The financial consequences of becoming disabled can be devastating if pharmacists lack proper financial planning.
As an attorney dedicated to representing disabled professionals with individual disability insurance (IDI) and long-term disability (LTD) insurance matters, I am often in the unenviable position of informing clients of the deficiencies in their coverage. Such was the case during a recent consultation with a pharmacist who was forced to cease working due to an orthopedic disorder affecting his physical and cognitive function.
Prior to becoming disabled, he was employed by a prominent local pharmacy chain. His base salary was $120,000 per year; however, his employment contract included a provision that provided up to $40,000 per year in additional compensation
Like many of the pharmacists I have come to work with over the years, he was approached early on in his career by a financial advisor who attempted to sell him an IDI policy with true own occupation coverage and a future increase option rider. He explained that he declined to obtain an IDI policy because his employer provided an employee benefit package that included an employer-sponsored LTD plan.
The pharmacist explained that he did not know the difference between IDI policies and LTD plans; however, he declined to obtain a separate IDI policy because his employer paid 100% of the LTD plan premiums. He stated that he did not see a benefit in having 2 disability insurance products, especially when he would be responsible for paying the premiums for an IDI policy.
As will be outlined below, this decision significantly compromised his financial security when he became disabled and ceased working.
Why is Disability Insurance Important?
Statistics show that 25% of pharmacists will cease practicing prematurely due to a disabling medical condition.1 The financial consequences of becoming disabled can be devastating if pharmacists lack proper financial planning. Specifically, studies indicate that 38% of disabled pharmacists will struggle to pay their normal living expenses within 3 months of losing their regular income.2 These studies also indicate that approximately 65% of disabled pharmacists will be unable to pay their normal living expenses within a year of becoming disabled.3
To avoid significant financial hardship, it is recommended that pharmacists obtain disability insurance that provides a net benefit equal to 60% to 70% of their gross earnings. This general rule accounts for the applicability of tax consequences. However, as will be outlined below, there are a number of factors that can affect a pharmacist’s perceived disability coverage.
The Difference Between IDI Policies and LTD Insurance Plans
Not all disability insurance products are created equal and this is certainly true when assessing the differences between IDI policies and LTD plans. Although IDI policies vary by company and the coverage elected, the insured/pharmacist controls the coverage they seek to obtain.
Specifically, IDI policies are traditionally purchased directly by the pharmacist through a financial advisor/broker. The pharmacist is able to select their coverage options. This is especially important when given the option to obtain true own occupation coverage. The pharmacist is also able to set their monthly benefit amount, based on their earnings, as well as the elimination period (duration of time a physician must meet the policy definition for disability before a benefit is payable), the maximum benefit period, and a variety of other coverage options based on what is offered by the insurance company.
If the pharmacist pays the premiums with pre-tax dollars, their disability benefit is a non-taxable/ tax-free benefit. Moreover, unlike LTD plans, the IDI policy is owned by the policy holder/pharmacist. The coverage is not tied to their employment with an employer. This means the policy is transportable and follows the pharmacist throughout their career, regardless of any employment changes.
Conversely, LTD coverage is elected by the pharmacist’s employer. Traditionally, the pharmacist does not have any input in coverage options. This includes the definitions that govern their coverage and their maximum monthly benefit. When evaluating benefit plans for employees, it is common for employers to elect inexpensive LTD plans with watered-down coverage.
These LTD plans provide summary plan descriptions that lead pharmacists to believe they have own occupation coverage through age 65 years or to their Social Security retirement age; however, these LTD plans often contain hidden coverage limitations. Most notably is the concealed 24-month limitations on own-occupation coverage, as well as exclusions and limitations on specified medical conditions, such as mental health disorders and subjective medical conditions. These limitations often go unnoticed by pharmacists until they actually need to file a claim.
Four Issues that Affect Perceived LTD Coverage and Benefits
1. LTD plans often mislead participants into believing their coverage contains true own occupation coverage
As noted above, LTD plan marketing materials and summary plan descriptions are often worded in a way that misleads pharmacists into believing that the provided coverage is better than what was actually obtained. The most common issue is confusion regarding the use of own-occupation coverage. Unbeknownst to many in the general public, the own-occupation moniker is used to define multiple tiers of coverage, all of which are technically classified as own-occupation products. To ensure pharmacists thoroughly understand their coverage, they should understand the 4 general types of own-occupation coverage and the difference between same. These tiers include:
1. True own-occupation
2. Limited true own-occupation coverage
3. Modified own-occupation coverage
4. Modified own-occupation coverage with limited own-occupation coverage
As the name suggests, true own occupation coverage provides a full disability insurance benefit if the insured is unable to perform the material and substantial/principal duties of their occupation. As long as the insured is receiving appropriate medical care and meets the other policy requirements, the insured will receive 100% of their disability benefit, regardless of whether they choose to work in any other occupation. This coverage remains consistent through the maximum benefit period, as agreed upon at the time the policy was issued.
Similarly, limited true own-occupation coverage provides the above level of coverage; however, it is only in effect for a set number of years. This varies based on what was agreed upon at the time the policy was issued. The policy will specify this period. Typically, it is documented as 24-months, 60 months, or whatever was agreed upon at the time of issue.
After the insured/pharmacist received benefits for the agreed upon time period in the contract, the coverage changes. Depending on the contract, the policy definition for ongoing benefits changes from true own-occupation coverage to a lesser tier of coverage and/or terminates. Often, after the contracted years of true own-occupation coverage is exhausted, the policy converts to a modified own-occupation policy or requires that the insured be totally disabled from engaging in any gainful occupation to be eligible for ongoing benefits.
Modified own-occupation coverage provides a total disability insurance benefit if the insured is unable to perform the material and substantial/principal duties of their occupation and is not gainfully employed. This definition gives the insured the impression that they have true own-occupation coverage; however, if they are totally disabled form working in their occupation, and chose to engage in any other work activity, they are not considered disabled under the base policy.
If the pharmacist does not have a residual/partial disability rider, their decision to work in another occupation, regardless of their earning capacity, sacrifices their disability benefit and coverage. The fear of losing one’s disability benefit often prevents pharmacists from pursuing less lucrative employment opportunities.
Modified own-occupation coverage with limited own-occupation coverage is what is typically found in LTD Plans. These policies provide coverage that reads as follows:
For the first 24 months of disable, the insured is entitled to disable benefits if he/she is unable to perform the material and substantial/principal duties of their occupation and is not gainfully employed. If the insured is working in their occupation, or any other occupation, a proportionate loss benefit will be paid provided that they are unable to earn greater than 80% of their Predisability Monthly Earnings.
After 24 months of benefits have been paid, the insured must be totally disabled from performing Any Gainful Occupation.
Although these policies often contain a maximum benefit period to age 65 years or higher, the insured’s perceived own-occupation coverage is limited to 24 months and is offset/reduced if their disabled monthly earnings in a new occupation is greater than 20% of their predisability monthly earnings.
Regardless of the coverage actually provided in the LTD plan, most of the pharmacists I represent enter my office subjectively believing they have true own-occupation coverage. However, most employer-sponsored LTD plans only provide modified own-occupation coverage with limited own-occupation coverage. This misunderstanding in definitions often leads to significant differences in the pharmacist’s perceived coverage, leaving them grossly under insured. To properly understand one’s coverage, pharmacists should review the definition of total disability found in their policy.
2. How is the monthly LTD benefit calculated?
Pharmacists are also confused about how their LTD plan calculates their monthly benefit. Unlike IDI products that contain a set numerical monthly benefit, LTD plans traditionally use a formula to determine a pharmacist’s monthly benefit. The LTD benefit is typically based on a percentage of the pharmacist’s covered monthly earnings.
Generally, the LTD plan will state the pharmacist’s monthly benefit is the lesser of 60% of their covered monthly earnings or the maximum disability benefit (the number agreed upon when the employer negotiated the coverage and specified in the LTD plan). To properly understand one’s coverage, pharmacists should review the definition of their monthly earnings/covered monthly earnings. Most LTD plans seek to limit the company’s financial exposure by excluding other forms of compensation, such as bonus and/or extra compensation and only cover the pharmacist’s base monthly salary immediately prior to becoming disabled.
3. The effect of other income benefits
Camouflaged within most LTD plans is a provision regarding other income benefits. This provision entitles the LTD plan administrator to reduce a pharmacist’s monthly benefit, dollar for dollar, if they are receiving income from any of the listed sources. These LTD plans often contain additional language, compelling pharmacists to apply for any and all benefit programs listed, with another provision allowing the insurance company to estimate reductions if the pharmacist does not apply for same.
Although the LTD plan will provide a detailed list, the most common other income benefits that could affect a pharmacist’s LTD benefit are state disability benefits, Social Security benefits, workmen’s compensation, salary continuation, voluntary retirement payments attributed to an employer-funded plan, and benefits received from other group disability plans. In practice, the most common other income benefit that affects clients’ LTD benefits is Social Security disability.
To assess your exposure to reductions based on other income benefits, you should thoroughly review the definition section of your LTD plan. If your LTD plan does contain a list of other income benefits, understand your LTD plan administrator will seek to apply a dollar-for-dollar reduction to your monthly benefit.
4. Tax consequences
Similarly, unlike most IDI products, which are typically paid for with after-tax dollars and provide a tax-free benefit, most LTD plans are paid for with pre-tax-dollars. As such, if a pharmacist is relying on an LTD plan that was paid for with pre-tax-dollars and depending on where they live, the LTD benefit could be subject to federal, state, and city/local income tax obligations. These tax consequences can significantly reduce a pharmacist’s perceived coverage, jeopardizing their financial security.
To assess your tax liability, simply review how your premiums are paid with your employer and/or a certified public accountant.
When meeting my client for the first time, he confidently explained that he reviewed his LTD plan before our consultation and that he was confident that his coverage provided a $10,000 monthly benefit and own-occupation coverage through his Social Security retirement age/to age 67 years. He became disabled just after turning 50 years of age and believed his LTD policy would pay him $10,000 for the next 17 years. Based on his rough math, he believed his LTD plan would pay out more than $2 million during the life of his claim.
However, by not accounting for the definition of total disability/own occupation coverage, the definition of monthly earnings, the applicability of other income benefits, and the tax consequences, he significantly miscalculated his coverage and monthly benefit.
1. The definition of total disability/own occupation coverage
To my client’s surprise, the LTD plan’s definition of total disability did not provide true own-occupation coverage. Although the LTD plan stated that it provided own-occupation coverage, the policy actually contained a modified own-occupation coverage with limited own-occupation coverage.
Specifically, the LTD plan contained the following definition:
Due to Injury or Sickness, you are unable to perform the material and substantial duties of your regular occupation; and you have a 20% or more loss in your indexed monthly earnings due to the same Injury or Sickness.
After 24-months of payments, you are disabled when it is determined that due to the same Injury or Sickness, you are unable to perform the duties of any gainful occupation for with you are reasonably fitted by education, training or experience.
As I explained to my client, his LTD plan did not contain true own-occupation coverage and his LTD benefits would terminate after 24 months of benefits were paid if he was able to work in any gainful occupation. I further explained that based on this definition, his benefits would terminate after 24 months if the company could establish he had any sustainable work capacity.
Based on the scope and severity of his medical condition, he was not capable of working in his occupation, or any other occupation, so he was not harmed by this definition. However, if his medical condition was not so severe, his claim would have been limited to 24-months of benefits. This would have resulted in a significant miscalculation of his coverage (approximately 15 years of benefits).
2. Covered monthly earnings
My client’s LTD plain defined his monthly benefit as 60% of your monthly earnings to a maximum benefit of $10,000 per month. This led my client to incorrectly believe he was entitled to a $10,000 a month benefit.
Specifically, the definition of monthly earnings was not located on the specification page in the front of the LTD plan. Rather, it was buried in the middle of the plan and limited his monthly earnings to his average base monthly salary. This definition specifically excluded all other compensation.
To my client’s surprise, the LTD plan specifically excluded the $40,000 per year he received in additional compensation from his employer. As noted above, his base salary was $120,000 per year and his employment contract included a provision that provided up to $40,000 per year in additional compensation, which he received in previous years. As such, my client’s perceived covered earnings of $160,000, was limited to $120,000. Moreover, my client misunderstood that maximum benefit provision, which only covered “60% of your monthly earnings to a maximum benefit of $10,000 per month.”
Based on the information presented, my client’s monthly earnings were $10,000 per month ($120,000/12 months). His LTD plan only covered 60% of his monthly earnings, resulting in a $6000 per month benefit. By not fully understanding the definition of his monthly earnings, the client overestimated his monthly LTD benefit by 40%. This miscalculation resulted in him overestimating his LTD coverage by $48,000 per year/$4000 per month.
To confirm your monthly benefit, review the definitions contained within your LTD plan. If you still have questions, discuss the same with human resources and/or someone with knowledge and experience dealing with these products.
3. Other income benefit offsets
Based on this client’s medical condition, he was eligible for Social Security disability. This provides him with a monthly benefit of $2500/$30,000 per year. Under his LTD Plan, his $6000 per month/$72,000 per year benefit was reduced to $3500 per month/$42,000 per year. By not fully understanding the definition of his other income benefits and monthly earnings, the client overestimated his monthly LTD benefit by 65% or $6500 per month/$78,000 per year.
To understand the effect of other income benefits on your LTD plan, review the itemized list and assess your potential eligibility for each noted benefit. Add these numbers together and reduce them from your noted monthly benefit. This will provide you with a general estimate of potential reductions in your LTD benefit.
4. Tax liability
This client also did not account for the tax liability on his LTD benefit. Because 100% of the premiums for his LTD plan were paid for by his employer with pre-tax-dollars, 100% of his benefit was classified as taxable income. Based on where this client lives, his benefit is subject to federal, state and city income tax liability.
Accordingly, his $3500 per month/$42,000 per year benefit was subject to a combined tax liability of approximately 35%. His tax liability further reduced his benefit from $3500 per month/$42,000 per year to $2275 per month/$27,300 per year.
To assess your tax liability, simply review how your premiums are paid with your employer and certified public accountant. If the premiums are paid for with pre-tax dollars, then the benefit is most likely subject to tax liability.
The Financial Fallout
Had the client consulted with a financial planner and/or other qualified consultant prior to becoming disabled, he might have been able to obtain additional coverage that adequately insured his income. Unfortunately, this pharmacist misunderstood his LTD coverage and significantly compromised his financial security.
When he entered my office, he believed his LTD plan provided a $10,000 per month benefit until he reached 67 years of age. He even estimated his potential benefit payout over this time period to exceed $2 million. After going through our analysis, he was devastated to learn that he overestimated his coverage by 77%; leaving him with an LTD benefit of $2275 per month/$27,300 per year to support his family.
This client’s story is all too common and can be easily avoided by consulting with a qualified professional to review and assess your coverage. Your financial security and family’s well-being may one day depend on it.
About the Author
Ethan F. Abramowitz, Esq., is a nationally recognized disability insurance attorney, and focuses his practice on the representation of disabled physicians, dentists, lawyers, and business executives. He is licensed in Florida, Pennsylvania, and California. (Ethan@Seltzerlegal.com)