Business Continuation Planning

Revisiting the critical need for disability coverage

by Dana P. Hardy, Jr., LUTCF

Mr. Hardy is a financial representative of Centinel Financial Group, LLC in Maynard, Massachusetts. He can be reached at 978-461-0090 x21 or

Small business owners have the difficult challenges of remaining competitive in their marketplace, while striving to generate maximum revenue. These challenges may not be new, but they are certainly more difficult in today’s environment, given the economic volatility of the last few years and new regulations that affect the overall health of a business, such as:

  • Government regulations;
  • Human resource issues;
  • Healthcare and insurance; and
  • Taxes

These constantly evolving dynamics can affect the owner’s level of uncertainty, stress and overall bottom line. Many owners spend their days focusing on these issues because they are dealing with them in the present. But, there are challenges that pose an equally, if not more, significant risk to their livelihood and do not seem to garner enough attention – namely, the disability of the owner, partner or key executive within the business.

The real threat of an extended or permanent disability for the owner of a small business is whether or not the following questions can be answered:

  • Does the business have enough capital to cover rent, operating expenses and employee payroll if the owner, partner or key stake-holder were to become disabled?
  • If the owner or business partner becomes disabled, can the business pay them a personal salary during this time? Without a formal business continuation plan, any income paid to a disabled partner can be treated as a “non-deductible dividend” to the corporation, yet be fully taxable to the disabled employee.
  • How long can the business survive without the owner’s presence and abilities?
  • Even if you enjoy the relationship you have with your business partner, how long do you feel the business can continue paying 100% of his or her salary?

A business owner relies on their business to fund their personal expenses and lifestyle. If the owner were to experience a long-term unexpected or permanent disability, this can completely unravel a business continuation plan. As part of a continuation strategy for the owner, there are two general categories of disability income insurance that can help protect an owner’s interest in their business. The first is Disability Overhead Expense Insurance and the second, complementary policy, is Disability Buy-Out Insurance Coverage.

Disability overhead expense insurance provides benefits to help keep a business operational, when the owner is no longer able to generate an income due to an extended period of disability or qualifying illness. This insurance is designed to cover the operating expenses of a business if the owner suffers a short-term, long-term or permanent disability (depending on the provisions within the policy). Unlike personal, or individual disability income insurance, which covers personal expenses in the event the owner becomes disabled; Disability Overhead Insurance covers core business operating expenses.

This type of coverage helps cover business expenses such as:

  • Rent
  • Utilities
  • Taxes
  • Employee payroll/wages
  • Management consultant fees (i.e. legal, accounting)
  • Insurance premiums
  • Miscellaneous business supplies

By helping to keep the business afloat, Disability Overhead Expense Insurance can buy the owner time to determine the next steps for the business; whether that means continuing the business if the owner is able to recover, or helping keep the business stable for a potential sale.

The second type of disability insurance mentioned is Disability Buy-Out Insurance. This type of policy can help fund the purchase price of an owner’s interest in the business, if the owner were to be faced with a long-term extended or permanent disability. Whereas business overhead insurance helps fund the costs of running the business, Disability Buy-out Insurance helps fund a buy-sell agreement should the disability become a long-term, permanent condition.

Further, in addition to helping keep the business running during a period of disability, both of these types of coverage help build confidence and credibility for the owner’s business partners, lenders and family members. Specifically, disability overhead expense and buy-out insurance coverage helps maintain confidence for the owner’s customers, lenders and key associates.

They help in the family estate planning process by having a pre-arranged insurance policy that can provide coverage for the owner(s), so that family members do not have to step in and run the business in the event of a permanent disability. They help provide confidence for the owner’s partners or key stake-holders by having a provision in place to continue with a business plan in the event of a disability; while having essential business expenses covered during the disability period.

The target client for these types of policies is a small business owner or business that is closely-held. In this scenario, the owner(s) are active participants in the day-to-day running of the business and their presence is crucial to generating revenues.

As with any other fundamental business expense, the owner needs to consider the tax consequences of purchasing these policies. As a general rule, the premiums paid for Disability Buy-Out coverage are not tax-deductible. However, disability benefits paid to the business or to the non-disabled business owner(s) are received income tax-free. In the case of Disability Overhead Expense coverage, premiums are tax-deductible and the benefits received are taxable to the business. However, expenses being covered by overhead expense are deductible.

Many businesses fund a buy-sell agreement using life insurance to help protect the business in the event of an owner’s death. However, they may not have taken into consideration the need for a business continuation plan in the event a key owner lives, but can no longer manage or contribute to the business due to a disability. This is where disability coverage can help mitigate the owner’s potential risks. Owners can always attempt to gain loans from banks or creditors to help keep a business afloat, but that may pose a challenge if the primary owner is the one disabled and there is no viable continuation strategy in place for the business.

I have opened many cases for clients over the years by asking two questions:

  1. When is the last time you looked at your buy/sell agreement and adjusted the amount of funding in the agreement?
  2. Have you addressed disability in the agreement?

Some owners may have limited funds available to properly cover their disability risk through an insurance purchase. In these scenarios, it may be beneficial to look at designing a policy with a longer elimination period or shorter benefit period. This would not fully cover the overall risk, but it may help provide some level of funding for the business. If you are reviewing an existing policy for a client, it is important to make sure that the policy provides coverage for essential expenses and not just limited expenses, meaning check to see if employee salaries are covered. You want to carefully read if the policy pays for benefits in the event of a partial or a total disability.

In today’s environment, it is essential that an owner has a strategy in place to mitigate as many risks as possible. Disability Overhead and Disability Buy-Out Insurance can help provide options for the owner, and compliment an overall succession plan, at a time when the business most needs direction and funding.