REVIEW SUMMARY FOR
DISABILITY INCOME COVERAGE
CHAPTER 1
DEFINITION AND OVERVIEW GUARANTEED
RENEWABLE
Disability Income Insurance is health insurance that provides
income payments to the insured wage earner when income is
interrupted or terminated because of illness, sickness, or accident.
(Dictionary of Insurance Terms, III Edition). Basically, there are two
types – Long-term and Short-term, the difference being the length of
time that income can be paid.
GUARANTEED RENEWABLE
A Guaranteed Renewable insurance policy (contract) is
renewable at the option of the insured for a specified number of
years, or to a stated age. The company cannot refuse to renew the
policy and it cannot change any of the policy provisions, except for
the premium. If the insurer wishes to change the premiums for the
policy, it must do so for the entire policyholder classification, not
just for one or a few insureds. Usually the insured has the right to
renew the policy to age 65 by paying the premiums on time.
ACCIDENTAL MEANS vs RESULTS
When “accidental means” is used regarding a bodily injury,
there are two requirements that must be met if the loss is to be
covered: Both the cause of the injury and the result (the injury)
must be unexpected and unforeseen. In addition, the event must
not be under the control of the insured that results in the bodily
injury. Most states prohibit the use of the accidental means clause
in any health insurance contract.
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SICKNESS
The definition of “sickness” is not entirely uniform among
companies and their products, but generally it is defined to means
sickness or disease that first manifests itself during the time that
the policy is in force. Some insurers extend the “first manifest”
language to mean a sickness or disease that is first diagnosed and
treated during the time that the policy is in force. There is little
difference, actually, and the intention in either case is to cover only
sickness that is first contracted during the time that the policy is in
force.
PREEXISTING CONDITION
Similar to preexisting condition clauses in other types of
health insurance, it usually applies to the first two policy years and
is used to exclude benefits for any loss that results from a (medical)
condition – sickness or disability - that had not been acknowledged
or reported by the insured, and that occurred prior to the policy
date.
PREEXISTING CONDITION LIMITATION
A typical preexisting provision in a disability income policy
could read: “This policy does not pay benefits, which are based on a
preexisting condition if:
The preexisting condition is not
misrepresented in the application; and
disclosed
or
is
The preexisting condition impairs the Insured or causes a
loss of use or other loss during the first two years after the
effective date of the coverage, based upon an impairment
or other loss that started before the effective date of
coverage, or if receiving medical care which relates to the
injury or sickness
RESIDUAL DISABILITY INCOME INSURANCE
If Residual Disability Income coverage is provided, benefits are
usually provided for the unused portion of the total disability
benefit period, up to age 65. If an individual is at least age 55 at
the time of disablement, and total disability lasts less than a year,
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residual benefits are payable for the unusual portion of the benefit
period for up to 18 months, but not beyond age 65.
OWN OCCUPATION
The most comprehensive definition as included in a policy and
the one that the majority of policies use, may state: “The inability
to perform the major duties of your occupation—the insurance
company will consider your occupation to be the occupation you are
engaged in at the time you become disabled.” They will pay the
claim even if the insured is engaged in another occupation.
A typical policy definition such disability would read: “Total
Disability means that due to Injuries or Sickness:
1. You are unable to perform the duties of your
occupation; and
2. You are under the care and attendance of a physician.
DETERMINING THE NEEDS
Determining the needs is the most important step in
“programming” for Disability Income insurance and starts with the
consumer who must determine how they would maintain their
present standard of living were they to become disabled. This
should always be a practical approach as a theoretical or unrealistic
approach will, sooner or later, be discarded and many times not in
favor of another plan.
NEEDS FACT-FINDER
The most effective method of determining the needs of the
consumer in case of disability, is by using a “needs fact-finder.”
Financial and estate planners are familiar with this concept, which
is simply to list the expenses that would have to be met in case of
disability. By completing such a form, many times an individual
will be made aware of an expense that they would have in case of
disability, but one that they had not otherwise considered.
NEEDS ANALYSIS
Needs analysis is part of the programming for Disability
Income insurance. Programming points out the coverage gap,
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which is the difference between the existing resources and the total
income requirements.
Simply put, which is usually the best
method in analyzing the needs, three questions go straight to the
heart of the situation:
“If I should become disabled tomorrow,
1. How many dollars would I need every month as a
minimum without reducing my standard of living?
2. How many days would I want to wait before disability
payments would start? and
3. How long would I want disability payments to
continue?
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CHAPTER 2
POLICY PROVISIONS
ELIMINATION PERIOD
The elimination period is the number of days at the beginning
of a disability during which no benefits are paid – often referred to
as the “waiting period” and is similar to a deductible in other types
of policies. The purpose of the elimination period is to exclude
illnesses or injuries that disables the insured for only a few days
and therefore, can be met by the insured from their own funds.
The longer the elimination period, the lower the policy
premium.
Some Disability Income insurance policies require that the
elimination period be satisfied with total disability only, or with
consecutive days of disability. Most experts feel that an elimination
period must be satisfied with either a residual or a total disability
VOLUNTARY INTERRUPTION OF ELIMINATION
PERIOD
Most of the major Disability Income insurers offer a provision
that allows the insured to return to work for a brief period of time
without penalty before the end of the elimination period. The
recovery period is usually limited to either 6 months, or if the
recovery period is less than 6 months, to the length of the
elimination period. If the insured is then disabled because of the
same or different cause after this interruption, the two periods of
disability will be combined to satisfy the elimination period.
RECURRENT DISABILITY PROVISION
Most, if not all, Disability Income insurance policies include a
recurrent disability provision that determines if a recurrent or
consecutive disability or episodes of disability, is to be considered
as a new disability or as a continuing claim. This provision
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typically provides that recurrent disabilities from the same cause
will be considered as one continuous period of disability, unless
each period of disability is separated by recovery for a period of not
less than six months.
THE BENEFIT AMOUNT
For personal Disability Income insurance policies, the amount
of the disability income is payable on a monthly indemnity basis for
a fixed amount. In essence, the disability income policy is an
indemnity policy. (For general reference, an indemnity agreement is
designed to restore an insured to his or her original financial
position after a loss.)
One of the fundamental principles of
indemnity is that the insured should neither profit nor be put at a
monetary disadvantage for incurring the loss. Since the purpose of
Disability Income insurance is to reimburse the insured for loss of
income due to disability; therefore, in order to understand this
product, these fundamentals should be kept in mind.
The benefit amount limits take into consideration any other
income to the insured, such as from other type of sick-pay plans
offered by the employer, Government (SSI) disability plans, and
other types of personal &/or group insurance. The limits may also
be reduced if an insured has a significant amount of unearned
income, or if they have a high net worth (such as $3-5 million).
PARTICIPATION CHARTS
Most companies use a “participation chart” which determines
the maximum monthly benefit according to the applicant’s annual
income. Limits have grown over recent years, and whereas it used
to be 50 or 60 percent of compensation with a monthly cap of
$6,000 or so was normal, these limits are much higher in today’s
market.
BASIC BENEFIT PROVISIONS
There are different benefit provisions for total disability and a
benefit for waiver of premium, and they are used by all insurers in
spite of any other coverage that may be included in the policy. The
benefit provision will define loss, the method of benefit payment,
and determination as to termination of benefits.
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WAIVER OF PREMIUM BENEFITS
The Waiver of Premium (WP) provision is rather
straightforward and similar to WP provisions in other types of
insurance. Simply put, the premiums for the Disability Income
insurance policy will be waived for any premiums due after the
insured has been totally disabled for the shorter of (1) 90
consecutive days, or (2) the elimination period. If premiums have
been paid during the WP period they will be refunded. The
premiums will be waived as long as the insured remains disabled,
until age 65. The WP terminates when the insured reaches age 65
in nearly all policies.
REHABILITATION BENEFIT
This benefit is used as an inducement for a disabled insured
to return to work. It provides for payment of a specified amount
(typically 12 times the total of the monthly indemnity and any other
supplemental indemnities) to cover the costs, when not paid by
other insurance or public funding, when the insured enrolls in a
formal retraining program that will help the insured return to work.
Note that the rehabilitation is not mandatory in the greatest
majority of the policies.
RESIDUAL DISABILITY BENEFIT
As briefly discussed earlier in this text, this benefit provides a
lower monthly indemnity in proportion to the insured’s loss of
income, when the insured returns to work at lower earnings. If the
policy’s definition of total disability is “own occupation,” the
residual benefit is paid only when the insured has returned to work
in his “own occupation.” It is interesting to note that about 35% of
all Disability Income insurance claims either start or end in a
residual claim.
In most Disability Income insurance policies, the insured may
be either totally or residually disabled for purposes of the
elimination period and waiver of premium.
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PARTIAL DISABILITY BENEFIT
There is a distinct similarity between the Partial Disability
Benefit and the Residual Benefit, and most policies have replaced
the partial benefit with residual benefit provisions for professional
and white-collar occupations.
Typically, the Partial Disability Benefit provides 50% of the
monthly benefit amount payable for total disability, and is paid for
the lesser of (1) six months, or (2) the remainder of the policy
benefit period, provided the insured has returned to work on a
limited basis after a period of covered total disability.
SUPPLEMENTAL PROVISIONS FOR INCREASED
FUTURE BENEFITS
AUTOMATIC INCREASE BENEFIT PROVISION
The option or provision that adjusts the benefits while the
insured is on claim so that the insured will not suffer loss of income
due to increases in the cost of living, is the Automatic Increase
Benefit Provision, which provides for increased benefits in the
monthly benefit payment as designated by a specified table,.
Usually these increase in each of 5 consecutive years, at a
published fixed rate (usually 5% or 6%). There are increases in
premiums also, with each increase in benefit being paid for at the
attained age rate (for the portion of the benefit that was increased).
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CHAPTER 3
GROUP DISABILITY INCOME INSURANCE
UNDERWRITING
Group underwriting is considerably different than individual
underwriting, regardless of the product.
In group insurance,
individual evidence of insurability is not typically required and there
are usually much broader benefits available to group insureds.
The philosophy of the benefits of group insurance is most
prevalent during the underwriting function. Group underwriting is
usually not concerned with the health or other such aspects of any
particular individual, but the purpose is to obtain a group of
individuals that will yield a predictable rate of mortality/morbidity.
INCIDENTAL TO GROUP
The primary requirement that eliminates adverse selection as
much as possible is that the members of the group must have come
together for some reason other than obtaining insurance. This is so
important as otherwise many groups would be formed for the sole
purpose of getting insurance.
FLOW OF PERSONS THROUGH THE GROUP
In order to obtain the necessary morbidity/mortality for the
group, it is necessary that there be new entrants to the group and
an exodus of older and impaired persons. Employer-employee
groups because of the flow of persons can be expected in most
cases to be in average health.
BENEFITS MUST BE AUTOMATIC
In order to avoid anti-selection – selection against the insurer
– groups normally must provide benefits that are beyond the control
of the employer or employees. However, because of competitive
pressure principally and pressure from large employers for more
benefits and greater flexibility in choosing benefits, insurers have
become more liberal and more flexible, particularly in the area of
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adding excess coverage to basic health plans provided by an
employer and in more health care financing choices.
Group benefits must be independent of the employer or
employees.
MINIMUM PARTICIPATION
Hand-in-glove with the above underwriting requirements is
that of minimum participation. The rule is basically that all eligible
employees in the group must be covered by insurance. If the plan
is contributory (employee pays part of the premium) the rule-ofthumb is usually 75% of the eligible employees must join. If the
plan is noncontributory (employer pays all premiums), the
requirements are usually 100% participation.
FLEXIBLE BENEFIT PREMIUM PLANS
Flexible Benefit Premium Plans are frequently called Cafeteria
Plans ” and it offers an employer the opportunity to provide their
employees with the option to pay premiums for various qualified
benefits with pretax dollars. Qualified benefits can include:
Accident and Health Insurance (Medical and Disability
Income)
Group Term Life Insurance
Dependent Care Reimbursement Account
Medical Reimbursement Account
401(k) plans
Vacation Days
Health Reimbursement Arrangements (HRAs)
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CHAPTER 4
GOVERNMENT DISABILITY INSURANCE
OLD-AGE, SURVIVORS, DISABILITY AND HEALTH
INSURANCE (OASDHI)
REQUIREMENTS FOR COVERAGE
Benefits under OASDHI is based upon the individual being
part of the labor market, which is different than most of the rest of
the world as plans in other countries are based on some sort of
universal coverage for all nationals. All occupations are covered but
certain occupations have special eligibility rules because of legal or
administrative reasons.
DISABILITY BENEFITS
An unmarried child of a deceased, disabled or retired worker
covered under the Social Security program who (the worker) has
been disabled since before age 22, is eligible for a cash disability
benefit at age 18 or later. The child’s benefits are payable for as
long as the disability continues, and are the same as the benefit
received by a dependent child who is not disabled, of a disabled,
retired or deceased worker. Another benefit may be paid to a
mother or father who is taking care of a disabled child that is
receiving benefits, and also applies if he/she is a spouse of a
disabled, retired or deceased worker.
The rehabilitation
requirement also applies to a disabled child.
DEFINITION OF ELIGIBLE INDIVIDUAL
Government regulations state that “Each aged, blind, or
disabled individual, married or not, and who fulfills certain income
requirements shall be an eligible individual.
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WORKERS’ COMPENSATION
All states require that employers provide Workers’
Compensation for employees who are injured on the job or who
develop an occupational disease. While it is true that these benefits
cover medical care and loss of income, these benefits are not nearly
adequate to maintain a person’s lifestyle. For instance, in some
areas the weekly income is slightly more than $250 a week.
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CHAPTER 5
INDIVIDUAL UNDERWRITING
SEX
In Disability Income insurance, the sex of the insured is of
considerable importance as females are a higher disability risk than
males at all ages except up to age 55 and older. While insurers
have attempted to restrict certain risks to keep the premiums as
close as possible to being equal between the sexes, restricting
benefits for pregnancy, miscarriage, abortion, and other such risks,
did not made much difference.
MEDICAL
Perhaps the most important factor in underwriting life and
health insurance, is the determination of the health condition of the
applicant. In order to determine the health condition, both the
health history and the present health condition of the applicant
must be known.
The underwriting techniques estimate the
probable influence on future claims of the current impairments of
the applicant and the previous medical history.
MENTAL HEALTH
Underwriters of life and health insurance are concerned with
the mental health of the applicant. If a person’s health has
deteriorated because of age, it would not be that significant in the
Disability Income insurance area because of the age limitations, but
would still throw up a warning flag. Insurers do not have good
statistics on Alzheimer’s disease or dementia, for example, so they
must take a conservative approach to avoid claims because of
cognitive impairments that will result in a disability claim.
OCCUPATION
For Disability Income insurance, since it is extremely workrelated, occupation is a very important underwriting factor as the
possibility of being disabled is affected by the applicant’s
occupation, and benefits are a function of the occupation.
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For Disability Income insurance, insurable occupations are
classified into broad groups that have similar claims costs with
premiums depending upon each class. The number of classes range
from 3 to 6, depending upon the company and the types of coverage
provided and expressed in alphabet letters – “A” through “C.”
APPLICATION PART I
On an application for disability insurance, after identifying
information such as name, address, age and sex, the most
important information section to be completed is information on
Occupation.
Every application will have very precise instructions as to how
to enter the occupation of the applicant.
One company, for
instance, asks that the agent circle the occupation if the applicant
is an Accountant, Attorney, Trial Attorney, Controller, Dentist,
Optometrist, Pharmacist, Physician, Podiatrist, or Psychologist
(Ph.D). If Dentist, Physician or Podiatrist, specialty is required.
If not one of those mentioned above, the Occupation title, length of
time employed in that occupation, duties and whether owner,
partner or employee. Number of hours worked per week is also
required.
MEDICAL
The question will be asked if the applicant had worked in their
regular occupation less than the usual number of hours per week
because of sickness or injury, over the past (usually 30 or 60) days.
OTHER UNDERWRITING CONSIDERATIONS
FOREIGN TRAVEL OR RESIDENCE
Foreign travel or residence in a foreign country has to be fully
explored because of the difficulty in claims investigation and
obtaining underwriting data.
UNDERWRITING WITH GENETICS
Using genetics as an underwriting tool is a subject of
discussion and disagreement. There is great concern that test
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subjects may soon become unavailable, as many people just do not
want to know about any gene problems they may have and are
frightened that others may find out if there is an abnormality. Also
of concern is that insurers would use genetic testing to select only
those individuals that are very low risk, thereby creating a “superclass” of insureds, which would be good for those with no
abnormalities as premiums would be lower and benefits higher.
The problem is, however, that there would then be an “under-class”
of those who are not insurable because of the results of genetic
testing.
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CHAPTER 6
UNDERWRITING (CONTINUED)
SUBSTANDARD RISK UNDERWRITING
As a result of underwriting, an insurance company may
A.
B.
C.
D.
reject an application,
accept the application at standard rates and on a
standard policy form.
accept the application on a higher premium policy
form, or
accept it on a regular policy form with higher
premiums.
EXTRA PREMIUM
Most insurance companies offer coverage to impaired risks by
requiring an extra premium. Typically, insurers will void the
preexisting condition clause in the policy in respect to any
impairment on which an extra premium is charged. However, it
should be understood by the insured when this type of situation
arises, that the preexisting condition is waived only on the specific
condition creating the extra premium.
ANTI-DISCRIMINATION LAWS
Every state has anti-discriminatory laws which prohibit
insurers from discriminating among those persons applying for
insurance in areas such as premiums charged, policy terms,
benefits provided among persons of same class, etc.
REINSURANCE
Health insurance relies heavily on reinsurers as reinsurers not
only provide capacity for newly developed plans, but they also help
insurers design and price these products.
Disability Income
insurance, in particular, requires substantial liability. Reinsurance
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is used to avoid financial difficulties caused by fluctuation in loss
experience and in the company’s overall operating results.
SURPLUS-SHARE REINSURANCE
It should be noted that the reinsurer pays its share of the loss
directly to the insurance company as legally, there is no
relationship between an insured and a reinsurer. The agreement is
only between the insurance company and the reinsurer.
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CHAPTER 7
PRICING AND ADMINISTRATION
If everyone were charged the same premium, adverse selection
would be present because those in poor health would purchase the
plan, but those in excellent health would probably not continue the
same policy as they could find it less expensive elsewhere - or they
are willing to self-insure. This would then leave a body of poor risks
at inadequate premiums and the loss ratio on those policies climbs
higher and higher. There are some limitations on placing risks into
certain categories as the number of rating classes would be limited
by the administrative expense of handling so many classifications,
and further, there would not be enough policies in each categories
to validate the actuarial studies. In other words, there would not be
the necessary spread of risk in each category which is at the very
heart of adverse selection.
DETERMINING ANNUAL CLAIM COSTS FOR
DISABILITY INCOME POLICIES
The annual claim costs that are used in premium calculation
for a disability income benefit varies considerably by occupation
class.
LOSS RATIO
Loss ratio is a term that is used extensively in most forms of
insurance, and particularly in health insurance. If one has to
explain why premiums are higher for one class of insured than for
another class, or if there is a premium increase on the same policy
form, the theory usually is that it is because the “loss ratio” is
higher, or in case of an increase, higher than expected.
Loss ratio is actually a method of establishing the level of
morbidity costs based upon the ratio of claims incurred to
premiums earned.
There are two types of loss ratios, permissible loss ratio and
incurred loss ratio,
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Permissible or expected loss ratio is the portion of each
premium dollar is used to pay claims. The remainder of the
premiums is assumed to pay taxes, expenses and profits.
Incurred loss ratio is the portion of each premium dollar that
is actually used to pay claims
GROSS PREMIUMS
The Gross Premiums is the premium that must provide not
only for benefits to be paid—which is called the net level premium,
but also for expenses, taxes, and funds held for contingency
purposes in case claims and expenses are higher than expected.
They are usually computed on the assumption that they will be paid
annually, although premiums can be paid on other basis.
EXPENSES
Expense assumptions used in premium calculation for
Disability Income insurance include premium taxes, agents’
commissions, policy issue costs, underwriting costs, claim costs,
and investigation/legal costs. These expenses are much higher the
first year (administration-underwriting-issue costs plus the higher
first year commissions), and are relatively constant after the first
year – except for inflation, of course.
INTEREST
While low interest rates are good for many industries, it is a
double-edged sword for insurance because premiums are based
upon assumed interest on the investments of the insurance
company. If the interest rate is higher than assumed, benefits can
be increased, better and less expensive policies can be introduced,
and dividends are paid. On the other hand, as in today’s economic
climate, when interest rates are at a historic low, the insurers are
not making the money on their products that they had assumed
because of the difference in the assumed interest rate and the
actual interest rate being collected. With the present interest rates,
many companies have had to divest themselves of investments in
order to meet their profit objectives and pay claims.
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FINAL DETERMINATION
New insurance plans are almost always a result of a request of
the agents and the marketing department. Then once the product
is introduced, it is the marketing department and agents who really
determine whether the product performs as intended. Insurance
company files are full of policy forms and rates of products that the
agents could not or would not sell.
HEALTH INSURANCE RESERVES
Reserves (for all health insurance products) consist of three
types:
(1) Policy reserves are the present value of future
claims and established so that the company may meet all
of its contract obligations.
(2) Claim reserves and liabilities basically are those
that cover claims that are incurred but not as yet paid.
(3) Expense liabilities are technical reserves that are
used to pay loss adjustment expenses and taxes that the
company must pay and that have accrued prior to the
filing of an annual financial statement.
UNEARNED PREMIUM RESERVES
Technically, the unearned premium reserve for individual
coverage is the pro-rata portion of the policies’ gross premium, from
the time period from when the statement is filed (Dec. 31, of
previous year) to end of the time period for which policy premiums
have been paid on the policy, regardless of any policy renewal
provisions. Perhaps it can be more easily understood by simply
using the name of the reserves “Unearned Premium” – the
premiums that have been paid to the insurance company for
coverage that it has not as yet afforded the policyholder. If the
premiums paid on a policy on an annual basis, for instance, is
$100, but the policy was dated July 1, then only half of the
premium is earned at the end of the year. (The remainder will be
earned at the rate of 1/12 each month, until July 1 of the next
years, etc.,)
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CLAIM RESERVES
Claim reserves are amounts that the insurer expects to pay (in
the future) for claims that have been incurred prior to the date of
the Annual Statement, and have not been paid in full. Since claims
in Disability Income insurance tend to be of Long-term duration,
these reserves are particularly important.
LIABILITY FOR CLAIMS INCURRED BUT NOT REPORTED
In many situations, since an insurer was not aware of a claim
at the time the Annual Statement was filed because the insurer had
not been so notified, a liability for claims incurred but not reported
is established. Usually this is an estimation based upon the volume
of business in-force or premiums earned on that business.
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CHAPTER 8
COMPARISON OF INDIVIDUAL DISABILITY
INCOME INSURANCE POLICIES
PAYROLL DEDUCTION
Fourteen companies allow their plan to be available through
payroll deduction. Oddly, only one company admitted having a
separate policy form for payroll deduction, which usually is issued
with smaller benefits, shorter waiting period, and with a different
premium structure than individual policies. From experience, one
can assume that not all companies admitted to having separate
payroll deduction plans.
RIDERS AND BENEFITS AVAILABLE
The most popular rider is the “Cost of Living Adjustment
Rider,” followed by “Own Occupation Protection Rider,” Future
Purchase Option,” “Supplemental Social Insurance Benefit,” “Partial
Disability” or “Total Disability.” Several companies offer “Return of
Premium Rider”, and at least one company considers it as their
most popular Rider.
ISSUE AGES
Minimum issue age is 18 among all policies. Maximum issue
age is overwhelmingly 60, with a few at age 59, and one at age 61,
and 2 at age 65.
TARGET GROSS INCOME REPLACEMENT RATIOS
Target ratios are the maximum percentage of income that can
be replaced by the Disability Income insurance policy, and they are
generally broken into three income categories, except for two
policies that use the same percentage for all income categories (68%
for one and 60% for the other).
To generalize these statistics, for amounts up to $50,000,
most policies use 65% to 70% of gross income. For amounts up to
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$100,000, 57% to 60% are the most frequently used. For amounts
of $200,000 and up, there is a larger range, but generally speaking
it runs between 45% and 60 %.
BASIS ON WHICH RESIDUAL OR PROPORTIONAL
DISABILITY BENEFITS AVAILABLE
The principal basis for residual or proportional disability
benefits to be paid is loss of income.. Typically 20% or 25% loss of
income for 80% of the time with loss of time and income
requirements waived if on total disability for 3 months. If there is
actual disability, the insured must not be able to perform one or
more of the material duties related to his occupation. Some policies
specifically state that if there is a 75% loss of income, it will
automatically be considered as total disability. One policy uses loss
of one-half or more of time spent in usual performance of their
duties. Another policy makes it dependent upon loss of 85% of
income.
TYPES OF BUSINESS ENTITIES
The three types of business entities are Proprietorship,
Partnerships, and Corporations. The differences in the types of
business entities are important in determining the type of Disability
Income insurance that would be used for business purposes.
COMPARISONS OF TYPES OF BUSINESS
ENTITIES
PROPRIETORSHIP—PARTNERSHIP—CORPORATION
In comparing the type and ownership of the three types of
business entities, the corporation is the only one that is authorized
by law, whereas a proprietorship and a partnership are created by
the voluntary action of an individuals or in case of a partnership,
both parties.
KEY EMPLOYEE INSURANCE
Financial losses and adverse affects due to the disability of the
Key Employee can be protected against by issuing Disability Income
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insurance policies on Key Employees and making the business the
owner and beneficiary. In case of disability of the Key Employee,
the business will receive payments that will aid them in either
acquiring another person that can perform the duties, or can assist
by stabilizing the company until the Key Employee is able to return
to work.
DETERMINING THE VALUE OF POSSIBLE LOSS
The major question in considering disability income insurance
for business continuation purposes, shall always be how much
insurance is needed for the business to continue as before. The
simplest (and most accurate) answer is that the value of a business
is the value of current and present profits. If the company is a
corporation, the value of the stock provides the most accurate
measurement of the value, but losses will be assumed to be the
result of any major operational, property loss or – most importantly
in determining the value of a loss – the personnel loss and how it
affects the business.
SUMMARY OF KEY EMPLOYEE DISABILITY
INSURANCE
The function of Key Employee Disability Income insurance is
to pay a monthly indemnity sum to a business entity during the
period of time that the Key Employee is disabled.
The Key
Employee is the named insured under the policy.
Benefits
commence after the elimination period and continue while he is
disabled, for a period of 12 or 24 months.
ENDORSED CONTRIBUTORY PLAN
An “Endorsed Contributory Plan” is where the employer only
“endorses” the plan but the employee pays the premiums, usually
through payroll deduction. The document should show “Endorsed
Contributory Plan” at the top.
FORMAL SALARY CONTINUATION PLAN
A formal salary continuation plan issues a document
outlining the plan and which should include an outline of the
disability payments the employees may expect.
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GROSS REVENUE
The maximum disability benefit will be paid if the insured is
totally disabled in his regular occupation, regardless of any “gross
revenue” the insured may receive.
“Gross revenue means any income received by you or your
business for personal services performed by you in your regular
occupation. All revenue will be accounted for on a cash basis. While
you are totally disabled as defined above, income accrued but not
received before the Elimination Period began will be excluded from
gross revenue during disability.”
EXCLUSIONS AND LIMITATIONS
The most typical exclusions is that the policy does not pay
benefits which are “based on injury or sickness caused by war or an
act of war, whether declared or undeclared.”
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CHAPTER 9
Life and Health insurance policies are usually purchased for
family or personal purposes, but many are used for business
reasons.
TYPES OF BUSINESS ENTITIES
Three types of business
Partnership and Corporations.
entities
are
Proprietorship,
Disability Income insurance when used for business purposes
is used primarily in Key Employee insurance, for continuation of
business purposes, and can also be used for nonqualified executive
benefits.
KEY EMPLOYEE INSURANCE
Many businesses, if not most businesses, revolve around the
expertise, experience, capital, technical knowledge, or for some
other reason have an individual or several individuals, who are
valuable assets to the company and are necessary for the continued
successful operation of the company.
Financial losses and adverse affects due to the disability of the
Key Employee can be protected against by issuing Disability Income
insurance policies on Key Employees and making the business the
owner and beneficiary.
The function of Key Employee Disability Income insurance is
to pay a monthly sum (indemnity) to a business entity during the
period of time that the Key Employee is disabled.
SALARY CONTINUATION PLANS
A salary continuation plan is offered to the employees as a
fringe benefit by the employer, and typically does not involve
deferring current compensation to the employee. The plan, simply
put, provides for an employee’s salary to continue in case of
disability.
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These plans may be “qualified” which determine the tax
treatment of the premiums and benefits. Non-qualified plans are
usually discriminatory, i.e., the employer can pick-and-choose as to
who participates, and the tax consequences are more severe than
with qualified plans.
A qualified plan meets certain Internal
requirements for favorable tax treatment.
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Revenue
Code
CHAPTER 10
BUSINESS OVERHEAD AND BUSINESS
CONTINUATION PLANS
BUSINESS OVERHEAD INSURANCE
A specialized but very important area of Disability Income
insurance used for business purposes is that of business overhead
expense insurance. As the term indicates, this provides for the
needs of the business if the owner (or principal) becomes disabled
and is therefore not able to perform their important role in the
business or to generate most of the sales.
THE BUSINESS OVERHEAD POLICY
DEFINITION OF DISABILITY
Usually the definition is the one that simply states that
benefits are payable if the insured is unable to perform his duties in
the business, which is basically the own-occupation type of
definition.
MAXIMUM BENEFIT
The amount of the benefit depends entirely on the expenses
that the firm anticipates and the income flow from the business.
One should keep in mind that the more the revenue from the
business is likely to decline due to disability of the owner/principal,
the larger the benefit amount that is needed.
CROSS-PURCHASE AGREEMENT
The Cross-purchase agreement is an arrangement between the
business owners themselves, and not between the business and
business owners.
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THE PARTNERSHIP CROSS-PURCHASE
AGREEMENT FORM
There usually is a provision that states that each partner owns
the insurance policy on the other partner, and the payment of the
premiums by the partnership is only a matter of convenience and
the partnership is not a party to the agreement.
The right to purchase additional insurance is always included
as the value of the business may increase.
THE PARTNERSHIP ENTITY AGREEMENT FORM
The provisions restricting the lifetime transfer of property, the
provision whereby the decedent’s estate must sell and the survivors
must buy the interest, and the valuation provision are essentially
the same as in the Cross-purchase agreement.
The major
difference between the Entity agreement form and the Crosspurchase agreement form, is the provision that states that the
partnership is named the owner and beneficiary of each of the
insurance policies. As mentioned earlier, the premiums paid by the
partnership are not deductible for income tax purposes for the
partnership.
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CHAPTER 11
THE DISABILITY BUY-SELL AGREEMENT
INSURANCE POLICY
BUY-OUT EXPENSE BENEFIT
POLICY TRANSFER
Typically, the policy allows for transfer of coverage under
certain conditions, but not until the policy has been in force a
stipulated period of time – typically two years. Coverage can be
transferred to a new owner if the insured leaves the company and
starts a new business and no evidence of insurability is required.
ENTIRE CONTRACT
There is always a legal statement that the policy with
application and any attached papers, riders or forms, constitutes
the entire contract and no change in the contract can be made
unless approved by an officer of the insurance company. Agents
may NOT make any changes or waive any provisions of the policy.
CORPORATIONS
A corporation
completely separate
from the owners.
largest companies
owners.
is a business entity that is vested with a
tax and legal status that is apart and separate
A shareholder becomes an “owner” and the
are corporations, some with thousands of
CLOSE CORPORATIONS
A Close Corporation (closely-held corporation) is a corporation
whose stock is not freely traded and is held by only a few
shareholders – often with the same family. The legal requirements
and privileges of Close Corporations vary by jurisdiction. They may
be also referred to as Closely-held Corporations, or Closed
Corporations.
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Even though a Close Corporation may be run much like a
partnership, the limited liability for the shareowners (stockholders)
and the corporation’s legal status as a corporation or legal entity,
differentiate it from a partnership. In the discussion of Disability
Income insurance, however, a Close Corporation is treated much
like a partnership – one reason being that most Close Corporations
started as a partnership.
PROFESSIONAL PRACTICE
Since a large part of the Disability Income insurance market is
with professional persons, and in particular the medical field, it is
quite common for a professional organizations to be a “P.A.” or
“Professional Association.” Theoretically, a P.A. is a group of
professionals organized to practice their profession together,
through not necessarily in corporate or partnership form.
Therefore, legally and for liability and tax purposes, a P.A. may be a
corporation, proprietorship or partnership. Therefore, for Disability
Income purposes, they should be treated as whatever business
entity they have legally accepted.
For malpractice insurance
purposes and other reasons, most P.A.s operate as sole proprietors
BUY-SELL AGREEMENTS – CORPORATE
These problems can be avoided by establishing Buy-Sell
agreement properly drawn, either the Entity (also called Stock
Redemption when it involves corporations) or the Cross-purchase
plan as described in the partnership application of these
agreements.
The agreement binds the remaining stockholders (nondisabled) or the corporation (if a Stock-redemption plan) to buy the
stock of the disabled stockholder at an established price as set forth
in the agreement. Further, it obligates the shareholder to sell his
stock to the surviving stockholders (under a Cross-purchase plan)
or to the corporation (Stock Redemption plan).
TAXATION OF CORPORATE BUY-SELL
AGREEMENTS
Premiums paid for Disability Income insurance under the
corporate Buy-Sell agreement, whether Cross-purchase or Stock
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Redemption, are not income tax deductible.
are not usually taxable.
Disability payments
CREDITORS
Under the Cross-purchase plan, the policies are not owned by
the corporation, so creditor-corporation problems do not arise.
Under the Stock Redemption plan, the policies are owned by the
corporation and are part of the assets, and subject to attachment
by creditors.
BUSINESS CONTINUATION INVOLVING EMPLOYEE
STOCK OWNERSHIP PLAN
Under a qualified employee Stock Ownership plan designed to
purchase the employer’s stock, if stock in the corporation becomes
available after a business-continuation plan has been invoked, it is
feasible that the employee Stock Ownership plan could purchase
this stock as it is made available. Actually, the employee Stock
Ownership plan could enter into an agreement with one or more of
the stockholders or business owners whereby they could purchase
any stock made available because of the disability of one of the
stockholders. The employee Stock Ownership plan can purchase
insurance to fund this purchase. This arrangement is generally
used when stock becomes available because of the death of a
stockholder, and the funding is by life insurance but there seems to
be no reason that the same arrangement couldn’t be used for
disability of the stockholder.
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CHAPTER 12
CLAIMS & CONSUMER ANALYSIS
FILING A CLAIM
Companies will vary as to claim filing requirements, but
essentially they are all the same. The following procedures are quite
typical.
To make a claim under a policy, the following steps must be
taken: First, the insured, his legal representative or the policyowner
(if the insured is unable to provide notice) must give Notice of Claim
(someone must notify the insurer that disability has started as
defined in the policy).
PAYMENT OF BENEFITS
The insurer will pay benefits due under the policy in United
States dollars. The insurer will not pay any benefit until they have
sufficient Proof of Loss. When the insurer has determined that the
claim is payable, they will pay according to the Benefits provision
MODERN CLAIM EVALUATIONS
SUPPORT FOR BACK-TO-WORK
To the surprise of not many, studies show that most
employees really do want to get back to work, and this desire is
important in returning the employee to work or at least, restoring
some normalcy to a life interrupted by a disability. Insurers use the
services of vocational rehabilitation professionals in this matter,
particularly if they are motivated to return to work.
MODERN CLAIM EVALUATIONS
Many people have a mental picture of a claims investigator as
being a “private investigator” who sneaks around with a video
camera to take pictures of the insured without the knowledge of the
insured, hoping to catch him in some physical activity that would
belie his claim of being disabled.
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CLAIMS INVESTIGATION METHODS
One result of a claims investigation cold be a termination of an
existing claim. The company usually would submit a letter of
termination at that point, which means that the claimant has only
three ways to go:
1. The claimant can accept the decision.
2. The claimant can officially complain to the insurance
company that the termination was not justified.
4. He could hire an attorney and fight the termination in
court.
DISABILITY INCOME INSURANCE CONSUMER
GUIDE
MYTHS
One of the best known myths regarding Workers’
Compensation is that in case of a disability, Workers’ Compensation
will replace the lost income. The actual truth is that Workers'
compensation will pay only if your disability is job-related.
POLICY FEATURES AND BENEFITS
According to the Health Insurance Association of America, LTD
plans generally do not replace more than 80 percent of the predisability earnings.
Both premiums and benefits of disability
income protection insurance vary depending on risk factors such as
age, gender, health history and physical condition, income, and
occupational/job duties.
OTHER IMPORTANT POLICY PROVISIONS
One of the important additional features in an income
protection policy relates to returning to work.
Determine if the policy encourages the insured to return to
work. Usually, if a disabled person returns to some type of work,
but suffers a loss of income due to part-time employment or
downgrade in position, then a lower amount of pre-disability salary
would be paid. The percentage of loss of more than 20 percent of
pre-disability salary would usually result in payment of partial
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disability benefits equal to the same percentage of the regular
monthly benefit as the percentage of lost income.
Sometimes benefits are payable if the insured engage in
company-approved rehabilitative raining or work while disabled.
Typically, the total income received during this rehabilitative period
cannot exceed his pre-disability annual compensation.
WHAT TYPE OF POLICY SHOULD YOU BUY?
There are two general types of policies, those purchased on a
group basis offered through an employer or through a membership
organization, and individual policies purchased from agents who
represent one or more insurance companies.
GROUP POLICIES
Group policies provided by an employer on a noncontributory basis are the least costly since "non-contributory"
means the employer is paying all premiums.
In a union
environment, this type of policy is usually negotiated
WHICH TYPE OF POLICY WILL STAY IN FORCE
LONGER?
Employer group policies can be terminated if the employee
leaves employment, retires or reaches age 70, if the employer
terminates the group policy or if your employer fails to pay the
premium
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