Long-Term Disability (LTD)
An extended illness or injury can create a significant financial hardship. Although employees will often express a greater demand for more visible benefits, a Long-term Disability benefit is far more important in protecting the financial well-being of employees. Very few employees will ever be forced to sell their homes because they need eyeglasses or dental work. However, a loss of income can have much more serious repercussions.
The main design features of a Long-Term Disability plan are described below.
The elimination or waiting period is the period of time that the claimant must be disabled before receiving benefits. The most common elimination period is 17 weeks so that the LTD benefit integrates with the Employment Insurance (EI) plan. However, the elimination period may be as short as 3 months and as long as one year. The length of the elimination period has a direct impact on the LTD premium as a longer elimination period will result in fewer claims. For plans that include a Short Term Disability benefit, the Long Term Disability plan is designed so that the elimination period ends and benefits begin as soon as Short Term Disability benefits cease.
The benefit schedule is generally based on a percentage of the employee's pre-disability gross earnings. When determining an appropriate benefit schedule, the tax status of the LTD benefit must be considered. Unless the plan member is paying the entire LTD premium, the benefit will be taxable when received.
An LTD plan which is taxable should be based on a higher percentage of the employee's pre-disability gross earnings than a plan that is non-taxable. A taxable LTD plan will often be based on a schedule as high as 75% of pre-disability gross earnings whereas a non-taxable plan will generally not exceed 67%.
When determining an appropriate benefit schedule, it is also important to consider the plan's "All Source Maximum". The purpose of the all source maximum is to prevent situations in which an employee's total income (from all sources), while disabled, comes too close or exceeds his/her pre-disability earnings effectively eliminating the financial incentive for the employee returning to work.
Based on the all source maximum definition, the LTD benefit payable will include all direct offsets (WSIB benefits and CPP/QPP disability and retirement benefits) and indirect offsets (automobile insurance plan benefits, group or association insurance plans benefits, retirement or pension plan benefits, etc.). Therefore, when calculating the benefit a disabled employee is eligible for, income from the following sources will be included under the all source definition: Workplace Safety and Insurance Board benefits, Canada or Quebec Pension Plan disability and retirement benefits, automobile insurance plan benefits, group or association insurance plans benefits, retirement or pension plan benefits, earnings or payments from any employer, self-employment income, and earnings from any government plan excluding Employment Insurance benefits.
When the total income received exceeds the all source maximum, the benefit payable is reduced by the excess amount. For taxable benefits, the all source maximum is generally based on 85% of pre-disability gross earnings. For non-taxable benefits, the all source maximum is usually based on 85% of pre-disability net (after-tax) earnings.
In the case of non-taxable LTD plans, it is often useful to use a graded benefit schedule to avoid paying for a disability benefit that is in excess of the maximum benefit that can be received (as a result of the 85% all-source maximum). For example, a common schedule would be 66.7% of the first $2,500 of gross monthly insurable earnings and 50% for all earnings in excess of $2,500. Otherwise, employees may be paying for an LTD benefit beyond that which they are eligible to receive.
There are two types of maximums that apply to an LTD benefit: a non-evidence maximum and an overall benefit maximum. These maximums are determined by the size of the group, the volume of insurance and the nature of the business.
The non-evidence maximum (NEM) is the amount of insurance that the insurer will provide to employees without providing medical evidence of good health. A high non-evidence maximum is therefore an important feature of the LTD plan as it guarantees employees a minimum level of coverage (subject to eligibility based on income). For employees who are eligible for coverage in excess of the non-evidence maximum, medical evidence must be provided to the insurer. The insurer will generally grant the excess coverage only to those individuals who are determined to represent a normal level of risk.
The overall maximum is the maximum amount of insurance that the insurer will provide under the terms of the contract.
The benefit period is the maximum amount of time for which LTD benefits are payable. The most common benefit period is to age 65. However, benefit periods of two and five years are not uncommon. The longer the benefit period, the larger the insurer's liability and therefore the higher the premium.
Definition of Disability
The definition of disability is perhaps the most important element of the Long Term Disability contract. There are two basic definitions of disability, both relating to an individual's ability to work: own/regular occupation and any occupation.
Under the own occupation definition of disability, an individual is considered disabled if he/she is determined medically to be unable to perform the essential duties of his/her own/regular occupation.
Under the any occupation definition of disability, an individual is considered disabled if he/she is determined medically to be unable to perform the essential duties of any occupation for which he/she is reasonably qualified by training, education or experience.
The most common plan provides coverage based on the "own/regular occupation" definition for the first two years (after the elimination period) and reverts to a "any occupation" definition thereafter. Under the first definition, own/regular occupation, it is far easier for an employee to meet the eligibility requirements for disability. It is therefore very common for an individual to receive disability benefits under the "own/regular occupation" definition and have them cease when the "any occupation" definition comes into effect.
Most insurers will provide LTD coverage with an "own/regular occupation" definition available for the first 2-5 years. A few insurers have this definition available up to age 65. The less restrictive the definition, in other words, the longer the period with an "own/regular occupation definition", the higher the premium.
Partial and Residual Disability Benefits
These benefits are not generally part of the standard LTD contract of most insurers, but are available as an option.
The partial disability benefit provides coverage to an individual who qualifies for the total disability benefit and is able to work in a reduced capacity. Generally, benefits are payable if the individual has a loss of income exceeding 15-20% compared to his/her indexed pre-disability earnings. The eligibility for partial disability benefits is linked to the definition of disability. For example, if the "any occupation" definition of disability is applicable, an individual will be eligible for partial disability benefits if his/her earnings capacity in any occupation is reduced by at least 15-20% due to the disability.
The residual disability benefit pays a specific percentage of insured earnings in contrast to the partial disability benefit which varies and is based on a percentage of loss of income. The residual benefit is payable if a disability lasts at least as long as the initial assessment period (usually at the end of the two year own occupation period) and prevents the individual from being fully employed. Residual disability payments begin after the total disability period ends. The benefit is reduced only if the individual's income from all sources (including the residual benefit) exceeds 100% of the employee's pre-disability income.
Cost of Living Adjustments (COLA)
Disability benefits are generally based on a fixed percentage of pre-disability earnings. For lengthy disabilities, inflation can substantially diminish the value of the benefit. To reduce the impact of inflation, many companies offer a Cost of Living Adjustment option. COLA provides for indexing of the disability payment based on the Consumer Price Index (CPI). Generally, there is a maximum annual adjustment (e.g. 3-6%).