What Is the Purpose of Disability Insurance?

Disability insurance is a financial product designed to provide income when an individual is unable to work due to a qualifying disability. This type of insurance helps to protect an individual’s earning capacity.

Understanding Disability Insurance

Disability insurance provides a regular income stream when an individual cannot perform their job duties due to illness or injury. It is distinct from health insurance, which covers medical expenses. This financial protection ensures a portion of lost income is replaced, allowing individuals to maintain financial stability even when they are not actively working.

Addressing Income Loss

An individual’s income is often their most valuable financial asset, supporting daily living expenses and long-term financial goals. A sudden inability to work due to disability can severely disrupt financial stability, impacting everything from mortgage or rent payments, utilities, and food costs to contributions to savings and retirement accounts. Disability insurance replaces a portion of that lost income, preserving financial continuity when earnings cease. For example, policies typically replace between 60% and 80% of a person’s monthly salary. This financial bridge allows individuals and families to meet ongoing obligations, such as credit card payments, auto loans, student loans, and even childcare expenses.

Core Components of Coverage

Disability insurance policies include specific components:

• The “definition of disability” outlines the conditions under which benefits are paid. Some policies use an “own occupation” definition, meaning benefits are triggered if an individual cannot perform the duties of their specific job. Other policies may use an “any occupation” definition, which is a more stringent standard, requiring an individual to be unable to perform any job for which they are qualified by education, training, or experience.
• The “waiting period,” also known as the elimination period, is the time an insured person must be disabled before benefits begin. This period acts like a deductible measured in time, and it can range from a few days to several months, commonly 90 days for long-term policies.
• The “benefit period” determines the maximum length of time for which benefits will be paid. This can range from a few years to potentially reaching retirement age, such as 65 or 67.
• Finally, the “benefit amount” specifies the percentage of pre-disability income that the policy will replace, typically ranging from 50% to 80%.

Different Forms of Protection

Disability insurance is broadly categorized into two forms based on the duration of income protection they offer. Short-term disability (STD) insurance is designed to replace income for temporary disabilities, typically ranging from a few months to a year. This form of coverage helps bridge income gaps for conditions like recovery from surgery or a temporary illness. Long-term disability (LTD) insurance, in contrast, provides income replacement for extended periods, potentially years or even decades, for severe or permanent disabilities. This policy protects against disabilities that prevent an individual from working for an extended duration, sometimes until retirement age. Both forms provide income replacement for different durations of incapacity.