Group Disability Insurance: How It Works and What It Covers

Disability insurance is more than short- versus long-term disability coverage. There’s also individual and group disability insurance. 

Group disability insurance is a common benefit many employers offer to their employees. It works like this: an insurance company agrees to cover lost income due to injury or illness for all employees in a business without requiring individual medical exams. For businesses, this means providing a nice perk to employees at a cheaper cost (which helps retain talent). For insurance companies, it’s a way to gain more customers in one go. 

Sounds like a win-win for businesses and insurers, but what about the employees?

Differences between individual and group policies

Both policies provide financial protection if you have an illness or injury, but the differences in group vs. individual disability coverage can mean the difference between financial stability and unexpected setbacks.

The tax surprise: Employer-paid premiums

Here’s a little-known secret most people don’t realize when they opt into their group plan. If the employer pays the premiums on these policies (how nice of them!), the IRS treats the disability benefits as taxable income if the employee ever needs to use them. 

While it’s not a huge deal for short-term disability, which typically lasts less than a year, it can be a game-changer for long-term disability. Imagine needing to rely on these benefits for an extended period, only to find that taxes significantly reduce the amount you have to live on. 

The risk of job changes

Group plans can encourage employees to stay with their employer. But if the employee leaves their job, group disability coverage is  no longer in force. This is the case whether an employee leaves their job willingly or unwillingly. Given how often people now jump between employers, this can create a gap where they have no insurance at all. 

What if the company was also paying for life insurance? That’s gone, too. 

In the worst-case scenario, someone could end up at an employer with no group coverage and develop a medical condition that makes them uninsurable by most traditional insurance companies. If you buy individual disability insurance, it follows you through every employment change. It doesn’t matter if you were a veterinarian and now run a carpentry business.

Related: Have a Pre-Existing Condition? How to Get Disability Insurance

Coverage definitions

The biggest reason I’m a fan of individual plans versus group disability benefits is their definitions of disability. It’s rare for a group policy to have a true own-occupation definition. True own-occupation means if an injury or illness prevents you from performing the duties of your occupation over the previous 12 months, the policy pays out monthly benefits until you can resume your previous duties (or until retirement age if you never recover on a long-term policy). 

Group long-term disability plans typically opt for cheaper definitions of disability, such as a 24-month own-occupation, then any reasonable occupation thereafter, or modified own-occupation. Both are still much better than having no coverage at all, but the protection is weaker. 

Control and customization

This highlights the main issue with group plans: the policyholder has little control over the policy's features, such as the elimination period (also called waiting period), benefit period and other optional riders.

Can you buy an individual plan if you already have a group plan?

Yes! Buying a supplemental policy is the best practice. Not only can you sometimes double dip on the benefits (as long as the contract language in the group policy is okay with it), but this stops the worst-case scenario of leaving your job and being unable to enroll in new coverage. 

Related: Can You Have Two Disability Insurance Policies? Yes – Here’s Why You Should

Most individual disability policies include language in their contracts allowing for increases in the monthly benefits if the insured has lost access to group coverage. If you wait to purchase an individual policy until later, you risk having pre-existing conditions that result in exclusions on the policy.

Understanding the “group cap percentage”

The amount of private coverage you can purchase depends on how much coverage you get from the group plan. For disability income insurance, companies don’t want to insure people for more than 60% of their income. They call that being over-insured. 

“Wait!” you exclaim. “My work policy says it is for 60% of my income, does that mean I’m not eligible to buy an individual disability policy?” Usually, most people are still eligible for some amount of coverage. That 60% is called the group cap percentage, but it’s rarely the amount their policy actually covers. 

For example, common contract language might specify, “covers 60% of income, or $10,000 a month, whichever is less.” It might sound like a lot, but several factors can reduce the benefit you receive. For starters, the benefit is probably taxable, and the policyholder might only get to keep $8,000 of it. Still, it's not bad. 

But what if they’re an anesthesiologist with a $6,000 monthly mortgage payment? Suddenly, that $10,000 a month seems woefully inadequate, especially when we don’t know how long their disability will last. 

Say their normal annual income is $400,000. That means they’d be eligible to purchase at least an additional $10,000 monthly in individual coverage on top of their group policy. In this scenario, it would cover 60% of their income. Not quite what the group policy’s language would make one think at first glance.

Are group plans bad?

Group plans are hugely beneficial, especially since most people depend on employee benefits for things like health insurance or a disability insurance policy. Without them, most people would have no coverage at all. 

Group plans are much more affordable than individual plans, eligibility is easier, and in some cases, they can provide disability insurance coverage that’s sufficient enough. 

A word of warning about group disability policies

There’s a wide discrepancy in benefits from employer to employer. Like with all employee perks, some employers cheap out on disability coverage while others do a pretty great job looking out for the best interest of their employees. 

If you can opt out of your group disability plan at work, talking to an insurance broker is worth your time. We can review your policy, give you our thoughts, determine if it’s sufficient coverage, help you qualify for an individual policy, and answer any questions about disability insurance. 

Most of us are only paid by the insurance company when we sell a policy, and for continuing to service it afterward, so it should be free just to talk to us. To get started, fill out our request form below.