Insurance: Protecting Against Disability

 

Sobering fact of the month: According to insurance-industry statistics, you are more likely to suffer an accident or illness that disables you for at least three months than you are to die before age 65.

Disconcerting suggestion of the month: Although you undoubtedly have life insurance, you may not have adequate disability coverage. Particularly if you own your own company, disability can have far-reaching implications. "How long is your business going to continue if you are disabled?" asks Bob Glovsky, vice-president of Baystate Financial Services in Boston. "If the key owner is out, it could fold up in a couple of months."

To avoid such a catastrophe, insurance experts say, owners of closely held corporations and partnerships should consider at least three distinct kinds of disability policies.

The first is a disability income policy. It is likely that your company already offers its employees such a policy on a group basis. It is also likely, however, that the maximum benefits paid by the policy your current income. You and your company's other top-salaried people may therefore need to be "carved out" of the group (as insurance agents say) and provided with your own coverage.

That coverage can come in one of two forms. "One kind of policy says, in effect, we will insure you as president of the ABC Corp., and if you can't perform your duties as president you will get benefits," explains Gary L. Dockray, marketing general manager for CIGNA Corp.'s individual financial services division. That, says Dockray, is the traditional type of disability income policy.

A recent innovation is called earnings insurance. Instead of the older policy's all-or-nothing coverage (you either can or cannot perform your duties, so you get either full benefits or nothing), earnings insurance lets you work as much as you are able. It then reimburses you for lost income, usually up to 80% of your previous level.

Both policies, Dockray notes, come with a variety of possible riders, such as cost-of-living adjustments, that an insurance agent can explain.

Should your company buy the policy, or should you? There is a trade-off here, and it involves taxes. As Howard J. Saks, a Los Angeles insurance specialist, explains it, your company can purchase a disability-income policy and deduct the premium as a business expense. But any benefits ultimately paid under the policy are then considered taxable income to you. Alternatively, you can buy the policy with your own aftertax dollars and receive benefits tax free if catastrophe strikes.

Protecting your income, of course, is only half the battle. The other half is protecting your business. Depending on your situation, you may need an over-head-expense reimbursement policy, a disability buy-out policy, or both.

An overhead-reimbursement policy, as its name suggests, pays the rent while you are recovering and figuring out what to do next. Designed mainly for businesses whose operations depend heavily on the owner's daily involvement -- a small consulting firm, say -- it covers your employees' salaries, payroll taxes, insurance premiums, and other fixed costs. It won't pay, however, for such variable costs as goods and supplies, nor will it pay the salary of anyone hired to replace you.

Benefits in a typical expense-reimbursement policy last one to two years and start after a 30-to-90-day waiting period. Some companies, says Saks, set a limit on how much they will write; others, like Guardian Life Insurance Co. of America, set no limit but will pay only 50% of expenses over a certain level. Most policies, in any event, are cheap. A typical lawyer or law firm, says Baystate Financial's Glovsky, might pay $100 for $3,000-a-month coverage with a 90-day waiting period and a year's worth of benefits.

The most neglected area of disability insurance, say the experts, is disability buyout coverage. "It's the most overlooked situation in buy/sells," says James Schwartz, a fee-only personal financial planner in Aurora, Colo. "Many CPAs and lawyers are either unaware or just learning" of such policies, agrees Saks.

A disability buy-out policy provides the money for a corporation (or the remaining partners, in the case of a partnership) to buy out a disabled owner. Typically, a buy/sell agreement is activated a year after the original disability. At that point, the company collects on its policy and buys out the disabled owner, who thereby gets his or her money out of the enterprise.

"These policies had some growing pains " says Charles I. Bauer, head of sales promotion for New York Life Insurance Co.'s individual health insurance division. For example, he says, these policies often used to pay benefits on an install ment plan, with the disabled partner being bought out over time. If the partner recovered, the buyout had been triggered and had to proceed, but the payments suddenly stopped. Now, Bauer says, it is not uncommon for companies to pay off in a lump sum after a one-year or two-year waiting period. But the policy's provisions should be checked.

Expense-reimbursement and disability buyout policies can be bought and paid for by the company itself. In the latter case, however, the policy premium is nondeductible and thus must be paid with aftertax dollars. The reason for this, says Howard Saks, is that any benefits coming from the policy are tax free.

All of these policies, the experts agree, require the advice of an insurance broker or financial planner. Not everyone needs them, and some may prefer self-insuring against at least a portion of the risk. Do not, however, count on just taking your money out of the company forever if you can't work. After a year or so of disability, says Gary Dockray, the IRS will view such outlays as a dividend distribution rather than a salary, unless you have a formal written plan for salary continuation. Without such a plan, the company will have to pay taxes on the money -- and so, of course, will you.