What You Need to Know About Disability Insurance for the Self-Employed

Disability Insurance for the Self EmployedDisability insurance is hardly a sexy topic of conversation, or even a common worry.

After all, it’s not like most of us do anything more strenuous than checking our email on the average day, so how likely is it that we will need disability insurance?

As a matter of fact, it’s pretty likely.

According to the Council for Disability Awareness (CDA),

“over one in four of today’s 20-year-olds will become disabled before they retire.”

The average length of disability is a frighteningly long 31.2 months. These statistics reflect the fact that illness, rather than injury, is the leading cause of long-term absence from work, accounting for 90% of all disability claims. And not even the most safety-conscious among us can claim to be immune to disease.

As important as disability insurance is for all workers, the self-employed have a particular need to protect their income. Without an employer behind you to provide even the most basic of disability policies, your income and potentially your entire business is vulnerable.

But policies for the self-employed can be difficult to find. Here is what you need to know about finding disability insurance when you are your own boss:

1. You May Need to Work Without a Disability Net for a Few Years

The insurance industry is all about mitigating risk. And as every freelancer knows, making a go of self-employment is (in some ways) riskier than collecting a steady paycheck. For that reason, insurers need to see that your income is relatively stable before they will even begin to look at underwriting your policy. According to Barry Lundquist, President of the Council for Disability Awareness, insurers need to know that your self-employment status is a career, and not just something you are doing while you’re between jobs.

In addition to your employment and income history, your insurer will consider if you are a good health risk and if you pose a risk of policy lapse—which tends to be high among the self-employed. Considering the fact that insurers lose money on disability insurance policies in the first year, even without any claims, it’s understandable why your insurer would want to make certain you will keep up the premium payments.

All of that adds up to needing good credit and several years of income records—generally about three—before you can find a disability insurer willing to take on a self-employed client.

2. The Passive Income Conundrum

An additional issue that the traditionally-employed don’t have to deal with is the question of how passive income fits into underwriting for the self-employed.

For instance, I published a book on retirement earlier this year, which is earning me royalties. My hope is that it will continue to earn royalties for me throughout the coming years. While that money will add to my income, I also don’t have to work to bring it in. So how will an insurer view my passive income when underwriting my policy?

According to George Davidson, president of Secura Consultants, it’s important to remember that there is no such thing as purely passive income. Royalties from books are at least somewhat dependent upon promotion and marketing, so suffering a disability just when a book is launching could have a negative effect on your royalties.

For that reason, Davidson recommends working with an insurance agent who is willing to negotiate with underwriters. In general, underwriters will simply disregard passive income that is less than about 10% of your income as a whole. So if you earned $50,000 total last year, of which $5,000 was from royalties, your insurer will simply look at your total income without worrying about your royalties.

If your passive income is a larger share of your total income, a good agent who has experience in negotiating with disability insurance underwriters can get your passive income alleviated in underwriting, particularly if he can prove that a disability would have a negative effect on the promotional work that you do.

Basically, it’s important to be able to pinpoint the continuing work you do in order to bring in your “passive” income, and make sure you communicate that aspect of your business with your insurance agent.

3. How to Find the Right Disability Insurance Product

There are a couple of ways to make sure you have the disability coverage you need as a freelancer. The first is to plan ahead—before you even leave your traditional job. According to Barry Lundquist, a small percentage of disability policies are portable, so you can take them with you when you quit your cubicle-dwelling job.

Another option is to look for professional groups or associations that might offer insurance options. For instance, a lawyer deciding to work freelance from home might be able to purchase a less expensive plan through her local Bar Association.

Finally, it is certainly possible to find a reasonably-priced individual policy. It will just take some legwork on your part to find an insurance agent or financial adviser who is well versed in disability insurance and who is comfortable negotiating with underwriters.

George Davidson likens finding such an agent to finding a doctor—you want someone with a lot of experience with your particular issue, not someone who is a generalist. Davidson recommends the International Disability Insurance Society as a place to start your search.

The Bottom Line

Your income potential is your greatest asset. It pays to protect yourself against the possibility of losing that asset. After all, you insure your cell phone. Why not your income?

Image Credit: Mike Schmid

About Emily Guy Birken

Emily Guy Birken is a former English teacher and respected personal finance blogger. She lives in Milwaukee, Wisconsin with her engineer husband and two high-energy little boys. She has written four books: The Five Years Before You Retire, Choose Your Retirement, Making Social Security Work For You, and End Financial Stress Now. Emily's thoughts on parenting and life in general are found at The SAHMnambulist.