Income Protection

Disability: The Comfortable Discussion

Advisors simply cannot overlook this important coverage… for their clients and themselves

by Jim McCarthy

Mr. McCarthy is president of Empire State Benefits, LLC, an independent disability insurance focused General Agency. Connect with him by e-mail: jim@empirestatebenefits.com. 

I am going to ask you to consider what I believe are some compelling statistics:

• Over 4.4 Million working age Americans experienced a disabling injury or illness in 2015.

• Just over 1 in 4 of today’s 20 year-olds will suffer a serious disability before they retire.

• About 12% of the U.S. population is classified as disabled. More than 50% of those disabled Americans are in their working years, from 18 – 64.

• Medical problems contributed to half of all home foreclosure filings in 2006*

And yet, with these metrics in mind, why is it that many financial professionals are not discussing the possibility of disability with their clients? Even more surprising, I have found that many financial professionals have not even reviewed their own disability income protection safety net.

What About Your Own Coverage?

Let’s do a spot check: Can you answer the following questions about your own safety net? If you experienced an unanticipated loss of your earnings, how would you pay your bills? If you have current disability coverage in place, how does it work? What is the definition of disability (what triggers benefit payments)? How much money would you receive during a covered disability? Is this enough to pay your bills and/or continue your lifestyle?

These are important questions that you likely have asked some or all of your clients at one point or another. Have you asked yourself the same questions? Are you prepared for a long term disability?

If you are one of many insurance and/or financial advisors that are uncomfortable discussing disability insurance with your clients, a great way to get more comfortable with the subject is to review (and improve, if necessary) your own personal coverage. The process can be relatively quick and painless… but can provide tremendous rewards over the long haul.

One of the rewards is obvious: you will be protected from the financial hardship that would result from a long-term disability. Less obvious is the level of understanding, personal experience and conviction you will gain on the subject (not to mention the possibility of some improved sales results). Having your own affairs in order allows you to guide clients from a place of confidence and personal reference. The statement, “this is the plan that I went with” can be very powerful when used with a client or prospective client.

Look to Closely Held Businesses

A great market for this discussion is small business owners/entrepreneurs. Not only is there a risk that the business owner/entrepreneur will become disabled, but a risk that one of his or her valued employees will become disabled.

If you were to ask a small business owner about their employees, frequently there is one or more that have been instrumental in the success of the business. So, the small business owner is likely to feel a strong loyalty to those employees as they were critical to the initial business survival and growth and are critical to the ongoing success of their business.

If a long-term, valued employee were to become disabled, the business owner might feel a strong obligation to keep their trusted employee on the payroll, despite the fact that they are disabled and can no longer work.

Unfortunately, without proper planning, there are at least 5 reasons why continuing payments to a disabled employee can prove to be a bad idea:

  • Precedent – By paying a key employee during a disability there is a risk of setting a precedent for other employees to claim disability and expect continued wages.
  • Personal Medical Information – Who determines when a disabled employee is disabled and becomes eligible for continued salary/benefits? Who determines when salary stops and/or when disabled employee has returned to full health? Unless the business in question is a medical practice or an insurance carrier, this could be a difficult situation to manage to say the least. Most employers would not want to be put in the awkward position of reviewing and deciding on a medical/disability claim.
  • Drain on Business– Business revenues can be affected by the loss (whether temporary or permanent) of a key employee, causing a drain on cash flow. Hiring a replacement can further drain business cash flow. Is the business strong enough to absorb the financial impact of paying a key employee during a disability? In addition, FAS 112 obligates the employer to carry the claim as a liability on the business balance sheet. This liability could complicate the business credit rating and ability to obtain business loans, etc.
  • Benefit Details – How much is the key employee to be paid during a disability? How long do payments continue? Who determines this?
  • Deductibility of Payments – Court precedent has been set ruling that continued wages paid to a disabled employee are, unless specific steps are taken prior to any disability, not a deductible business expense. In fact, if the employee is a shareholder, the IRS has ruled to treat continued payments as an informal dividend and subject to tax on a corporate and on an individual level**

So, as you see, while it may seem like a good idea to continue the wages of a disabled key-employee, without proper planning, it can get a bit complicated.

A Two-Step Solution

Fortunately, there is a two-step solution for your business owner client: First, establish a Qualified Sick Pay Plan (QSPP). A QSPP is simply a formal document that details exactly what the employer’s obligations are in the event of an employee suffering a disability.

These are important questions that you likely have asked some or all of your clients at one point or another. Have you asked yourself the same questions?

It defines who would be covered, what would trigger benefit payments, amount of benefit payments, and how long they would receive benefits/payments. It is important to note that the employer has much flexibility in designing the QSPP.

The plans can offer different levels of coverage, based on the employer defined class of employee, ranging from no coverage at all to a very rich program. When establishing the classes, the employer can discriminate by title, income, years of service…essentially any factor other than those prohibited by law (age, gender, etc.) or those that favor shareholders.

By simply establishing the QSPP and communicating the details to all of the employees, the business owner gains tax-deductibility of benefit payments, establishes the class of employees who would be covered by the plan, and removes any doubts or assumptions about how an employee would or would not be covered during a disability. The responsibility of administering and funding a claim is transferred to the underwriting insurance company.

The second step is to fund the QSPP with individual disability contracts (IDI). By funding the QSPP with IDI, we can off-load the responsibility of determining eligible claims and deciding when a disability claim begins and ends.

More importantly, funding with IDI would remove the financial burden of continuing payments to a disabled employee during a time when the business resources may be drained due to the loss of a key employee. Instead, payments would be made in the form of tax-deductible premiums during a time when the business is running on all cylinders.

In addition, funding the QSPP removes the obligation of the business to carry the financial liability of a claim against a self-funded plan (as required by FAS 112) on the business financial statements/balance sheet.

There are some who would suggest that step one can be skipped if a QSPP is funded with individual disability insurance policies as they can be considered to form a de facto QSPP. As with any matter involving formal agreements, it is advisable to consult an attorney to prepare or review the plan documents prior to implementation and an accountant to verify eligibility for tax deductions, etc.

Guaranteed Standard Issue May Be Available

Another challenge that might present itself during implementation of an insured QSPP is individual disability insurance underwriting.

For those with experience writing individual disability insurance, it would not be a surprise to suggest that some folks in a proposed group would likely have a negative medical history that could result in a sub-standard offer or even a decline of coverage. Fortunately, there is a possible solution.

Many carriers offer Guaranteed Standard Issue disability income insurance (GSI). GSI disability income insurance allows for purchase of individual, discounted disability policies without regard to medical history or personal financial details, aside from earned income (net worth or unearned income are not considered as they would be for a fully underwritten program).

Starting with as few as three employer-paid lives, many carriers will consider issuing coverage subject to only a few basic, gatekeeper questions. Provided there are enough proposed plan participants, each has been actively at work for the 90 or 180 days preceding the date of application, and each has the use of all four limbs, power of speech, hearing and sight, it is likely that a GSI program would be available.

The general rule of thumb is that the larger the number of eligible employees, the more favorable the guaranteed issue offer will be. I would recommend discussing the possibility of GSI with your disability insurance wholesaler/GA prior to introducing the idea to a client in order to qualify the case and confirm that GSI would be available to the specific industry and occupation of the individuals in consideration.

A Comfortable Discussion

While this may seem a bit overwhelming for the uninitiated, the more you discuss the idea of protecting your clients’ income and lifestyle, the more comfortable the discussion will become.

You will find that disability sales can be a great door-opener and even a lead product. Many find, from a psychological perspective, that it is easier for clients to picture themselves as disabled rather than deceased. In addition, the purchase of disability insurance is, quite frankly, more of a self-benefitting purchase than the purchase of life insurance.

Individuals can ultimately benefit directly from a disability insurance benefit while the death benefit from a life insurance policy is, aside from the peace of mind it can provide, entirely for the welfare of others. For these reasons, many producers find that clients can be more receptive to a discussion about disability insurance than a conversation about life insurance.

The best time to get started is now. Start with your own coverage, then move on to working with your clients to implement a program to protect their income. Don’t wait until it’s too late. Your client’s and possibly your own lifestyle may be at stake.

In addition, I would like to mention that our industry lost one of the greats this past holiday season. On December 21st, 2015, J. Kenneth Wylie passed away. Ken was an industry leader, a disability insurance guru, a great person and a great friend. I can attribute most of the information shared with you in this article to Ken’s incredible vision and his teaching. Thank you, Ken, for your knowledge, your guidance, and, most importantly, for your friendship. You will be missed. ◊

 

 

 

*Council for Disability Awareness, http://disabilitycanhappen.org
**Estate of E.W. Chism, TC Memo 1962-1966, aff’d 322 F.2d 956 (9th Cir. 1963)
**The Chesapeake Manufacturing Company, Inc. v. Comm., TC Memo 1964-214
Please Note: this article is not to be considered legal or tax advice. The cited cases are provided as historic examples when employers faced the issues discussed. It is advisable to consult an attorney and/or a CPA on any matters involving interpretation of the law and/or taxation.