Advantages and Disadvantages of Group Disability Income Insurance
Updated: May 1, 2021
Four (4) advantages and fifteen (15) disadvantages of group disability income insurance.
Ever wonder why employers pay for disability insurance when so many employees don't seem to care? In short, it isn't just for the employees.
When workers develop a medical condition, too often those employees try to work through it when they really shouldn't. The consequences of underperformance, especially due to bad decisions, can be extremely costly to the business. These costs include:
loss of key clients to competitors
slower production due to the need to revise work
team culture problems (especially if the cause is psychological)
the ongoing drain on payroll
Eventually it becomes clear that it would have been in everyone's best interest to go their separate ways. But that's hard to do when the cause of underperformance is medical in nature, because terminating sick employees just as they're about to lose their house is bad juju and invites litigation.
To get out of this jam, employers have disability insurance. From the standpoint of the business, the most important reason to have disability insurance is to get unhealthy, underperforming employees off the payroll without firing them.
One of the decisions businesses face when designing a disability insurance program is whether group disability insurance should be used to cover all earnings or whether to blend in a portion of individual disability insurance for a portion of it. Individuals who are transitioning to employee status may face a related question which is whether they should keep their individual disability insurance if their new employer offers group insurance, because they may appear redundant (they are not). So, let's look at the advantages and disadvantages of traditional group disability insurance.
Advantages of Group Disability Insurance
relative to individual disability insurance
Employees don't need to do anything to be covered if it's employer-paid. Coverage is automatic by virtue of membership in the eligible employee class, which the employer administers without employee cooperation.
Employees can qualify regardless of medical, financial or occupational risk considerations. While individual policies can match this on the most important points, under what is called a Guaranteed Standard Issue (GSI) underwriting program, group insurance is unique in that it disregards other existing coverage and other individually specific risk factors.
Ultra-streamlined administration and communication is greatly aided by uniformity of policy language for all members and the use of a single composite rate. As a result, group disability insurance integrates very well with enrollment and HR platforms.
The cost is low if it's employer paid - usually less than 1% of payroll, and for larger groups 1% would actually be considered high.
Disadvantages of Group Disability Insurance
relative to individual disability insurance
Having group insurance tends to make employees complacent about whether they are actually protected in the way they want, or whether they have enough. When it comes time to file a claim, employees are often surprised to learn that group Long Term Disability (LTD) insurance is intentionally designed not to be enough, and achieves this through the use of formulaic adjustments to the benefit. At the same time, employees overlook how their needs will change at the time of claim, especially regarding medical premiums and expenses which, because they are no longer an active employee, must be funded without employer financial support. Retirement contributions some to a halt, too. Employees grossly underestimate how much benefit they will need because the existence of group insurance is an excuse to ignore the subject, on the assumption the employer has taken care of it.
Group disability insurance eligibility is typically reduced or cancelled when the employee cuts back due to gradually declining health because the benefit is a function of earnings immediately prior to claim, not a function of average earnings over the last few years. A recent dip in earnings, even if due to poor health, will reduce the benefit payable. Reduced earnings is closely related to loss of employment due to underperformance, which results in the loss of coverage just before it's needed. Group insurance works best in sudden transitions from full time work to not working at all, as opposed to gradually deteriorating situations.
A voluntary, employee paid group program may not be sustainable. If participation drops below the minimum threshold, employees who signed up will lose their coverage.
Employees typically do not have the choice to work fewer hours without losing eligibility, at least not for longer than a few months.
Pre-existing conditions are typically excluded during a person's first year of coverage. This is problematic for new recruits who just expect to be covered without looking under the hood, and many employers don't realize the problem either. While prior credit clauses are standard, it doesn't apply to new hires.
The definition of disabled (or disability) generally requires exhaustion of work modification options before claims will be paid. This is true even with high quality group policies. If that doesn't get the carrier out of a claim, the carrier can usually wait until the claim is two (2) years old, when the definition of disability usually changes to "any" occupation. At that point, the insurer has much more room to be creative.
Group insurance does not allow moonlighting while disabled from one's own occupation...at least not without penalty or restriction. The issue here is whether an individual who is disabled from their own occupation can work in a different occupation and still collect full disability benefits, other than as a temporary incentive. A policy that allows this level of freedom is called true own occupation disability insurance. Why would this be important? Because the ability to moonlight in a different occupation can be a key factor in persuading certain highly driven employees who work for their own sense of self worth and fulfillment to take the disability option. Highly compensated employees and workaholics especially often do not see themselves as "disabled" even when it is plainly obvious that a medical condition has made them less capable. The only way they will accept it is if they are allowed to do something else. The way group insurance works, it's hard to persuade workaholics to leave their post. That's too bad because workaholics (especially those with mental and substance abuse issues) have the potential to cost the business the most money through their high salaries and bad decisions.
Group insurance generally contains special limitations on the duration of benefits for specific types of claims which historically present a high risk for the insurer. Mental/psychological and substance abuse limitations are ubiquitous with group insurance, but not individual insurance. Some group policies limit claims for other special conditions like environmental, musculoskeletal and self-reported subjective claims such as pain. If the claim is subject to one of these special limitation categories, the claim is usually limited to two (2) years instead of Normal Social Security Retirement Age.
Benefits are pegged to recent earnings, which can be very bad for workers coming off of a low earnings year, as benefits would be permanently lower.
Variable earnings are usually not covered by group LTD and neither are earnings over a certain amount. So, 60% could pencil out to 25% or so, after the formulaic adjustments are applied. Self employed members, however, can usually get net income insured if the policy is configured for that.
The benefit is reduced by Social Security Disability Income (SSDI) benefits (if available) and often is taxable. After offsets and tax withholding are thrown in, what the worker thought was going to be a real benefit is suddenly vaporized. Additionally, such integration imposes a rather significant headache through compulsory application to Social Security and paying back the overpayments.
Upon being medically released, ongoing loss of income is the employee's problem. Ongoing loss of income happens for several reasons. First, residual performance deficits may persist. Reduced capacity to perform may be somewhat subjective, but for highly compensated workers even the most subtle residual deficit can have a significant impact on productivity. Another reason: bonuses may not be paid for another year or two after returning to work because they are paid only annually and require time on the job to satisfy performance thresholds. A final reason may be that clients have defected while the worker was out, and it may take time to rebuild. Group insurance is not designed to insure against these types of economic losses because they are incurred after the disability has passed. To insure against income loss due to prior disability as well, only a properly configured individual policy will do.
Group insurance financially disqualifies employees from acquiring additional individual insurance. This comes into play only for certain workers that value high quality disability insurance but the employer doesn't want to pay for it. Disqualification does not mean that benefits are denied. It means that an applicant will not qualify for a policy that is as large as he or she wants in the first place. Instead, they qualify for a smaller policy because, in the eyes of an individual disability insurance company, each worker has a finite amount of insurable "room" which is a function of current earnings minus other existing coverage. If that insurable space is filled with the low quality group insurance, it acts like packing peanuts, leaving less room for the kind of coverage the employee needs. There is nothing the employee can do about it. It is not possible for employees to acquire individual insurance that is redundant with group insurance because insurance companies won't allow it. Insurers even ask about other coverage the employee is eligible for (whether actually covered or not), or will soon become eligible for. Effectively, employees are stuck with whatever the group has on offer, and can only augment it to the degree a gap exists. To be fair, group insurance poses no disadvantage to individuals who purchased a policy prior to group insurance coming into effect (acquiring coverage in that order - with group coming in behind individual - allows the employee to enjoy both), nor does group insurance harm employees who wouldn't purchase individual insurance anyway. The harm comes from having low quality group insurance because it gets in the way of individuals acquiring better stuff on their own.
The employer has to administer billing and employees cannot pay their cost directly. Furthermore, if employer has all of the responsibility and employees are in no position to take over the reigns. If the employer goes out of business or just doesn't pay the bill, the employee cannot call the insurance company and ask to be billed directly. Coverage would be cancelled. Furthermore, employers have to stay on top of compensation fluctuations and make sure the volume is being reported in a timely fashion and charged for, otherwise a disabled employee will not receive the proper benefit amount.
Rates can go up.
Group disability insurance is designed to provide basic coverage for the masses at minimal cost and maximum convenience. It's uniformity makes it the easiest way for businesses to ensure that there will be at least one option to get sick employees off the payroll, which may be all the business needs. But for individuals, group insurance goes only part of the way due to the need for financial security and choice. To the extent that individual financial security and choice matter, individual disability insurance should comprise a larger portion of a person's total coverage, although not necessarily at the employer's expense.