Understanding Residual Disability Benefits: Are They Worth The Cost? Part 2 – Prior Monthly Income

In the first post in this series, we identified the basic formula disability insurers use to calculate residual (partial) disability benefits.  Now, we will examine how each of the components of that formula can change, depending on the insurer, and how those changes can affect the calculation of residual disability benefits, beginning with Prior Monthly Income (alternatively called Prior Earnings or Prior Net Monthly Income, depending on the insurer).

Prior Monthly Income, broadly speaking, is the baseline against which any loss of income is measured.  If you are pursuing a residual disability claim, it is in your best interest to have the highest Prior Monthly Income possible.  However, many doctors who file disability claims have conditions that are both chronic and progressive, like degenerative disc disease, which cause a slow, steady decline in productivity, and thus in earnings, for years before they ever make a claim for disability benefits.  In addition to lowering the Prior Monthly Income, this can cause other problems with a disability claim, as discussed in our recent article on residual disability claims.

Some residual disability riders, particularly on policies sold in the late 1980s and early 1990s offer at least some accommodation for a gradual drop in income preceding a claim.  For example, Paul Revere Life Insurance Company policies defined “Prior Earnings” to be the greater of (1) your average monthly earnings for the year before disability began; or (2) your highest average monthly earnings for any 2 consecutive years during the 5 year period before disability began.  Under this policy (“Policy A” in the example below) you could look back to the previous five years to maximize the average monthly income.

Policies issued more recently tend to be more restrictive.  For example, a Guardian/Berkshire Life Insurance Company policy (“Policy B”) from 2007 defines “Prior Income” as the average monthly income for either the last full calendar tax year or for the last two out of three tax years, whichever is greater.  A Principal Life Insurance Company policy (“Policy C”) issued in 2007 defines “Prior Earnings” as the highest monthly average earnings for any consecutive 12 month period out of the last 24 months.

To see how these different provisions change the outcome, assume a scenario in which a doctor earned the following amounts: $300,000 ($25,000 per month) in 2009, $300,000 in 2010, $240,000 ($20,000 per month) in 2011, $180,000 ($15,000 per month) in 2012, and $180,000 in 2013.

Also assume that the same doctor is now residually disabled and only able to earn $10,000 per month, with a policy that has a maximum benefit amount of $15,000 per month.  This table shows how the benefit amount would differ, based on which policy the doctor had:

Policy              Prior Monthly Income             Loss Of Income (%)               Benefit Amount

Policy A          $25,000[1]                                  60%                                        $9,000.00

Policy B          $17,500[2]                                  42.86%                                    $6,429.00

Policy C          $15,000[3]                                  33.33%                                    $5,000.00

There are other variables that further complicate the calculation of Prior Monthly Income, including whether earnings are based on an individual doctor’s production, or whether they are based on a practice’s profitability, which we will further examine in the next part of the series.  However, understanding the relevant time frame, based on the terms of your individual policy, is an important first step in evaluating a potential claim for residual disability benefits.

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[1] Taking the average of the highest two out of the preceding five years (2009 and 2010).

[2] Taking the average of the highest two out of the preceding three years (2011 and 2012).

[3] Taking the average monthly income for any 12 month period over the last two years.