SAFEGUARDING YOUR BUSINESS AND PERSONAL INCOME

Safeguarding Your Business And Personal Income – How Disability Insurance Works
Business Owners and Financial Risk

In today’s fast-paced economy, very few business owners
or professionals hesitate to protect themselves against
unforeseen but likely financial risks. That is why they
insure their valuable buildings, equipment and motor
vehicles against property damage and theft. Many business
owners also retain liability or malpractice insurance
to protect against the risk of unacceptable financial loss
arising from damages caused by them or their employees
to property or other people. Yet many business owners
fail to protect themselves from the financial effects of a
crippling injury or illness that can strike either themselves
or a key employee.

Unfortunately, the chances of a disability striking a business
owner and causing severe financial hardship are a
reality. A 1998 U.S. government study indicated that one
out of every 10 Americans between the ages of 18 and 64
cannot work due to severe disability.* For a business
owner dependent on himself or herself or a key employee
to maintain profitability and earn a living, the replacement
of personal income from outside sources is not likely.

• Social Security Administration records reflect that 50%
  of all disability claims are denied because applicants cannot
  demonstrate that their disability will last for at least
  12 months or will result in death.
• National Safety Council studies show that two-thirds of
  disabilities are not job-related and therefore are not
  covered by worker’s compensation.† Business owners are
  generally not eligible to receive worker’s compensation.
• A business owner with health insurance will find that
  such insurance only covers his or her medical expenses.
  Health insurance does not provide income to the
  business owner to pay his or her home mortgage, auto
  loan or other personal expenses for support of his or her family.

A business reliant upon the skills of an owner for its
financial success will likely suffer a noticeable decline in
revenues accompanied by fixed or increasing operating
expenses in the event of an owner disability. Unable to
work and operate the business profitably, a disabled owner
may be unable to pay employee salaries, rent, mortgage,
utilities, property taxes, casualty insurance, and installment
payments for equipment or motor vehicles. If a
severe decrease in revenues should occur, the disabled
business owner may experience a “freeze” on his credit
lines or be denied loans by a commercial lender. If the
owner’s disability is perceived as severe or irreversible:

• Key employees may leave the business to find
  other employment.
• Customers may turn elsewhere to have their needs met by competitors.
• There may be no choice but to liquidate the business to satisfy debts and prevent further financial loss.

Types of Disability Insurance Plans
There are three major types of disability insurance coverage
available to business owners. They are:
Income Replacement
This type of policy is designed to replace up to 60% of
the business owner’s or key employee’s pretax income in
the event of either a short- or long-term disability due to
injury or illness. This is income for personal and family
use. Short-term disability benefits are paid from the date
of illness or injury for a period of up to six months.
Generally, long-term disability benefits are payable for a
period beginning six months from the date of illness or
injury. If the business owner cannot return to work, longterm
disability benefits are usually payable to age 65.
Some disability insurance carriers will pay a benefit up
to age 75.
A business owner or key employee can protect his or her
personal income through an individual or group disability
insurance policy. Group disability insurance policies tend
to be more cost-effective with less stringent medical
underwriting and issue requirements than individual policies.
Group policies usually require 10 or more participants
and are designed to replace loss of personal income
with the extra advantage that particular professions or
vocations are guaranteed issuance of coverage. Group
policy applications require a complete employee census,
including name, gender, birth date, W-2 compensation,
job duties and state of residence.
Income replacement plans will pay a maximum monthly
benefit based on a percentage of an employee’s or business
owner’s pretax salary (usually 60%). In the case of a
highly compensated person, these percentage-based plans
will only insure a maximum of 60% of salary for a maximum
monthly benefit of $12,000.

Overhead Expense Protection
A business must still meet its monthly expenses even if a
disabled owner or key employee is no longer generating
revenues to meet those expenses. This type of policy pays
a stream of cash to the business every month for meeting
expenses arising from employee payroll, federal and state
taxes, rent, mortgage, utilities, office supplies, equipment,
manufacturing plant operations, or motor vehicles. With
some insurance carriers, maximum monthly benefits can
be as high as $15,000. These payments are made after
a long-term illness or injury has disabled an owner or
key employee who is critical to the financial success of
the business.
Overhead expense policies only pay temporary benefits
to a business. Benefits paid under an overhead expense
policy generally last for a maximum period of 12 to 24
months or until the key employee returns to work. If the
owner or key employee does not return to work, the business
has only 12 to 24 months to recruit, hire and train a
suitable replacement or wait until business revenues have
had a chance to recover. If a business cannot recover from
an owner’s permanent disability, it may have to be sold.
Overhead expense policies require the business to furnish
financial statements and tax returns to document monthly
expenses to determine the amount of coverage available.
Keep in mind that overhead expense payments do not
replace the business owner’s salary or other income generated
from the business. The owner would need an
income replacement disability policy to accomplish that.

Buyout
This type of insurance coverage is appropriate for a business
with more than one owner. A disability buyout policy
will make a lump sum payment to the business or any
remaining owner(s) after any owner has been disabled for
12 months or longer with no likelihood of recovery.
Disability buyout insurance is typically accompanied by a
written buy-sell agreement between the business and each
of its owners that obligates the business to redeem a disabled
owner’s interest in the business. The business or
other owner(s) will use the lump sum payment to purchase
the interest of the disabled owner. The remaining
owners will then own the business without having the
financial burden of borrowing money, liquidating business
assets, taking severe reductions in salary or making
installment payments to buy out the permanently disabled owner. Generally, disability buyout policies will have a
coverage limitation of $500,000 to $1,500,000 per person,
depending on the value of each owner’s shares, so these
policies are typically most appropriate for smaller businesses.
These types of policies require the business to
furnish extensive financial information or a formal
appraisal to determine the amount of coverage available.
For all disability plans, business owners can take advantage
of significant premium discounts if they are nonsmokers
and pay premiums on an annual basis.

Important Features of Disability Insurance Plans
When reviewing a personal or group disability insurance plan, the business owner or professional is advised to
look for the following nine key features:

1. A reasonable definition of sickness. A policy should
define illness so that the business owner(s) or the
business won’t be denied benefits when a claim is
filed. For example, disability from an illness or injury
should be considered to start when a person
becomes aware of the condition, not when the condition
originates. Similarly, benefits should be available
when the policyholder (owner) tests positive for an illness
or disease, not when symptoms begin to appear.

2. Partial disability protection. With this coverage, a
disabled business owner can collect some personal
income or overhead expense benefits even while
working part time. The policy should not require the
business owner to become totally disabled for a
period of time before collecting partial payments.
This feature is important because a business
owner who develops a degenerative disease over
many years may not otherwise qualify for any
disability payments.

3. Own-occupation clause. A business owner will
receive benefits under this clause if he or she can no
longer work in his or her chosen profession or vocation.
The alternative, any-occupation coverage,
denies benefits if you can perform any job outside
your work field, however menial. This feature is
important because a business owner is seldom so
disabled that he or she can’t qualify for some less
physically demanding employment.

4. Occupation or job duties A business owner’s occupation
or job duties are important for determining
the maximum period for which benefits will be
paid for any illness or injury. A business owner who
is engaged in potentially hazardous activities is
presumed to be at greater risk of injury and may
therefore be limited to a benefit period of two to five
years in the event he or she suffers a disability. For
example, it is more likely that a business owner who
operates or works with heavy machinery is more at
risk of being injured than a business owner who performs
management duties in a retail store.

5. Inflation rider. Benefits paid on a policy with an inflation
rider will increase with changes in the Consumer
Price Index. The inflation-adjustment rate should be
calculated on a compounded basis rather than a
simple yearly addition. The inflation rider shouldn’t
cap benefits at an arbitrary level. With an inflation
rider, benefit levels are typically adjusted upwards
only for the first five years a policy is in force or after
a claim is filed and approved.

6. Guaranteed policy renewal. With this provision, a
disability insurance carrier can’t refuse to renew the
policy if the insured person’s health becomes worse.
Many plans offer noncancelable coverage, guaranteeing
an annual level premium until a business
owner reaches age 65.
7. Additional purchase benefit. This feature lets the
business owner buy additional coverage at specific
intervals without proof of insurability. For example,
an additional purchase benefit increase lets a business
owner increase his or her coverage every five
years between the ages of 25 and 50 upon showing
proof of a 20% or greater increase in personal
income or business revenues. This is a critical feature
because a growing business or a successful professional
could end up severely underinsuring his or
her needs for personal disability, buy-sell or overhead
expense needs for coverage.

8. Flexible waiting periods. Disability insurance policies
offer waiting periods of 30, 60, 90, 180 or 360 days
until a claim is paid for illness or injury. It is more
cost-efficient to save on premiums if you opt for a
waiting period of 90 days to one year. A longer waiting
period may cut premium costs up to 40%. A
longer waiting period is comparable to a higher
deductible on your homeowner’s or auto insurance.
If you opt for a longer waiting period to save on
premiums, it is advisable to have emergency savings
to meet personal or business income needs.
9. Catastrophic disability. This policy rider or provision
lets a business owner collect an additional disability
benefit in addition to his or her base benefit. This
additional benefit could amount to several thousand
dollars each month. A catastrophic disability occurs
when the business owner suffers the loss of speech,
hearing in both ears, sight in both eyes, the use of
both hands or both feet, or one hand and one foot. In
these cases the catastrophic disability benefit will be
paid to the business owner up to age 65 or for the
first five years after disability occurs.
Well-known disability insurance carriers can offer you
detailed written samples of the various plans that they
have available to meet a business owner’s personal
income, overhead expense or buyout needs. These sample
plans will contain the contract terms and provisions
for the business owner to review and consider in helping
him or her determine whether a particular plan is suitable
and cost-effective.

Protect Yourself and Your Business Today
Cost-effective disability insurance plans can serve a wide
variety of needs to insulate the business owner against
financial catastrophe by providing him or her a guaranteed
stream of cash to meet personal income, overhead
expense or buyout needs.
Ask your financial consultant how they can help you
design and implement a personal disability, overhead
expense or buyout plan to protect your income and business
from the devastating and irreversible financial losses
arising from the serious injury or illness of an owner or key employee.