How Disability Insurance Works

Disability insurance provides a percentage of an employee’s income if they suffer a non-work-related illness or injury and are unable to work, whether short-term or long-term. 

Your business may offer disability insurance coverage benefits to protect employees and provide peace of mind in the event of disability.

Does your business have general liability coverage? Learn more about general liability insurance in our Best Small Business Insurance review.

What is Disability Insurance?

An injury or illness suffered off the job that prevents someone from working happens fairly frequently. According to the Social Security Administration, more than 25% of people in their 20s will suffer a disability lasting at least 90 days before they turn 67.

There are many types of injuries that could lead to short- or long-term disability. These include spinal cord injuries, heart attacks, back injuries, and illnesses such as diabetes and cancer. 

Disability insurance for small business can give employees peace of mind knowing that a minor injury, or even major surgery, won’t send them into financial ruin. A small business disability policy will ensure that employees are entitled to receive a portion of their income until they are able to return to work, even if the injury is not work-related.

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What Does Disability Insurance Cover?

Every disability insurance policy will have information about circumstances that affect employee benefits. These include:

  • The premium amount - Like other types of insurance policies, disability insurance requires paying a monthly premium to remain active.
  • What constitutes a disability - Different policies have different requirements for the types of disabilities they cover. Some policies cover injuries that keep you from working at the job the employee used to have, even if you can do another job for less money. Other policies only provide benefits if an employee is unable to work at all.
  • Benefit amount - Depending on the specific policy, employees can expect to earn about 60% to 80% of what they earned before they were injured.
  • Benefit duration - Like all insurance benefits, disability benefits are limited in duration. They may last for a few months, a few years, or until an employee reaches a specified age.

How Does Disability Insurance Work?

Disability insurance doesn't just cover injuries like a broken bone or sprained ankle. It also covers illnesses like cancer, depression, diabetes, heart disease, or anything else that prevents an employee from working.

There are several types of disability insurance:

  • Short-Term Disability Insurance
  • Long-Term Disability Insurance
  • Social Security Disability Insurance
  • State Disability Insurance

When an employee becomes injured and is unable to work, they will need to file a claim with their disability insurance company to begin the process of getting benefits. 

The insurance provider will request details about their injury, documentation from a medical provider, and other information to determine whether or not the employee’s injury meets the requirements for obtaining benefits.

Employees are typically responsible for submitting their own claims and following up with necessary documentation to receive their benefits.

The time it takes to apply for, process, and approve a disability insurance claim will vary, but employees are usually able to receive benefits in just a few weeks. Once a claim is approved, employees will begin to receive a certain percentage of their income for the duration of their recovery up to a predetermined term limit. 

While disability insurance covers an employee that is injured in general, a separate type of insurance policy, workers' compensation insurance, is intended to cover an employee's medical expenses and other financial losses if they are injured on the job. Most employers choose to maintain both types of coverage so that their employees are fully protected in the event of any injury.

Types of Disability Insurance

Now that we’ve explained how disability insurance works, let’s dive into the specific types of disability insurance.

Short-Term Disability Insurance

Short-term disability insurance provides benefits if you suffer a temporary illness or injury. Employer group plans usually provide short-term disability insurance.

Although this type of policy is available on the open insurance market, it often isn’t worth the money. You typically receive 40% to 60% of what you made before you became disabled, and benefits usually last no more than a year. As a result, the premiums may end up costing more than the benefits.

Musculoskeletal disorders, mental health problems, digestive disorders, and pregnancy are the most common reasons people file short-term disability claims.

Long-Term Disability Insurance

Long-term disability insurance provides benefits if you suffer a long-term illness or injury that prevents you from working for months or years. The type of policy provides benefits until the disability ends or for a set period of time, such as 10 years or up to age 65.

This type of disability insurance can be purchased through a group plan or on an individual basis. Although it’s more expensive than short-term disability insurance, most experts agree that it’s worth more in the long run because benefits are much higher – about 60% to 80% of the income you earned before becoming disabled.

Long-term disability claims are most frequently filed due to cancer, mental health problems, serious injuries, musculoskeletal disorders, and pregnancy.

Social Security Disability Insurance

Social Security Disability Insurance (SSDI) is a disability insurance program administered by the Social Security Administration. SSDI has stringent eligibility requirements that not everyone can meet. For example, you must:

  • Work for enough time and recently enough in a job covered by Social Security
  • Become disabled according to the Social Security Administration’s definition
  • Meet specific income requirements

State Disability Insurance

Five states, including New Jersey, New York, Rhode Island, California, and Hawaii, require employers to offer disability insurance coverage to their employees. These plans have significant coverage and benefits limitations that are specific to each state.

Cost of Disability Insurance for Small Business

The cost of disability insurance is set per employee and based on their unique situation. Typically, disability insurance costs about 2% of an employee’s annual salary. However, the exact amount depends on a variety of factors, including:

  • Age: As with life insurance, older people pay more for disability insurance, all else being equal. This is simply because older people are more likely to become ill or injured.
  • Gender: Unlike with life insurance, men pay up to 40% less than women for disability insurance because they file fewer claims on average.
  • Medical history: Just like a health insurance policy, a disability insurance policy will charge higher premiums for someone with a problematic medical history. If you have used or are using tobacco, have a chronic disease or a family history of one, are overweight, or have other medical issues, you will pay more for disability insurance.
  • Occupation: More dangerous occupations, such as construction workers, police officers, and firefighters, have higher disability insurance premiums. In addition, someone who has a physical job that can't be done in a wheelchair while recovering from an injury will pay more for disability insurance.
  • Annual income: Because disability insurance benefits are proportional to your annual salary, the more you earn, the more you will collect in benefits, and thus, the higher your premiums will be.
  • Place of residence: If you live somewhere with more stringent regulations, a higher number of annual claims, and/or a higher cost of living, you will have higher disability insurance premiums.

Does My Business Need Disability Insurance?

If your business has employees, it is highly recommended that you maintain disability coverage for your employees. Disability insurance is a perk that many employees will appreciate, as it provides peace of mind that they will still have income if an injury or illness prevents them from working. Business owners can be covered by disability insurance as well.

That said, small business owners are only required to provide disability insurance for their employees in New Jersey, New York, Rhode Island, California, and Hawaii. Instead, most other states only require small businesses to carry workers' compensation insurance for work-related injuries if they have employees.

How to Get Disability Insurance for a Small Business

To purchase disability insurance as a small business owner, you normally must show that your business has made a profit for at least the past two years. This information, on which the disability coverage amount will be based, probably will require producing tax returns.

There are some exceptions to the rule above, including:

  • Your business has signed contracts that show it will make a certain amount of income in the future.
  • Your previous job and current business are in the same industry.
  • Your business is in a field that has a high earning potential, such as the fields of medicine, law, accounting, or architecture.

Note that disability insurance won't help pay employees' salaries, rent, utilities, and other overhead costs if a small business owner becomes ill or injured and can no longer operate the business. Instead, business interruption insurance may provide coverage for these types of situations.

Disability Insurance FAQs

How much does disability insurance cost?

The cost of disability insurance depends on a number of factors. On average, employees can expect to pay about 1% to 4% of their annual salary for a disability insurance policy. Determining factors can include your age, gender, medical history, occupation, annual income, and place of residence, as well as whether you get a short- or long-term policy.

What is not covered by disability insurance?

Work-related injuries aren't covered by disability insurance. Instead, they're covered by workers' compensation insurance. Certain other situations that can cause disabilities typically aren't covered either, such as committing crimes, being injured in prison, fighting in a war, or intentionally injuring yourself.  Additionally, if you're over 65, you may not be eligible for disability insurance, or it may be unaffordable. Pre-existing medical conditions may also be excluded from coverage in some policies.

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