disability markets and enhance your sales opportunities. Be especially alert
for products that track with the increasing consumer interest in disability coverages featuring
more liberal definitions of disability, higher monthly benefits, longer benefit periods, and a
wide variety of options and riders.

Profitable Underwriting

Agents and insurers alike must be mindful of the historical cycle of disability income
insurance as presented in Chapter One. In the past, policy liberalizations have resulted in
poor claims experience followed by tightening of policy provisions. Currently, the industry
appears to be in the part of the historical cycle characterized by underwriting constraints
because of recent poor profits. However, insurers who have stayed in the DI business through

                                           170
varying market conditions have identified and implemented better underwriting controls.
Stricter attention to medical and financial factors and careful classification of risks has
resulted in an increase in better risks accepted, poor risks declined, and appropriate policy
modifications for mid-range risks. Insurers who have so improved their underwriting
practices are in a position to continue offering the more beneficial features and provisions
that make DI policies attractive to consumers.

Insurers known for being at the cutting-edge of DI developments are currently examining a
managed care approach to DI claims, similar to managed care concepts associated with
medical expense insurance. Managed care for disability claims appears to be a natural
extension of the tendency for insurers to provide rehabilitation benefits and could be a giant
step toward controlling costs to ensure the stability of disability insurance products.

Agent Opportunity

As an agent, you can benefit yourself and your clients by becoming allied with the insurance
companies that have a proven record of successful innovation and maintenance in the
disability income insurance field. We encourage you to begin at once to investigate the
opportunities that await you en route to becoming a full service" insurance agent for your
present and future clients.

As a service-oriented agent, you will be interested in the professional and ethical issues
discussed in the next chapter.




Chapter 10 Review Questions

1.     Statistics indicate that the small business market for Disability Income Insurance has:

       a.    Been over sold
       b.    Barely been tapped
       c.    Come and gone
       d.    Is unaccessible to the agent




                                        171
2.     With an "annual renewable term" Disability Insurance the policy has:
     a.   A high initial premium
     b.   A low initial premium
     c.   A level premium
     d.   A disappearing premium


3.   A Life Disability Insurance combination policy

     a.   Allow cash values of the life policy to pay premiums for disability income
          insurance
     b.   Requires the insured to purchase two separate policies
     c.   Cannot be written on an individual bases
     e.   Is the same as a life policy with a disability rider


4.   Newer Disability Income insurance policies provide:

     a.   Long-term care conversions
     b.   Lifetime benefit extensions
     c.   Both of the above
     d.   Neither of the above


5.   Underwriting for Disability Income Insurance

     a.   Has always been profitable
     b.   Has had poor claims experiences in the past
     c.   Ignore medical and financial factors
     e.   Is the same as underwriting for Life Insurance



                                  Answers
                                  1.   b. Barely been tapped
                                  2.               b. A low initial premium
                                  3.               a. Allows cash values of the Life
                                         Policy to pay premiums for
                                         Disability Income Insurance
                                  4.   c. Both of the above
                                  5.               b. Has had poor claims
                                         experiences in the past

                                        172
                             Chapter Eleven
                                    Ethical Issues

Professionalism

It is no accident that this chapter concerning ethical issues begins with the subject of
professionalism. While acting in a professional manner involves more than attention to
ethics, it is difficult to imagine that a person who does not take ethical issues seriously could
ever become a genuine professional. Consider briefly some of the attributes that characterize
professionalism in the life and health insurance business.

Knowledge and Skills

It may seem almost too obvious to mention, but an agent must have appropriate insurance
knowledge to act professionally. The knowledge you acquire to start selling insurance is just
the beginning of a lifetime of self-development to stay abreast of new products and evolving
issues in the insurance business. Expanding knowledge is essential for professionals who
help people manage the financial decisions that profoundly affect their future well being.

Along with increasing knowledge, you must develop the skills to use what you learn in a way
that benefits both you and your clients. For example, it is not enough simply to know the
features of every product you can sell. You must also know for whom each product is most
appropriate-how a product does or does not meet the financial objectives of a particular
client-because to sell an unsuitable product can be a greater travesty than not selling any
product at all if the results are detrimental to the client.

Professional Designations

Insurance agents often seek educational opportunities that lead to one or more professional
designations conferred by recognized educators in financial service fields.

Chartered Life Underwriter (CLU)

One such well-known designation is that of Chartered Life Underwriter (CLU), awarded
by the American College in Bryn Mawr, Pennsylvania. To reach the CLU designation, agents
undertake in-depth study over a period of time of a wide range of topics directly related to the
insurance industry. Each topic is followed by an examination and when all exams are
successfully completed, along with specified experience requirements, the designation is
awarded.

                                              173
Chartered Financial Consultant (ChFC)
The American College also has a program of study that leads to the Chartered Financial
Consultant (ChFC) designation. Similar to the CLU designation in course and experience
requirements, the ChFC focuses less on life insurance company operations and more on the
myriad of financial planning considerations such as investments, retirement and estate plans.
Successful exam results coupled with the appropriate experience lead to the designation.

Certified Financial Planner (CFP)

Agents Interested in financial planning have another option, the Certified Financial Planner
(CFP) designation offered by the College of Financial Planning in Denver. The requirements
are similar to the American College designation, along with the necessity for successfully
completing the stipulated exams and having the required experience.

Registered Health Underwriter (RHU)

Agents who work in the health insurance field may add the Registered Health Underwriter
(RHU) designation to their badges. The course of study leading to the RHU designation is
offered by the National Association of Health Underwriters in Washington, D.C. After home
study and classes at local universities, agents complete three examinations. Successful
completion of course materials and the exams results in the designation.

Client-Focused

Professionalism also means being client-focused, or putting the client's needs first.
Unquestionably, one reason you have chosen the insurance business for your career is that
you want to pursue opportunities that will reward you financially in relation to your
achievements. That's fine; obviously, you must think of your own financial needs. What we
mean here by putting the client's needs first involves the decisions you make when (not if!)
you're faced with the temptation to go for the bigger commissioned item when the smaller
commissioned item fits your client's needs just a little bit better. Don't be fooled into thinking
that temptation will never present itself. You are almost certainly going to be faced with the
choice sooner or later and the thought will probably cross your mind that you really can
justify promoting the product that will give you the better commission. This is not at all an
insulting statement; rather it is an acknowledgment that we are all human beings subject to
tough decisions that can become tougher when our own financial security is a consideration.
Being aware that you will, sometime, be placed in such a position can help you recognize the
situation when it occurs, deal with it, and resolve it by focusing on the client. Interestingly,
agents generally find that putting clients' needs ahead of their own results in greater rewards
and more business for themselves.

                                              174
An Industry Representative
As a life or health insurance agent, you become a representative of the entire insurance
industry. In their own minds, people do business with other people, not with companies. In
effect, you become "the insurance industry" to many people because they will judge the
insurance business by their relationship with you. To your clients, since you are the insurance
company, your professionalism reflects how people view the insurance business.

Because you represent the insurance business, it is also important to respect your
competitors and convey that respect to clients when they broach the subject of the
competition. Never be disparaging about others in the insurance business, even if you believe
it is warranted. Instead, illustrate how you your product and your companies can meet the
client's needs. This parallels the idea of staying client-focused. You don't need to disparage
the competition in order to defend your products and practices if you can honestly and
objectively show clients what you can do for them.

In the Business of Service

Insurance is essentially a service business. Yes, you sell a product, but think about the nature
of the product, especially in comparison to other consumer products-a car, for example, when
a consumer buys a car, instant gratification results. The consumer drives the car off the lot;
can touch it, smell it and show it to other people: has instant use of it and will continue to use
it at his or her convenience. The benefits are tangible, obvious and immediate. Now consider
an insurance policy. Yes, the buyer has it in his or her possession, can touch it, smell it, and
talk about its benefits, but, quite frankly, from a consumer point of view, so what? The
primary benefit is generally not immediate (most people hope-especially for life insurance)
and there is nothing tangible to show for the money spent. For life insurance, the tangible
benefit-whether it is use of the cash value or payment of a death benefit-is available only in
the future. As a result, the most important current benefit of a life insurance policy is the
service an agent provides.

Insurance buyers sometimes complain that, while they receive a great deal of attention from
insurance agents who are trying to make a sale, they feel essentially abandoned after the sale
is made. This is an unfortunate signal that agents have forgotten about service. Here are some
important services an insurance agent performs:

        *Follow up with the client before the second premium is due. Because clients
          who allow a policy to lapse often do so by not paying the second premium, it is
          important to provide service early to reduce the chances of termination. Call clients
         to answer any questions they might have about the policy or about how to pay the
        next premium, showing your interest before the premium is due.

                                            175
        *Review client needs on a regular basis. Don't let more than a year go by without
        contacting your existing clients about reviewing their current needs. People's lives
       change. They get married… and divorced. They have children. Their income \
         increases. Life changes can generate needs for new or different products. If you
        don't take the initiative, clients think you don't care about them. Aside from serving
        the client's needs, remember that if you don't look after your clients, someone else
       might earn the business that could have been yours.

       *Assistance to beneficiaries when an insured dies is almost inevitable for life and
       health agents. Helping people through the claims process or answering questions
       and generally being available are services they will appreciate and remember. You
       will have the personal satisfaction of knowing you have helped people during one of
       the most difficult experiences of their lives.

Assist claimants in filing insurance claims. No matter how thoroughly you have explained
how the insurance works, insureds often forget or become confused when they actually need
to file a claim. You can help by answering questions, talking a claimant through the process
over the telephone or even visiting in person to help organize bills and fill out the claim
forms. If claimants don't understand which costs are covered, you can review the coverage
and show them how to use the policy and claim forms for future claims. If necessary, you can
help claimants reach the right person in the claims department to discuss a claim. As you can
see, a claim can offer numerous opportunities for you to provide small services that have
high value for your clients.

These services as well as the other factors included in this section about professionalism all
have a common objective-serving the client well-and that is at the heart of ethical behavior.

Fiduciary Responsibilities

We've talked about insurance involving a high degree of public trust. One part of that trust
has to do with the fiduciary responsibilities of insurance companies and their agents. The
term "fiduciary" refers to the holding of something of value for another, which is what the
insurer does on behalf of insureds. This term and its related responsibilities also apply to
agents since they advise the public about financial matters, suggest solutions that cause
members of the public to spend money and actually collect money from clients when they
purchase insurance.

This fiduciary position requires agents to be very careful and completely ethical in insurance
transactions. You must satisfy yourself that you have asked for and received accurate
information about the prospective insureds financial situation before you recommend any
product. When recommending a certain amount for a life insurance or disability income

                                            176
insurance policy or a certain type of health insurance policy, is able to show the applicant
what factors you considered. Clearly and honestly explain how cash values accumulate, what
they mean, what is guaranteed and what is not. Be able to explain the tax effects of such
things as policy ownership, dividends, early withdrawal of cash values, death benefit
installment payments and similar items. Describe exactly what must occur before disability
benefits are payable and explain elimination and benefit periods, residual payments and any
other policy benefits and restrictions. Discuss exactly the services that are and are not
covered by a health insurance policy. Be certain clients understand about deductibles,
coinsurance, and lifetime limits.

When you receive premium payments from clients, you must not use that money for anything
else even temporarily. Premium payments must not be placed in a bank account belonging to
the agent, the agent's business or any other person or entity unless authorized by the agent's
insurance company. Some insurers may authorize agents to place premiums in their own
accounts, retaining commissions and sending the balance to the insurance company. This
practice allows agents to both receive their own commissions and pay commissions to their
hired agents promptly.

Agency Authority

The insurance business operates largely on the basis of sales by agents who have been given
authority by the insurer to act on the insurance company's behalf in securing clients. This
concept of agency authority, sometimes called the powers of agency, again emphasizes the
high levels of trust and ethics necessary in the insurance business. The authority or power an
insurer grants to its agents is legally spelled out in the contractual agreement between the
insurance company and agents. Under common law, the insurance company is responsible
for its agents' actions under the authority the insurer grants to the agent. The legal waters
become somewhat muddied, however, by the concepts of actual, implied and apparent
authority.

Actual or Express Authority

Actual authority refers to the authority or power that is really and clearly given to the agent
by virtue of the agency contract. It is sometimes referred to as express authority because it is
expressly stated in the contract. For example, the contract might grant authority to represent
the insurer in the states of Oregon and Washington; to submit insurance applications on the
company's form: to collect and submit premium payments; and similar actions.




                                             177
Implied Authority

Often, a contractual arrangement that gives actual authority carries with it some additional
implied authority; therefore, implied powers are a subcategory of sorts of the express
powers. For example, if the contract gives the agent authority to collect premiums and
forward them to the insurance company without further qualification, it is implied that the
agent may collect premiums in any form-cash, personal check, money order or any other
negotiable form. The insurer could not then reject a personal check as payment of a first
premium on the basis that a certified check was required. On the other hand, agents must be
careful not to assume any authority is implied other than that included in the agency contract.
Agents can unwittingly bind the insurer to commitments it did not intend to make and at the
same time deceive the applicant or insured, knowingly or unwittingly, but illegally in either
event.

Apparent Authority

As opposed to actual authority, which occurs because of a contractual agreement between the
principal (the insurance company in this case) and the agent, apparent authority involves the
perspective of a third party. Simplistically stated, apparent authority is any power ascribed to
the agent because it appears to a reasonable third party that the agent does have that authority
from the insurance company. Like implied power, apparent authority can be binding upon the
principal, the insurance company, if the third person had no reason to think the agent did not
have the apparent power to act on the insurer's behalf.

In all cases involving the insurance agent's authority, agents and insurers should have a
clearly defined set of limitations under which agents can obligate insurers. It is also
important for agents to act in such a way that there is no ambiguity that will confuse third
parties such as applicants, insureds or policyowners.

Consumer Protection and Ethics

Like all businesses, the insurance industry is subject to laws designed to protect consumers
from unethical or illegal practices. Insurers, their employees and agents must abide by the
general consumer protection statutes that apply to all businesses as well as any consumer
laws specifically directed toward the insurance business. Most consumer protection laws
include a list of deceptive or otherwise illegal practices that specify, without being all-
inclusive, certain forbidden actions. Insurers and other businesses are expected to follow not
only the letter of these laws, but also the spirit. In this section, we will discuss regulations
that apply directly to the business of insurance.



                                             178
Unfair Trade Practices

Most states have adopted regulations recommended by the National Association of Insurance
Commissioners (NAIC) regarding unfair trade practices. The practices listed below are
included in NAIC's model.

Unfair Discrimination

In the context of insurance, unfair discrimination refers to:

        *Refusing to issue or renew, or canceling or declining a policy because of
         someone's (1) sex-or sexual preference in a few states; (2) marital status;
         (3) handicapped condition.

        *Limiting the availability of benefits or modifying benefits, rates, terms,
         conditions or types of coverage based upon any of the three items mentioned
         previously, unless any restrictions or modifications are based upon strict
         actuarial principles.

Rebating

In most states, it is illegal for insurance agents to be involved in rebating, which is offering
or giving something of value-other than the insurance policy itself-to an individual as an
inducement to buy insurance. A rebate could take many different forms, from a return of part
of the premium to splitting the agent's commission to receiving cash or a valuable gift. It is
also illegal for the insurance buyer to accept a rebate.

Illegal Policy Replacement

In some cases, a policyowner can benefit from replacing one insurance policy with another,
but in many cases the policyowner stands to lose a great deal by replacement. An agent who
convinces a consumer to drop one policy in order to buy another, without clearly explaining
any disadvantages and/or by misrepresenting facts to the policyowner's detriment, is guilty of
illegal policy replacement.

Policy replacement is illegal when an agent uses deception in order to gain the sale for his or
her own benefit without regard for the policyowner. Some potentially negative consequences
for life insurance policyowners are the loss of significant cash values, the inability to get the
same amount or type of coverage for the same premium rate, payment of new sales
commissions and administrative fees, and reinstatement of the contestable and suicide
exclusion periods.

                                           179
Agents sometimes must follow very stringent rules to ensure that policy replacement is legal,
including fair and direct comparisons of features and benefits and exactly how the agent
derived the comparisons. In some states, comparisons must be made in writing, signed by the
applicant as an acknowledgment of having received the written information, and copies must
be left with the applicant. Additionally, agents may be required to notify both the new insurer
and the insurer of the older policy that replacement is being considered.

Misrepresentation and Fraud

Agents who are guilty of illegally replacing a policy often do so by engaging in
misrepresentation and fraud-and these practices are also forbidden under any other
circumstances. Misrepresentation and fraud go hand-in-hand since agent misrepresentations
are assumed to occur for the purpose of defrauding the applicant or insured (and in some
cases the insurer). Specifically, agents may not misrepresent facts to consumers about the
policy being offered or about the financial condition of the insurance company that issues the
policy. Misrepresentation can occur orally or in writing, including any type of general
advertising, or during personal contacts.

Misrepresentation can also occur by virtue of an agent's failure to tell consumers something
they should know in regard to the life or health insurance sale or the policy. By omitting such
information that should have been disclosed, whether intentionally or unintentionally, agents
may find themselves liable for subsequent damage to the insured. For example, suppose an
agent tells a client that she may skip premiums for her universal life policy, but does not tell
her that doing so when there is little cash value can ultimately result in lapsing the policy.
Then, when the insurance company notifies her that her policy is about to lapse, she does not
have the cash to make a premium payment and loses the policy. The client can claim that the
agent is legally liable for her loss of the policy because the agent failed to disclose the
potential for losing the policy. This is an example of misrepresentation by omission.

Defamation

Another form of misrepresentation could occur in the defamation of competitors by an
agent. Because you are a representative of the insurance business, you should avoid showing
disrespect for your competition. In addition, you must avoid going beyond disrespect to
participate in this illegal act. Defamation is making false or malicious statements for the
purpose of harming another's reputation. This is an issue in consumer's rights because
defamatory comments might be made in the context of convincing someone to buy one
company's policy rather than the policy sold by another insurer or agent.




                                             180
Boycott, Coercion and Intimidation

Acts or agreements that use boycott, coercion or intimidation for the purpose of creating a
monopoly or unreasonable restraints in the insurance business are also unfair trade practices.
These three actions cover a great many possible illegal practices that could be directed
toward the consumer or toward other insurers or agents.

Advertising

Each state insurance commissioner is responsible for monitoring insurer-advertising
practices, in general, insurance advertising must be truthful and it must neither deceive nor
mislead the average consumer. Most states follow the National Association for Insurance
Commissioner's advertising standards, which include very specific practices to be followed
or avoided.

Misuse of Funds

The discussion about agents' fiduciary responsibilities indicated that misuse of funds, such as
premiums, is illegal. In fact, one of the unfair trade practices involves failing to remit
premiums to insurers or to refund premiums to applicants or to deliver claim monies. Agents
have a limited amount of time during which they must forward funds to the proper places or
face losing their licenses. Remember, monies intended for premiums or any use aside from
the agent's own legal use may not be commingled with the agent's own funds unless the
insurer authorizes the agent to retain commissions from premium payments and send the
balance to the insurer.

Another unfair trade practice addresses unfair claim practices, forbidden when a claim is
made against a policy. These are discussed in the following section.

Unfair Claim Practices

Although technically part of unfair trade practices statutes, unfair claim practices are
presented separately because they are specifically related to what occurs after a policy is in
force, when an insured files a claim. For life insurance policies, this is a once-in-a-lifetime
act. For health insureds, however, claims can arise frequently.

Again, the National Association of Insurance Commissioners has produced a model that is
used in whole or in part by all states. A few states have modified the exact language and/or
dropped or added specific items. Following is a paraphrased summary of prohibitions
frequently found in states' unfair claim practices laws, which apply to all types of insurance
transactions.

                                           181
1.     Misrepresenting pertinent facts or provisions about the particular coverage.

2.     Falling to acknowledge and act promptly after receiving communications about a
      claim.

3.    Failing to adopt and implement reasonable standards for promptly investigating
      claims.

4.    Refusing to pay claims without conducting a reasonable investigation.

5.    Failing to affirm or deny coverage within a reasonable time after receiving proof of
      loss statements.

6.    When liability has become reasonably clear, not attempting to settle claims promptly,
      fairly and equitably.

7.    Attempting to settle claims for less than a reasonable person would have expected by
      reference to written or printed advertising that accompanied or was made part of an
      application.

8.    Making claim payments without including a statement that sets forth the coverage
      under which payments are being made.

9.    Attempting to compel claimants to accept settlements or compromises less than an
      amount awarded in arbitration by describing an insurer policy of appealing arbitration
      awards in favor of insureds or claimants.

10.   Delaying investigations or claim payments by requiring an insured. claimant or
      physician to submit a preliminary claim report and a subsequent formal proof of loss
      form, both of which contain substantially the same information.

11.   Failing to promptly settle claims where liability is reasonably clear under one portion
      of a policy in order to influence settlements under other coverages in the policy.

12.   Failing to promptly provide a reasonable explanation of the factual or legal basis in
      the insurance policy for denying the claim or for offering a compromise settlement.

13.   Attempting to settle claims based upon an application for insurance that was altered
      without knowledge or consent of the insured.



                                          182
14.   Failing to adopt and implement reasonable standards for processing and paying
      claims once the obligation to pay has been established.
15.     Failing to expeditiously honor drafts given to settle claims.

Because states have discretion to use any or all of NAIC's model and may adapt the wording
and add or delete items, it is important for you to learn exactly what is included in the unfair
claim practices statutes where you do business.

Delivering the Policy

Delivering a new life, disability income or health insurance policy gives agents the
opportunity to reinforce the purchaser's good decision in buying the policy and to review the
policy's features. This is a very important time because if an individual is going to drop an
insurance policy, he or she usually does so very early in the life of the policy. In addition, in
the rare cases where the first premium was not paid with the application, it is the agent's
responsibility to collect the premium along with a statement from the insured person that he
or she is still insurable.

Policy Summary

Insurers usually must provide a policy summary along with the policy itself. Agents may use
the summary to highlight certain features of the policy and point out how the insured may
contact the agent or company, then review other important features they might wish to
emphasize. A policy summary is likely to be a single sheet providing basic information such
as:

        *The insureds name.
        *The name of the type of insurance purchased (as opposed to a special name the
         particular insurer has assigned to the policy).
        *The names of any types of riders attached to the policy.
        *The policy form number, which is the legal designation under which the policy was
         filed with the state insurance department.
        *The policy number (account number) the insurer assigns to the individual insured
        and his or her particular policy.
        *The effective date of the policy and riders.
        *The total annual premium and usually other modal premiums.
        *The life insurance policy loan interest rate.
        *Benefit options selected by the insured on disability income and other health
         policies, such as: deductibles, coinsurance, elimination periods, benefit periods, etc.


                                             183
Taking time to review the policy summary and the policy itself helps cement the developing
relationship with a new client, while explaining features of the policy that are of particular
interest to the client. For example, agents should explain Items that affect the client on an
ongoing basis, such as how the grace period works, how dividends are paid when applicable,
when yearly reports are sent for a universal life policy, how to file a claim for disability or
medical benefits, and similar information. This is also an opportunity to practice and
demonstrate the professional knowledge and skills that are so important in the insurance
business.

Protection for the Insurance Professional

People such as insurance agents, physicians or attorneys who offer professional services to
the public are expected to perform at a level somewhat above common standards. For
example, if you give poor advice to a friend about what to do for a toothache, but you are not
a dentist, you are held to a lower standard than if a dentist gave bad advice. The same is true
of a nonprofessional giving advice about financial matters, such as insurance. On the other
hand, the public holds professionals responsible for performing at a much higher level of
expertise and if those professionals make mistakes, as all humans do occasionally, they are
held legally liable for those mistakes.

Errors and Omissions (E&O) Insurance

Insurance agents can protect themselves against the possibility of being found legally liable
for costly mistakes with Errors and Omissions (E&O) Insurance. E&O Insurance for
agents is similar to malpractice insurance or professional liability insurance for doctors and
lawyers. Obviously, it's preferable to avoid the mistakes that might lead to a lawsuit, but
again, errors occur and the cost of E&Q Insurance is small compared to the potential cost of a
liability lawsuit settled out of your pocket.

Most mistakes can be avoided if you know and follow the law; communicate with your
clients-informing and listening; and stay up to date with changes in the insurance business
and legal environment. Earlier in this chapter, we mentioned how an agent may become
legally liable for loss to a client by omitting information that should have been given to a
client. In addition, experience demonstrates that agents have most often had liability
problems because they failed to do one of three things: (1) Match the coverage with the
client's needs; (2) Suggest and acquire adequate insurance: (3) Maintain the client's coverage
by allowing a policy to lapse without the client knowing it.

While E&O Insurance does not protect an agent who willfully, knowingly or fraudulently
causes harm to an insured, the coverage is invaluable for handling the legal consequences of
inadvertent mistakes.

                                             184
A Final Word

We come now to the end of this chapter and the end of the textbook. Maybe you've noticed
that the word "ethics" has appeared only a few times, yet we've chosen to title the chapter
"Ethical Issues. Although we haven't overused the term itself, we hope you have seen the
"thread" of ethics woven throughout this chapter as we discussed the professional
characteristics of agents as well as rules and regulations that guide the life and health
insurance business.

An important point about ethics is that, while ethical behaviors can be taught and unethical
behaviors can be punished, whether or not someone chooses to act ethically is, finally, a
choice. And while penalties may apply for violating the letter of the law, in fact, it is the
spirit of the law that most closely reflects ethical actions.

Similarly, it is the spirit with which an agent approaches the insurance business that inspires
ethical integrity.


Chapter 11 Review Questions

As your final review, please complete these exercises.

1.     Which of these is an important quality an insurance agent is expected to develop and
       offer clients? (knowledge/skills/service/all of these)


2.     Responsibilities of insurance agents that involve making financial recommendations,
       selling financial products and handling money are called (consumer/fiduciary/E&O)
       responsibilities.


3.     The type of authority that is granted in an agency contract is called
       (actual/apparent/implied) authority.


4.     The insurance industry is subject to (choose one item):

       a.    consumer protection laws specific to the insurance industry.
       b.    general consumer protection laws.
       c.    both a and b above.


                                           185
5.     The unfair trade practice of refusing to issue an insurance policy solely because of
       someone's marital status is known as (unfair discrimination/intimidation/coercion).
6.   When an agent delivers a policy, the Insurer typically includes an additional item that
     briefly describes certain identifying features of' the policy. This is called the policy
     (replacement/summary).




                                    Answers

                                    1.      all of these
                                    2.      fiduciary
                                    3.      actual
                                    4.      c is correct
                                    5.      unfair discrimination
                                    6.      summary




                                          186

								
To top