Social Security, History and Operations

views updated May 29 2018


Enacted in the midst of the Great Depression of the 1930s, Social Securitythe Old-Age, Survivors, and Disability Insurance program (OASDI)protects virtually every American. The nations central retirement income program is also its most important disability and life insurance program. After discussing the historical development of Social Security, this entry briefly describes the structure of the program, including revenue sources, benefits, and its importance to different groups of Americans. Contemporary Social Security policy issues are then identified.


In seeking to provide widespread and basic protection against what President Franklin D. Roosevelt called the vicissitudes of life, the Social Security Act of 1935 initiated two social insurance programs, three public assistance programs (i.e., welfare), and several public health and social service programs. Until 1950, Social Security, which was initially a social insurance program providing protection against loss of income in retirement, was neither the largest nor the most popular of the acts programs. It was the state-run welfare programs included in the act, which provided aid to widows with dependent children, the old, and the blind, that gained swift public acceptance, mainly because they quickly sent funds to states to distribute to these needy groups. In contrast, and in keeping with social insurance principles in which the right to a benefit is based on the prior payroll tax contribution of employees and their employers, the Social Security program began collecting taxes during the late 1930sthough the program was not scheduled to pay its first benefits to retirees until the early 1940s. Where welfare programs seek to give immediate relief to those in extreme financial distress, the Social Security Acts social insurance programsSocial Security, Unemployment Insurance, and later, Medicareseek to prevent financial distress.

The genius of Social Security and related social insurance programs is that they represent, and build upon, a compromise between sometimes conflicting political values; the concern that all Americans should have adequate protection against selected contingencies (e.g., retirement) and a commitment to the work ethic. Near universal coverage assures widespread protection. Social insurance provides a social and work-related means of pooling risks. In exchange for making modest work-related contributions over many years, the social insurance approach provides individuals and their families with an earned right to protection against predictable risks. Social Security, for example, is structured in a manner that seeks to provide benefits that are adequate to maintain basic living standards, especially for low and modest income persons. However, in keeping with the principle of individual equity, persons who have paid more in Social Security taxes generally receive larger monthly benefits.

Incremental expansion characterized the development of Social Security from 1939 through the mid-1970s. The 1935 Act provided for benefits to workers in manufacturing and commerce who retired at age sixty-five or later. Benefits were added in 1939 for the wives of retired workers and for the surviving wives and children of deceased workers. These benefits were made available to men in 1950. Importantly, the 1950 Amendments to the Social Security Act defined social insurance as the nations dominant public policy approach to protecting older Americans against loss of income in retirement. These amendments expanded coverage to include regularly employed domestic and farm workers and increased benefits, assuring that Social Security benefits would generally be more available and more beneficial to receive than benefits provided through the federal/state Old Age Assistance program, also funded under the Social Security Act.

Disability insurance protections for permanently and severely disabled workers age fifty to sixty-four were added to the Social Security program in 1956, and extended to all workers under age sixty-five in 1960. The 1956 amendments also gave women the right to accept permanently reduced retired workers benefits between ages sixty-two and sixty-four, an option that was extended to men in 1961. The high rate of poverty and near-poverty among the old combined with a growing economy to provide political rationale for substantial benefits increases from 1965 through 1972, greatly improving the economic status of elderly Americans. In 1972, the automatic cost-of-living allowance (COLA) was incorporated into the law. Beginning in 1974, benefits were adjusted annually for changes in the cost of living. This new provision assured that, once received, benefits would maintain their purchasing power no matter how long a beneficiary lived. While critically important for helping to assure stable incomes for the old, disabled, and surviving family members, this provision is expensive and made financing the program more sensitive to economic change.

In the mid-1970s the focus shifted to program financing, followed a few years later by a political climate that challenged the support for the traditional Social Security program. Unanticipated economic changes (i.e., high inflation, lower than anticipated wage growth, a slowed economy) created short-term financing problems in the mid-1970s and again in the early 1980s. Demographic changesincluding declining birth rates, increased life expectancies, and the anticipated aging of 76 million baby boomers born from 1946 through 1964fueled long-term financing problems. Legislation was crafted in 1977 and 1983 involving modest benefit reductions and tax increases, spreading the pain of these changes across many constituencies, including working persons, employers, and current and future beneficiaries (especially those most well-off). By the mid-1980s, when the rest of the federal government began running large annual deficits, the Social Security program began accumulating large yearly surpluses, a trend expected to continue through about 2020. Even so, the impending retirement of the baby boomers, a declining ratio of workers to beneficiaries, and anticipated increases in longevity mean that financing reforms will be needed to assure the timely payment of benefits after 2038 or thereabouts.

Social Security is arguably the nations most successful and popular public policy. A favorable climate incubated its expansion through the mid-1970s. Even during the financing problems of the late 1970s and the 1980s, little support existed for substantially reducing benefits or retreating from the social insurance principles that guided the program. Except for a few advocates on the extreme outskirts of American politics, the voices favoring means-testing Social Security (limiting benefit receipt to persons whose incomes and/or assets fell below certain levels) were silent until the early 1990s. Similarly, during the early 1980s virtually no one in the political mainstream was giving serious consideration to privatizing aspects of the program. For example, in 1982, a commission headed by Federal Reserve Chairman Alan Greenspan unanimously agreed that Congress should not alter the fundamental principles of the Social Security Program (National Commission on Social Security Reform, 1983). This commission also rejected proposals to make the Social Security program a voluntary one, or to transform it into. . . a program under which benefits are conditioned on the showing of financial need. But persistent claims that Social Security is unfair to the young, false claims that the program is financially unsustainable, a soaring stock market, and growing skepticism (especially among the young) about whether the program will meet peoples needs, combined with the deficit politics of the 1980s and 1990s to spawn an environment that legitimized calls to radically transform the program. Indeed, irrespective of their validity, by the year 2001 proposals to partially privatize Social Security were being given very serious consideration.

Todays Social Security program

Who benefits? Social Security has achieved its goal of providing widespread protection against financial risks associated with retirement, disability, and survivorship. Coverage is virtually universal, with 152 million workers (over 95 percent of the workforce) and their families included in the program. In February 2001, monthly benefits were paid to over 45 million persons, including almost 29 million retired workers; nearly 5 million surviving aged widows and widowers; 400,000 surviving mothers and fathers; 5 million disabled workers; and 3 million children under eighteen, mostly survivors or dependents of disabled workers.

Social Securitys benefits bridge the generations. The main source of survivor and disability protection for Americas families, for a typical twenty-seven year old couple with two children under age four, Social Security is the equivalent of a term life insurance policy in excess of $300,000 and a disability policy in excess of $200,000. The only pension protection available to six out of ten working persons in the private sector, it provides the equivalent of $12.1 trillion dollars in life insurance protection, more than the entire value ($10.8 trillion) of all the private life insurance protection in force (Ball, 1998). Even retirement benefits have clear cross-generational value. Assuming that one accepts the view that the United States government cannot renege on its commitment to provide benefits to future retirees, then, by making Social Security payroll tax contributions, younger workers earn the right to benefits when they retire. Also, by providing benefits to todays elderly persons, Social Security frees up resources that allow the adult children of retirees to invest more in the education of their own children (or their own retirements), rather than in the financial support of their aged parents.

Social Security has transformed old age in America. While government employee pensions and private pensions, annuities, assets, and earnings provide important sources of cash income for many elderly persons age sixty-five and older, Social Security remains the heart of the retirement income system. In part, because of the progressive nature of the benefit formula, more than 70 percent of the income going to aged households in the bottom 60 percent of the elderly income distribution comes from Social Security (see Table 1). Only for those in the highest 20 percent of the elderly income distribution do other sources of income, such as earnings and assets, eclipse Social Security in terms of their aggregate contribution to household income (U.S. Department of Health and Human Services, 2000). Occupational pensions make significant contributions to the aggregate incomes going to households in the three highest quintiles, but this source of income falls well short of Social Security for these households. While not unimportant, the aggregate contribution of cash welfare benefits (9.8 percent) to the 4.9 million aged units with less that $8,792 in annual income in 1998 was substantially less than that of Social Security (82.1 percent). Moreover, without Social Security, the poverty rate among Social Security beneficiaries age sixty-five and older would jump from 9 percent to 48 percent; for unmarried older beneficiaries, it would jump from 15 percent to 58 percent; and for older African-American beneficiaries the poverty rate would rise from 24 percent to 75 percent.

Financing and administering Social Security. Retirement, survivor, and disability protections are earned through the payment of payroll taxes by working persons and their employers. Today, most people know that their payroll taxes do not go into a special savings account earmarked for particular workers and their families. Current benefits are funded largely from the taxes paid by current workers, with the promise that the current workers will themselves receive benefits when they become eligible for them. Additional revenues come from treating a portion of Social Security benefits as taxable income and from the interest earned from investing the growing OASDI trust fund assets in government bonds. Social Security financing is held together primarily by the taxing power of the government and the publics (and hence politicians) strong interest in maintaining the program.

The Social Security Administration maintains a record of the earnings on which workers have paid payroll taxes. This record provides the basis for establishing eligibility to program benefits and determining the size of those benefits. Interestingly, each year less than 1 percent (0.9 percent) of trust fund revenues is spent on the administration of OASDI.

Employed persons contribute 6.2 percent of their earnings (with an equal employer match) up to a maximum taxable ceiling ($76,200 in 2000) into two trust fundsone for Old-Age and Survivors Insurance (OASI) and one for Disability Insurance (DI)which are often referred to as the combined OASDI trust fund. Self-employed persons make contributions equivalent to those made by regularly employed persons and their employers. The maximum taxable ceiling is adjusted each year for changes in average wages. Another 1.45 percent payroll tax goes to Medicares Hospital Insurance (HI) trust fund.

Social Security benefits. Elaborate rules link contributions to benefits. Four general rules are worth keeping in mind. First, persons who have worked for ten years or more (that is, earned credit for forty quarters) in covered employment are almost always eligible to receive retirement benefits at age sixty-two or later and their survivorship protections are in force. One credit for a quarter is actually given (a maximum of four per year) for having $830 of earnings in covered employment. Second, for disability protections to be in force, workers generally need to have worked for five out of the previous ten years. Third, there are exceptions to these basic rules. Younger workers, for example, are subject to far less restrictive eligibility requirements for survivorship and disability protections.

The fourth basic rule is that, in keeping with the programs goal of providing widespread and adequate protection, the Social Security benefit formula works to assure that long-term, low-wage workers receive a proportionately larger benefit (relative to their contributions) than high-wage workers. The increased payroll tax contributions of high-wage workers is recognized by a larger monthly benefit, but such workers receive a proportionately smaller benefit. This is done through a benefit formula that replaces a smaller percentage of covered earnings as a workers average covered earnings rise. For example, for workers retiring at age sixty-five in January 2001, Social Security replaces about 28 percent of earnings for those with earnings consistently at the maximum taxable ceiling, compared to about 58 percent for those whose earnings were consistently at 45 percent of median wages, and 42 percent for those with average earnings. The monthly retired workers benefit for this maximum earner would be $1,538 compared to $637 for the low earner and $1,051 for the average earner.

Nearly all covered workers are eligible to accept actuarially reduced early retirement benefits at age sixty-two or full benefits at the normal retirement agein 2002, age sixty-five and scheduled to gradually increase to age sixty-seven by 2027. Workers electing to postpone benefits past the normal retirement age receive credits that permanently increase the value of their monthly benefits. The surviving spouses of retired workers may receive reduced survivor benefits at age sixty (or age fifty if severely disabled) or full benefits at age sixty-five or later. Severely disabled workers are also eligible to receive monthly benefits if their condition meets the disability eligibility criteria. Other dependents of retired, deceased, or disabled workers (even, in some cases, financially dependent grandchildren, divorced spouses caring for dependent children, or adult children who were disabled prior to age nineteen) may also be eligible for monthly benefits. (Note: additional benefit information can be found by accessing the Social Security Administrations Web site:

Contemporary issues

How to address the projected Social Security shortfall, while also maintaining (and even strengthening) the social protections the program offers is one of the most pressing domestic policy issues of the twenty-first century. Even though Social Security is running substantial yearly surpluses ($155 billion in 2000), the long-term financial stability must be addressed.

The most commonly accepted estimates of Social Security actuaries suggest that the program has sufficient funds to meet all its obligations through 2038. After that, its projected revenue stream will be sufficient to pay 72 cents of every dollar promised through 2075 (estimates made in 2000 extend only for seventy-five years). These estimates suggest that tax revenues (payroll tax receipts and receipts from taxation of benefits) will be exceeded by outlays in 2015, but that income from all sources, including interest on trust fund investments in U.S. government obligations, is expected to exceed expenditures through about 2025 (Board of Trustees). After that, timely payment of benefits would require drawing down the assets of the OASDI trust fund until its depletion in 2037. Of course, the size of the actual problem could be larger or smaller. The SSAs more pessimistic estimates project a shortfall beginning in 2026 that is roughly 150 percent larger than its most commonly accepted estimates. On the other hand, its more optimistic estimates project that the OASDI trust funds can meet all its obligations through 2074.

Theoretically, the long-term financing problem could be addressed by immediately raising the Social Security payroll tax on employers and employees from 6.2 to 7.2 percent, or by immediately reducing all future benefits by about 14 percent. While this provides a sense of the size of the problem, no one is seriously suggesting either approach.

Social Securitys estimated shortfall is not highly disputed, but the perceived implications of the shortfall fuels a lively policy debate (see Aaron and Reischauer; Peterson). Conflicting approaches to reform reflect differing views of the extent to which individuals, rather than the national community, should be responsible for preparing for their retirement, disability, or survivorship. The traditional view emphasizes providing widespread and adequate protection as Social Securitys fundamental purpose. Hence, stabilizing financing while assuring adequate benefits that are not subject to erosion by inflation, business cycles, and market fluctuations are central reform concerns. Strong commitment exists for the moderate redistribution inherent in the benefit structure as a means of assuring that those who have worked for many years at relatively low wages will have minimally adequate incomes. In contrast, those seeking to shift Social Security towards a more private savings model draw on their strong belief in individual responsibility, limited taxation, and freedom of choice. They tend to emphasize maximizing rates of return and shrinking the role of government. While safeguards may be built in for some of the most disadvantaged, these proposals tend to be most beneficial to persons with higher earnings. For instance, most women would not fare well under a privatized retirement income savings program because women tend to have more intermittent work histories and lower earnings, and they live longer.

As in the past, incremental changes in benefits and financing can effectively address the projected financing problem. The large annual surpluses projected through about 2020 provide an opportunity to buy down the federal debt, arguably strengthening the economy in preparation for the retirement of the baby boomers. If the savings from interest the government would otherwise have to pay on the federal debt were then transferred to the Social Security trust funds (essentially a general revenue transfer after 2036), the program would be able to meet its obligations through about 2050. Diversification of trust fund investments, allowing for a small portion of the trust fund assets to be invested by an independent board in a broad selection of private equities, could help address the programs financing while also improving rates of return. There are many other proposals which, if done in moderation, would not greatly compromise the fundamental purposes of the program. These include raising the ceiling on wages subject to the payroll tax, increasing the normal retirement age, bringing the rest of state and local government employees into the program, small payroll tax increases, a technical adjustment in the COLA, and other small benefit reductions. As in the recent past, such changes will not be pain-free. But, given the larger goal of assuring financial stability of this popular program, the public is likely to accept such changes, especially if the burdens of change are viewed as being distributed equitably.

Because OASDI provides widespread protection across all income classes, and because it is especially important to low- and moderate- income groups, it is especially important to carefully assess the distributive implications of various policy options. Certain changes, such as COLA reductions or retirement age increases, especially if done in the extreme, will have a more deleterious effect on low-income persons who rely more heavily on Social Security for their retirement income. Also, in the context of reforming Social Securitys financing, it will be important to explore what can be done to improve the benefit for persons who continue to be at financial risk during their old age. For example, many women, especially divorced or very old widowed women, are very much at risk today, and, absent changes, this will also be the case for future cohorts of older women (Smeeding, Esters, and Glasse).

Too often, media, politicians, and analysts have reduced Social Security discussions to mere accounting exercises about the financial cost of the program, overlooking the benefits this program provides and the real consequences of possible changes to the well-being of individuals and families. Social Security is an institution that has strengthened the nations families and communities. As Social Security continues to evolve, it will be important to not lose sight of the moral dimension of a program that gives expression to and reinforces the values that hold us together as a nation and a people.

Eric R. Kingson

See also Disability, Economic Costs and Insurance Protection; Economic Well-Being; Generational Equity; Social Security Administration; Social Security, and the U.S. Federal Budget; Social Security, Long-Term Financing and Reform; Welfare State; Widowhood: Economic Issues.


Aaron, H. J., and Reischauser, R. D. Countdown to Reform: The Great Social Security Debate. New York: Twentieth Century Fund Press/Priority Press Publications, 1998.

Ball, R. M. Straight Talk About Social Security: An Analysis of the Issues in the Current Debate. New York: The Century Foundation Press, 1998.

Berkowitz, E. Americas Welfare State: From Roosevelt to Reagan. Baltimore, Md.: Johns Hopkins University, 1991.

Board of Trustees. 2001 Annual Report of the Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds. Washington, D.C.: U.S. Government Printing Office, 2001.

Kingson, E. R., and Sculz, J. H., eds. Social Security in the 21st Century. New York: Oxford University Press, 1997.

Kingson, E. R., and Williamson, J. B. Economic Security Policies. In Handbook of Aging and the Social Sciences. Edited by Robert H. Binstock and Linda K. George. New York: Academic Press, 2001.

National Commission on Social Security Reform. Report of the National Commission on Social Security Reform. Washington, D.C.: NCSSR, 1983.

Peterson, P. G. How Will America Pay for the Retirement of the Baby Boom Generation?In The Generational Equity Debate. Edited by J. B. Williamson, D. M. Watts-Roy, and E. R. Kingson. New York: Columbia University, 1999. Pages 4157.

Schulz, J. H. The Economics of Aging, 7th ed. Westport, Conn.: Auburn House, 2000.

Smeeding, T. M.; Esters, C. L.; and Glasse, L. Social Security Reform and Older Women: Improving the System. Washington, D.C.: Gerontological Society of America, 1999.

Social Security Administration, Office of Policy, Office of Research, Evaluation and Statistics. Income of the Population 55 and Over. Washington, D.C.: SSA, 2000. Available at

Social Security Administration, Office of Policy, Office of Research, Evaluation and Statistics. Fast Facts and Figures about Social Security. Available on the World Wide Web at

Steuerle, C. E., and Bakija, J. M. Retooling Social Security for the Twenty-First Century. Washington, D.C.: Urban Institute Press, 1994.

Social Security

views updated May 17 2018


SOCIAL SECURITY. The social security system in the United States was established on 14 August 1935, when President Franklin D. Roosevelt signed the Social Security Act. The act created a range of government programs, including unemployment insurance and federal welfare grants, but the term "social security" generally designates Old Age, Survivors, and Disability Insurance (OASDI) and related federal programs run by the Social Security Administration. In the second half of the twentieth century, social security grew to become the most expensive federal government program, directly touching the life of almost every American. It enjoyed widespread popularity for several decades, but by the end of the century worries about its future and concerns about its effects on the economy greatly diminished its popularity and led policy makers to consider major changes in its operation.

Before Social Security

Social security is primarily designed to provide income for the elderly by taxing the workforce. Before the establishment of social security, workers pursued a range of strategies to prepare themselves and their spouses for old age—relying primarily on the market and the family. The historians Carole Haber and Brian Gratton have shown that in the late nineteenth and early twentieth centuries, average annual household incomes of those sixty and over were only modestly lower than those in their forties and fifties and were rising over time along with overall economic growth. Most men continued to work into old age, but many were able to retire. The labor force participation rate of men aged sixty-five and over was about 76 percent to 78 percent between 1850 and 1880; thus the retirement rate was 22 percent to 24 percent. The retirement rate rose to 35 percent in 1900 and 42 percent in 1930. Social critics worried that elderly workers were adversely affected by industrialization and that many were becoming unemployable and were being thrown onto the "industrial scrap heap." Research by economic historians has shown that this was probably not the case, as increasing retirement rates were driven by rising incomes. The earnings of their children were an important component of the elderly's income during this period. Surveys from 1889–1890 and 1917–1919 show that children's wages provided about one-third of total income in households headed by those sixty and over. In addition, saving for old age was an important strategy, and nearly 30 percent of elderly households took in boarders. Nearly one million

people received Civil War pensions in the 1890s and first decade of the 1900s, declining to about 600,000 by 1920. They covered over half of elderly native-born Northern males and made up 42 percent of the federal budget at their peak. However, by 1930 only about 10 percent of workers were covered by pensions, especially government workers and long-term employees of large corporations such as railroads.

Many of the elderly lived in poverty, especially widows and those who had low earnings before reaching old age. A traditional response was for a poor widow to move in with the family of an adult child. As a last resort, the indigent elderly could move into an almshouse or poor-house run by a charity or local government. Conditions in these institutions were often harsh and moving there was generally considered to be a deep humiliation. Fear of being consigned to the poorhouse haunted many, but no more than 2 percent of the elderly lived there in the nineteenth and early twentieth centuries.

In 1889 Germany, under Chancellor Otto Bismarck, adopted the first modern social insurance plan, in which workers were taxed to provide money for an old-age fund. Many European countries followed suit, including France (1910), the Netherlands (1913), Italy (1919), and Britain (1925), as did many Latin American nations. The first federal old-age pension bill was introduced into the U.S. Congress in 1909, and Theodore Roosevelt's Progressive Party made old-age insurance part of its platform in 1912, but very little progress was made toward this goal until the Great Depression struck the American economy. The depression caused massive unemployment, forced many employers to cancel pension promises, wiped out the savings of some older people, and squeezed many families who supported their elderly parents. Calls for assistance for the elderly and for a system that would encourage retirement, opening up jobs for younger workers, abounded. As the depression continued, more and more state governments provided reliefpayments to the elderly poor, but most observers considered these to be grossly inadequate.

Establishment of the Program

On 29 June 1934 Franklin Roosevelt created the Committee on Economic Security (CES), chaired by Secretary of Labor Frances Perkins and led by Executive Staff Director Edwin Witte, a University of Wisconsin economics professor, to study social insurance and recommend legislation. Roosevelt and Congress were faced with a growing call to provide large pensions to the elderly. Most prominent were the "Share Our Wealth" plan of the Louisiana senator Huey P. Long and especially the retired physician Francis Townsend's plan, which called for a pension of$200 per month for those sixty and over—an amount that was more than one-third of per capita annual income—on the condition that recipients not be employed and that they spend their pensions within thirty days. Instead the CES recommended and Congress adopted (by 372 to 33 in the House and 77 to 6 in the Senate) a plan that gave much more modest immediate aid to the elderly through the Old Age Assistance program and created a more permanent system, Old Age Insurance. Old Age Assistance was a joint federal-state venture with the federal government matching state expenditures on a one-to-one basis up to a specified maximum per recipient (originally $15 per month). It allowed states to establish their own eligibility criteria and benefits levels. Meanwhile, the Old Age Insurance system began to tax workers and promised benefits when they reached age sixty-five that were tied to the amount of taxes they had paid, much like a private-sector annuity. This lag between payments and promised benefits made it difficult for future legislation to repeal the social security system. Franklin Roosevelt recognized this, explaining "We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions. … With those taxes in there, no damn politician can ever scrap my social security program." Alf Landon, the Republicans' unsuccessful 1936 presidential candidate, criticized the Social Security Act as unjust, unworkable, stupidly drafted, and wastefully financed, but Gallup polls showed that voters overwhelmingly approved of it, with 73 percent approving the social security tax on their wages. In late 1936, the federal government began assigning social security account numbers, taking applications at post offices. On 1 January 1937 workers began paying social security taxes and acquiring credits toward old-age benefits. The Supreme Court upheld social security's constitutionality in Helvering v. Davis on 24 May 1937. However, the 7 to 2 ruling made it clear that social security taxes are simply taxes like any other, and individuals have no legal right to any benefit based on paying them.

Initially over 9 million workers, including agricultural workers, domestic servants, and government employees, were excluded from the social security system, as were railroad workers, who had their own retirement fund established by federal law in 1934. It was originally planned to begin paying monthly pensions to retirees in 1942, but the Social Security Amendments of 1939 brought this forward to 1940, and on 31 January 1940 Ida May Fuller, a retired legal secretary from Vermont, became the first recipient of a monthly benefit check. The 1939 amendments also added a program to provide dependents' and survivors' benefits—akin to private-sector life insurance—and the program was renamed Old Age and Survivors Insurance (OASI). The acceleration and expansion of social security benefits was driven by the political popularity of spending social security's amassed pool of savings rather than letting it accumulate, especially in light of the "Roosevelt Recession" that struck the economy in 1937. As OASI switched from a fully funded system to a pay-as-you-go system, it became even more difficult to undo the system. Simultaneously, it abandoned the principle of tying benefits exclusively to payments and added a number of redistributive elements, such as providing additional benefits to elderly recipients who were married. With its mix of insurance principles and redistribution, social security carefully straddled the political boundary between stressing self-reliance and welfare.

Expanding Coverage and Benefits

Over the course of the next few decades, as the economy grew rapidly, social security continued to expand, covering more and more workers and adding new benefits. As Andrew Achenbaum observes, "as long as the number of new and current contributors far exceeded the number of beneficiaries, legislators could liberalize existing provisions, expand coverage, and increase benefits—and still point to huge surpluses in the trust funds" (Social Security, p. 3). In 1940, 43.5 percent of the labor force was covered by social security's insurance program. This rose to 55 percent in 1949. In 1950 farm and domestic laborers were added to the system. A few years later most of the self-employed were added, as well as military personnel, and coverage reached 78 percent in 1955. Subsequent expansion of occupational coverage pushed this figure to 85 percent by 1968. September 1950 also saw the first across-the-board increase in social security benefits, by a dramatic 77 percent, and Old Age and Survivors Insurance benefit payments became larger than Old Age Assistance payments for the first time. Subsequent benefits increases were often passed just before elections, as they were in September of 1952,1954, and 1972. Social security's replacement rate—measured as the OASI benefit in the first twelve months of retirement as percentage of employment income in the preceding twelve months—was 39 percent for the average one-earner couple in 1940. Due to inflation, this fell to 23.5 percent before the 1950 benefits increase and then rose to 52 percent in 1955, 58 percent in 1975, and 62 percent in 1995. In 1956 the Social Security Act was amended to provide monthly benefits to permanently and totally disabled workers aged fifty to sixty-four and for disabled children of retired or deceased workers. Old Age, Survivors and Disability Insurance (OASDI) became the system's new name. In 1961 men were allowed to take early retirement at age sixty-two (with lower benefits) for the first time. In 1965 health insurance was added to the social insurance umbrella, with the establishment of Medicare, although the Social Security Administration did not run this program. In 1972 amendments were adopted that expanded benefits considerably, eased earnings restrictions on nonretired workers and began to automatically adjust future benefits for the impact of inflation. In addition, the state-based supplemental payments to the needy, blind, and disabled elderly were federalized as the Supplemental Security Income (SSI) program, administered by the Social Security Administration. By 1972 every major idea of the 1935 Committee on Economic Security had been enacted, coverage had become nearly universal, and older Americans had a deep sense of "entitwlement" to their social security benefits. The growth of social security can be seen in tables 1 and 2. (The SSI columns' figures before 1980 are for its predecessor programs: Old Age Assistance, Aid to the Blind, and Aid to Permanently and Totally Disabled.

Table 1

Social Security Beneficiaries (thousands)
Wives and  
source: Social Security Administration (2001), Table 5.A4; Myers (1985), Table 11.7; and Social Security Administration (2002), Table IV.B9.
1940112 3055262,143
19501,171 5087004982,952

Table 2

Annual Social Security Payments
YearInsurance  Payments  (billions)Insurance  Payments  as % of  Federal  SpendingInsurance  Payments  as % of  GDPSSI  Payments  (billions)
source: Social Security Administration (2001), Table 4.A4; Myers (1985), Table 11.8; and Social Security Administration (2002), Tables IV.C2 and IV.C4.
1940$ 0.040.4%0.035%$ 0.49
1950$ 0.962.3 0.33$ 1.5
1960$$ 1.9
1970$ 31.916.33.07$ 2.9
1980$120.520.64.31$ 8.1

These programs are not part of social security's insurance system.)

Operating Procedures

Before examining social security's evolution in the twentieth century's last quarter, it will be valuable to explain its operating procedures. The insurance portions of social security (retirement, survivors, and disability benefits) have always been paid for by a payroll tax. Initially, the tax was 2 percent of the first $3,000 earned by employees (the "earnings base"). The tax is automatically deducted from payroll and is officially evenly split between the employer and the employee. However, most economists believe that the tax is effectively paid completely by the employee, whose pay would rise by the entire amount of the tax if it did not exist. The tax rate rose to 3 percent in 1950, 6 percent in 1960, 8.4 percent in 1970, 10.16 percent in 1980, and 12.4 percent in 1990 and 2000. The earnings base was also gradually increased, generally much faster than the inflation rate, reaching $4,800 in 1960, $25,900 in 1980, and $76,200 in 2000.

Social security retirement benefits are calculated in several steps. First the worker's Average Indexed Monthly Earnings (AIME) are calculated. Under the procedures adopted in the 1970s, all earnings on which a worker paid social security taxes up until the year he or she turned sixty are "wage indexed" to compensate for past inflation and real wage growth. To accomplish this, each year's wage is multiplied by an "indexing factor" that equals the ratio of the average national wage in the year the worker turns sixty to the average national wage in the year to be indexed. From this set of earnings, the worker's thirty-five best years are selected, added together and divided by 420 (the number of months in thirty-five years). This amount is the AIME. The second step determines the worker's Primary Insurance Amount (PIA) by applying a progressive formula to the AIME to calculate the monthly benefit that the person would receive if he or she retired at the "normal" retirement age. (The normal retirement age was sixty-five from the beginning of the social security system until 2003, when it begins gradually increasing to age sixty-seven by 2025.) The progressive formula has been selected so that low-earning workers receive payments that are disproportionately higher—compared to the taxes that have been paid in—than for high-earning workers. For example, in 2001 the Primary Insurance Amount was 90 percent of the first $561 of the retiree's AIME, 32 percent of the AIME over $561 and up to $3381, and 15 percent of Average Indexed Monthly Earnings above $3381. Adjustments are made to the retiree's Primary Insurance Amount, which is reduced for those taking early retirement and can be increased by as much as 50 percent if the retiree has a spouse who had little or no earnings. Finally, the monthly benefit check is adjusted annually for changes in the cost of living. The adjustment is determined by the rate of inflation in the Consumer Price Index (CPI). Most economists believe that the CPI overstates inflation, so this means that the retiree's monthly benefit buys more over time.

One of social security's initial purposes was to reduce unemployment by inducing older workers to retire. Throughout its history, social security has had a retirement earnings test. The 1935 Social Security Act prohibited any payment when income was earned in "regular employment." In 1939 "regular employment" was defined as earning more than $15 per month—about 25 percent of the minimum wage. The economist Donald Parsons estimates that this earnings test increased the retirement rate for men sixty-five and over by about six percentage points in 1940. In 1950, the income threshold was raised to $50, and the retirement test was eliminated for those age seventy-five and older. In 1960, for the first time, earnings over the exempt amount did not produce total loss of benefits; instead, for income in a certain range, benefits were reduced $1 for every $2 in earnings. In 1990, this rate was cut to $1 for every $3 in earnings for workers above the normal age of retirement. In 2000, as unemployment reached its lowest rate in over thirty years, both houses of Congress unanimously voted to eliminate the retirement earnings test for workers above social security's normal retirement age.

Comparing taxes paid to benefits received, it is possible to calculate the rate of return on a worker's social security "investment," just as one would for a private investment. Such calculations show that social security's rate of return was very high for the first population cohorts covered by the system. Rates of return for those reaching sixty-five in 1950 averaged about 20 percent. By 1965 returns fell to about 10 percent and they continued this downward trend because tax rates had increased and retirees had now been taxed for all or most of their working lives. Inflation-adjusted average rates of return from OASI are given in table 3, which shows that lower-income workers have higher rates of return. Single males' average

Table 3

Inflation-Adjusted Lifetime Rates of Return from OASI
 Year Cohort Turns Sixty-five
Group (earnings level)19501965198019952025 (projected)
source: Steuerle and Bakija, Retooling Social Security, p. 290.
Single Male     
Single Female     
One-earner Couple     
Two-earner Couple     

rates of return are lower than for single females because women live longer than men and therefore collect more benefits. Studies also show that blacks have lower rates of return due to their lower life expectancies. The table shows that rates of return are projected to continue declining—assuming that taxes and benefit formulas are unchanged.

Problems and Changes

By the mid-1970s, it was becoming clear that the mature social security system could not continue to finance all the benefits it had promised. In 1975, for the first time since 1959, social security ran a deficit, spending more on benefits than it collected in taxes. Deficits occurred again in 1976 and 1977 and were projected to continue, exhausting the Social Security Trust Fund—U.S. government debt owned by the social security system—by the early 1980s. In response, Congress substantially increased social security taxes, and benefits were scaled back by reducing spousal benefits and amending the indexing procedure. President Carter, signing the bill into law, predicted that these moves would make the system sound for decades to come. He was wrong. By 1981 worries about funding shortfalls reappeared and the Reagan administration proposed additional cuts in benefits, including scaling back the cost-of-living inflation adjustment and reducing early retirement benefits. The powerful senior citizens' lobby greeted these proposals with a withering wave of protests and the Senate immediately rejected them, but polls showed that two-thirds of the public were "not too confident" or "not at all confident" in the system. To defuse the issue, the president and Congress appointed the bipartisan National Commission on Social Security Reform, chaired by Alan Greenspan, to make recommendations to solve social security's financing crisis. In 1983, after intense political bickering, Congress accepted the Greenspan commission's proposals to further increase taxes, begin taxing the benefits of higher-income retirees, and gradually increase the normal retirement age from sixty-five to sixty-seven. Taxes were expected to greatly exceed expenditures so that the system's trust fund could be built up in anticipation of the retirement of "baby boomers" born between the end of World War II and the early 1960s. The bill was signed amid predictions that the funding problem was solved for generations to come, and the Social Security Trust Fund, which had never exceeded $40 billion before 1983, began to grow. It reached $214 billion in 1990 and $931 billion in 2000.

Unfortunately, this nest egg did not appear to be large enough given demographic trends and somewhat pessimistic projections of economic growth. By 1993, social security's board of trustees projected that OASDI would begin running deficits around 2015. Social security's spending would then exceed income by an everincreasing margin, and the board expected the trust fund to be exhausted by about 2035. The number of OASDI beneficiaries per one hundred covered workers, which had been 6.1 in 1950 and 26.6 in 1990, was expected to climb to 42.7 by 2030—there would be only a little more than two workers paying for every beneficiary as the population aged and life expectancies increased. In light of these pessimistic predictions, the 1994–1996 Social Security Advisory Council released its report in early 1997. Unable to achieve consensus, the council offered three options. The "Maintain Benefits" option (supported by six of the thirteen council members) proposed to essentially maintain the historical structure of social security by increasing taxes and slightly reducing benefits. However, the other two options broke with tradition. The "Personal Security Accounts" option (supported by five members) advocated a partial privatization of social security, proposing to divert nearly half of the social security tax into mandatory personal retirement accounts, allowing individuals to put their own social security funds into the stock market. The "Individual Accounts" option (supported by two members) was in between the other two, proposing that social security payroll taxes be increased, but that this money be put into government-run individual retirement accounts.

Leading economists, including the former Council of Economic Advisors chairman Martin Feldstein, began to advocate a transition to a completely privatized social security system. They argued that social security had slowed economic growth by reducing the national savings rate, reasoning that if social security did not exist workers would have saved more for their retirements and this savings would have boosted the investment rate, increasing the nation's capital stock. Because social security is mostly a pay-as-you-go system, however, the money was never saved and any money in the trust fund was lent to the government rather than invested. Feldstein estimated that this effect probably had reduced national income by about 6 percent and that social security taxes further reduced national income by curbing work incentives. Privatization advocates pointed out that inflation-adjusted long-run stock market returns have been about 7 or 8 percent per year—much higher than the returns earned and promised by social security. Privatization would essentially be a forced savings plan, but its critics warned that many individuals were not competent to make their own investment decisions, that the stock market was very volatile, that privatization allowed no room for redistribution, and that privatized plans would have much higher administrative costs than the social security system. Privatization's fans pointed to the success of Chile, which in 1981 replaced its failing pay-as-you-go retirement system with a privately managed mandatory savings program. Chileans earned impressive returns in their new system, which was soon imitated around the world. Amid these developments and a booming stock market, politicians began to advocate similar plans. President Bill Clinton floated the idea of investing surplus social security funds in the stock market, and in his campaign for the presidency in 2000 George W. Bush advocated reforming social security so that it would offer private savings accounts.

Many have seen social security as the most successful government program in American history. It has been credited with bringing true security to American workers, reducing the fear of poverty in old age, allowing more of the elderly to retire and giving them the resources to live independently. Others see it as a flawed system, an inter-generational transfer mechanism that has benefited the earliest cohorts of retirees, but which promises too little to the current and future generations, explaining most of the elderly's rising retirement, income, and independence as extensions of historical trends caused by continued economic growth. By the early twenty-first century, social security had become the subject of an intense political argument.


Achenbaum, W. Andrew. Social Security: Visions and Revisions. New York: Cambridge University Press, 1986.

Berkowitz, Edward D., ed. Social Security after Fifty: Successes and Failures. New York: Greenwood Press, 1987.

Berkowitz, Edward D., and Kim McQuaid. Creating the Welfare State: The Political Economy of Twentieth-Century Reform. Lawrence: University Press of Kansas, 1992.

Costa, Dora L. The Evolution of Retirement: An American Economic History, 1880–1990. Chicago: University of Chicago Press, 1998.

Feldstein, Martin. "The Missing Piece in Policy Analysis: Social Security Reform." American Economic Review 86, no. 2 (1996): 1–14.

Ferrara, Peter J., and Michael Tanner. A New Deal for Social Security. Washington, D.C.: Cato Institute, 1998.

Haber, Carole, and Brian Gratton. Old Age and the Search for Security: An American Social History. Bloomington: Indiana University Press, 1994.

Lubove, Roy. The Struggle for Social Security, 1900–1935. Cambridge, Mass.: Harvard University Press, 1968.

Myers, Robert J. Social Security. 3d ed. Homewood, Ill.: Irwin, 1985.

Nash, Gerald D., Noel H. Pugach, and Richard Tomasson, eds. Social Security: The First Half-Century. Albuquerque: University of New Mexico Press, 1988.

Parsons, Donald O. "Male Retirement Behavior in the United States, 1930–1950." Journal of Economic History 51 (1991): 657–674.

Quadagno, Jill. The Transformation of Old Age Security: Class and Politics in the American Welfare State. Chicago: University of Chicago Press, 1988.

Rejda, George E. Social Insurance and Economic Security. 6th ed. Upper Saddle River, N.J.: Prentice Hall, 1999.

Rubinow, Isaac M. The Quest for Security. New York: Henry Holt, 1934.

Social Security Administration, Social Security Online: History Page.

Steuerle, C. Eugene, and Jon M. Bakija. Retooling Social Security for the Twenty-first Century: Right and Wrong Approaches to Reform. Washington, D.C.: Urban Institute Press, 1994.

Weaver, Carolyn. "On the Lack of a Political Market for Compulsory Old-Age Insurance Prior to the Great Depression." Explorations in Economic History 20, no. 3 (1983): 294–328.

———. The Crisis in Social Security: Economic and Political Origins. Durham, N.C.: Duke University Press, 1982.


See alsoMedicare and Medicaid ; New Deal ; Retirement ; Retirement Plans ; Welfare System ; andvol. 9:The New American Poverty .

Disability Insurance

views updated May 21 2018

Disability Insurance

Disability insurance or disability income insurance (abbreviated DI in the industry), is designed to compensate the policy holder for income lost if the holder becomes disabled. DI usually also covers additional services such as rehabilitation. DI is one in a spectrum of protection measures available to individuals or groups. Group DI policies may have upper limits on their income protection provisions; sometimes it turns out to be difficult to realize a benefit under such policies because of elaborate and government-imposed review processes. Private DI policies were once available providing very high compensation replacement; insurance companies have changed their products since the 1990s in order to protect themselves against claims losses, but private policies can still be purchased with higher benefits than group policies.

Protection against disability in the workplace takes several forms, some at the option of the employer, some provided under state or federal law: 1) most employees have legally mandated sick leave privileges; 2) many employers offer short-term disability (STD) insurance in addition; private STD insurance is available but said by industry observers to be difficult to get for reasons laid out below; 3) worker's compensation programs are provided by state governments paid for through levies on employers; in most states the compensation is two-thirds of wages earned; other benefits (like retraining) may be provided; 3) Social Security disability insurance becomes available after an individual has been unable to work for a year; only those totally disabled are eligible; and payments begin six months after eligibility has been established; the amount paid, like Social Security itself, is based on past earnings but does not necessarily match them; 4) long term disability (LTD) group plans are offered in about 40 percent of medium to large-sized companies, according to Kiplinger's Personal Finance; far fewer small companies offer such insurance.


Individual disability insurance, according to Peter C. Katt, an industry advisor, writing in Journal of Financial Planning, ran into turbulent times in the late 1990s because of mistakes made in the 1980. These problems are still affecting DI companies and those wishing to buy policies.

The DI industry developed insurance products for individuals with high income some of which was badly underpriced in the 1980s. These came to be known as "own occupation" policies in which a person was deemed to be totally disabled if he or she could not perform the duties of his or her "own occupation." Thus, using one of Katt's examples, an orthopedic surgeon unable to stand during long operations because of persistent back pain would be deemed "totally disabled" and deemed entitled to collect up to 60 percent of his or her weekly compensation until retirement ageeven though this same person could easily, by switching to general practice, earn a very decent income if not at the peak level as a surgeon. Such policies became very popular with physicians, specialists, and lawyers. "DI companies fell all over themselves providing narrower definitions of such occupations." Claims experience later showed that the incidence of such narrowly defined disability was much higher than anticipated, the premiums charged too low to sustain the business, and therefore new DI policies are tailored much more in favor of the insurance companies in the mid-2000s.

"Own occupation" coverage may be limited to some period of time after the disability. Thereafter an "any occupation" clause comes into effect. Thus, for instance, a surgeon who must occasionally sit down is obliged to practice some other branch of medicine rather that sit back and collect high DI payments until age 65.

Costs of Individual DI

An individual thinking of purchasing individual DI should anticipate paying around 2 percent of his or her annual gross income in premiums for income benefits equivalent to between 45 and 50 percent of gross income, this benefit beginning 90 days after the disabling event and lasting until retirement at age 65assuming that the individual has no other work activity that produces income. These data are based on quotations obtained in 2006 for a hypothetical 51-year old non-smoking, non-drinking individual earning $250,000 a year in an administrative position. The average of premiums quoted was $4,620 per annum and the average monthly benefit at $9,797, equivalent to 47 percent of gross income.

Group Long-Term-Disability Packages

Group coverage generally replaces 40 to 60 percent of the insured person's income, but usually only up to about $5,000 a month. This compensation is fully taxable if the premium is paid by the employer, but the company is permitted to deduct the premium as a business expense. Group plans are relatively inexpensive but are designed to limit what is covered and to make benefits payable as predictable as possible for the insurance carrier. Definitions of disability are limited, any external income or benefits the claimant receives may be deducted from benefits, and certain conditions are excluded. The claimant's ability to sue the company must take place under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA). As Mark F. Seltzer reported in Physician's News Digest, the law surrounding ERISA-managed appeals processes has come to favor the insurance carrier.


Insurance works most rationally in a real life situation in which a particular claims event (e.g. a death) is very difficult to predict but the aggregate of such events can be projected statistically with fair precision. In such circumstances the insurance carrier can rationally calculate a reasonable premium which will ultimately pay the claimant what is contractually defined while permitting the carrier to have a profit.

"Disability" does not seem to fit the insurance model very well because it is less predictable and much more difficult to define and prove. The Social Security Administration states that 3 of 10 individuals may become disabled in their working years before reaching retirement age. But the agency does not have very specific definitions of the nature of disability or its duration, both of which have complex causes and factors.

Human disability may have as its cause what seem to be a nearly infinite number of interacting physical and mental disturbances the onset of which is almost impossible statistically to project to a population. And if the liability of the insurance carrier is, furthermore, income protection, the nature of the disability that may strike a policy holder does not necessarily link closely to the policy holder's earnings. There are definitional problems. Disability to perform one's "own occupation" is contrasted to performing "any occupation." And the literature in the field bristles with complaints about the adequacy of definitions in distinguishing between actual and subjective disabilitynot least the medical basis of something like chronic fatigue syndrome.

In this situation generally, the natural outworkings of socially provided protection schemes tend toward unsatisfactory outcomes. On the private side, insurance carriers attempt to limit exposure by a combination of high premiums in private policies and delimited benefits in mass policies. On the public side, minimal protection is provided but only in cases of total disability, which is the Social Security disability outcome.

Under the circumstances, DI is one optionand not a very satisfactory onethe small business owner can examine as a hedge against personal disability. An aggressive saving plan may be another. Substantial time in soliciting bids, in using legal resources to examine offered policies, and in researching alternatives to such expenditures are in the picture. In a well-run and profitable small business, an internal legal arrangement which will provide some limited income to the disabled owner at company expense may sometimes be the best solution whether or not it involves DI.


"Disability Insurance and Women." WebMD. Available from Retrieved on 15 February 2006.

"Do You Have Enough Disability Coverage?" Kiplinger's Personal Finance. 21 March 2003.

Greenwald, Judy. "Insurers, Regulator Clash Over Disability; Policy Language at Center of Fight." Business Insurance. 12 December 2005.

Katt, Peter. "Be Wise About Disability Insurance." Journal of Financial Planning. June 1997.

Koco, Linda. "New DI Society Gets Under Way." National Underwriter Life & Health. 21 November 2005.

Lynn, Jacquelyn. "What's the Damage?" Entrepreneur. July 2000.

Mariski, William G. "Cultural underwriting: a revived disability pricing concept?" National Underwriter Life & Health. 14 November 2005.

Panko, Ron. "Group Disability Plan to Help Small Employers." Best's Review. January 2006.

"Read the Fine Print." Kiplinger's Personal Finance. 21 March 2003.

Schneider, Larry. "Arthritis: Outcomes vary in disability insurance cases." National Underwriter Life & Health. 14 November 2005.

Seltzer, Mark F. Esq. "ERISA and Long Term Disability Claims." Physician's News Digest. November 2003.

Tinkham, Leo D. "Evidence of Cost Savings Grows for Integrated Disability Management." Employee Benefit News. 1 August 2000.

                                             Darnay, ECDI

Disability Insurance

views updated May 29 2018

Disability Insurance

What It Means

When a person cannot work because of an accident or illness, disability insurance (sometimes called disability income insurance) replaces a portion of that person’s income. For example, if a painter had disability insurance and one day, while working on the outside of a house, slipped off his ladder and broke his leg, he would receive monthly checks to pay for his living expenses. He would continue to receive money until his leg healed and he was able to go back to work.

In many countries some form of disability insurance is provided by the government. In the United States the national government provides several types of assistance for the disabled. Social Security Disability Insurance (SSDI), available to workers under the age of 65, covers people who cannot do any “substantial gainful activity”—that is, people who cannot do any job, regardless of their profession before the disability. In the example of the painter, if he were still able to do another job, such as telemarketing or working in a tollbooth, he would not be eligible for SSDI. Some disabled people with very low incomes, including those 65 years or older, might also be eligible for additional money called Supplemental Security Income. The U.S. Department of Veterans Affairs provides money and other forms of assistance to disabled soldiers.

Private disability insurance also exists. In the United States, because government assistance is available for some disabled people, private disability insurance is directed toward people who want to protect themselves against the possibility of being disabled but not qualifying for SSDI or for people who, in the case of a disability, would like a higher income than SSDI would provide. A lawyer, for instance, could purchase private disability insurance that would provide income if he had an accident or illness that prevented him from working in his existing profession, the law. In order to receive SSDI, the accident or illness would need to keep him from doing any work at all.

Private disability insurance is sometimes provided by companies for their employees. Individuals can also purchase it.

When Did It Begin

The idea of disability insurance, providing income to ill or injured people who cannot work, is not new. Some early examples were for soldiers. The ancient Greeks cared for their ill soldiers until they recovered, and in the seventeenth century soldiers in Holland were insured against the loss of hands or feet and other physical problems. In 1757 the British government provided assistance to dock workers who were sick or injured.

Private disability insurance in the United States began to be popular in the early twentieth century. Insurance companies, unlike in previous times, started offering disability insurance that could not be canceled by the company and for which premiums (the payment for the insurance) could not increase.

During the Great Depression (the worldwide economic downturn that began in 1929 and lasted until about 1939) the U.S. government took a greater role in protecting Americans from economic risk. In 1935 it passed the Social Security Act, which provided income assistance to retired workers aged 65 or older. In the mid-1950s the act was amended to assist younger Americans who were involuntarily retired, or disabled, because of an accident or illness.

As the government became more involved in protecting Americans from complete poverty, insurance companies increasingly sold disability insurance to wealthier consumers and professionals, including physicians.

More Detailed Information

Private disability insurance can be divided into two categories, short term and long term. Short-term disability insurance covers a worker for a period of a few weeks to a couple years. Companies often provide short-term disability insurance to their employees. Long-term disability insurance might last five years or longer, sometimes until the worker is 65 years old, when he or she would qualify for income payments from Social Security.

Important in any disability insurance is how it defines disability. Some insurance will cover a person who can no longer work in his or her chosen profession, such as teaching. According to other insurance, however, a person is disabled only when he or she cannot find work consistent with his or her training or experience. A doctor who suffered brain damage from a fall, for example, would not need to look for work that required little education, such as a job at a fast-food restaurant.

Disability insurance generally covers only a portion of the person’s previous income. Sixty percent of the former monthly salary is common, though with more expensive insurance, one can receive a higher percentage. Some insurance will provide a monthly payment, though reduced, to disabled people who can return to work part-time.

People buy disability insurance with the hope they will never be disabled and thus will never have to use it. One has to make a choice between making lower payments now and possibly receiving less income later or making higher payments now and possibly receiving more income in the future. As with any insurance, it is a risk.

Recent Trends

In the 1980s U.S. insurance companies competed aggressively to sell disability insurance to professionals, especially physicians. Doctors made a lot of money and could afford insurance, and they also tended to be dedicated to their work even when they developed physical problems.

In the 1990s—a decade that saw a dramatic increase in health-care costs and in the popularity of managed-care companies, such as HMOs and PPOs (health maintenance organizations and preferred provider organizations, respectively, which both attempted to limit health-care costs, including physicians’ fees)—doctors began to make less money, and many were frustrated with the new working conditions of managed care. As a result, an increasing number of physicians with physical ailments chose to stop working and to collect disability payments. Companies selling disability insurance, which once viewed physicians as attractive clients, suffered huge losses.