Three Types of Disability Insurance
Which One Is Right for Your Business?
by Bill Olmsted
There are three main types of long term disability insurance – individual, group, and multi-life. Each has their advantages, and as a business owner, it’s important to know how to structure the best plan for your employees.
Group Long Term Disability Insurance (LTD)
The most popular type for employees is a group long term disability insurance program (LTD). A group LTD plan is typically paid for by the employer, and covers all eligible employees. An eligible employee is typically someone who works more than 30 hours per week, and is a salaried employee of the business.
A typical group LTD plan will cover about 60% of the employee’s income, up to a certain monthly maximum. This could be expressed as covering 60% up to $10,000 per month in benefits. This would mean that everyone making $200,000 or below would have 60% of their income covered by the plan.
Anyone making more than $200,000 per year, in this example, would have less than 60% of their income being replaced since they are over the maximum monthly benefit of the plan. This is known as reverse discrimination – where the highly compensated are actually provided a lower percentage of their income replaced than their lower compensated colleagues.
When Group LTD is paid for by the employer, it is deducted as a business expense for tax purposes. That usually creates a situation where the benefits are received on a taxable basis when received by the employees. This further reduces the effective percentage of income being received. It’s one thing to have 60% of your income being replaced, but when you then have to factor in the loss of income taxes on that benefit, it amounts to something less than 60% of income being replaced.
While group LTD is the most popular type of coverage for most employees, it’s not always the best, and can have significant drawbacks. Those covered by an employer provided LTD plan are usually not able to opt out of it, and many don’t want to because of the price – free. Group LTD provides a baseline level of protection, but other forms of disability insurance should be considered to supplement it.
Multi-Life Disability Insurance
An employer can supplement a group LTD plan by putting in place a multi-life supplemental disability insurance plan for all, or some, of the employees. Two of the issues discussed above concerning the group LTD plan center around the loss of benefits due to taxes and the possibility of discriminating against the highly compensated owners/employees.
Take the example of a group LTD plan providing 60% coverage to a maximum of $10,000 per month for all employees. An employee making $100,000 per year would receive a $5,000 per month benefit if disabled, which would then be subject to income taxes. If we assume a tax rate of 25%, this would reduce the net disability benefit from $5,000 per month to $3,750 per month.
By offering a supplemental program, this employee could purchase an individual policy to supplement his group LTD in the amount of $1,740 per month. This could be structured as a tax free benefit, and would make the total tax free monthly income approximately $5,490, or $65,880 per year – about 65% of the gross income, and about 88% of what he was taking home after taxes when working.
It is a similar situation for the employee making $300,000 per year. Because the group LTD is capped at $10,000 per month, this employee is really only seeing a replacement percentage of 40%. While the receptionist is getting 60% of her income replaced, the owner or key executive is only getting 40% due to the cap of $10,000 per month. A supplemental plan could be obtained on a tax free basis that would add another $8,670 per month to the taxable $10,000 per month received from the group LTD plan, getting this employee much closer to their take home income.
One benefit of a multi-life supplemental program is that the employer can carve out certain classifications of employees to provide this benefit to on an employer paid basis. The benefit could be offered to all employees, or simply those key employees that the owner wants to reward.
Another one of the major benefits of this type of supplemental plan is that there is often underwriting concessions that are made. This can benefit employees who may not be in perfect health, and wouldn’t normally qualify for a fully underwritten individual plan. The larger the group of employees, the better the offer will be from the insurance company on guaranteed standard issue policies. It is not uncommon to have $5,000 per month offered to individuals on a guaranteed basis if the coverage is set up properly.
Finally, multi-life disability insurance policies are individual plans that are owned by the employee, not the business. This means that, unlike the group LTD plan, when an employee leaves the employer, the supplemental personal disability insurance policy is portable and goes with them to the next job. Providing a group program for all employees is typically considered a basic benefit of employment. For those employers who want to reward highly compensated employees or who wish to offer something more, a multi-life supplemental disability program is a great way to shore up the basic LTD.
Individual Disability Insurance
For those who aren’t covered by a group LTD plan or who are self employed, the best option for coverage is an individual DI policy. Unlike the multi-life plans, there is no guaranteed issue amount, and all plans are medically underwritten. This usually requires a blood test, a telephone interview, and records from the applicants’ personal physician. Coverage can be approved, declined, or approved with certain limitations for pre-existing conditions.
An individual disability insurance policy is what you will normally receive when you inquire on-line and request a quote, or when you speak to an agent. The underwriting process will look at your medical history as well as your financial qualifications to warrant coverage.
It is also important to note that individual plans can supplement group LTD plans in exactly the same way the multi-life plans do. The biggest difference is that the while the multi-life plans can come with guaranteed underwriting, the individual plans do not. If you are an employee at a company that does not wish to provide any further disability benefits, looking into an individual plan is a great option.
While there are three major types of long term disability programs, it’s important to understand how they work together to best protect ones income. Having only one type of plan could be a mistake and lead to a lower than expected replacement of income in the event you find yourself unable to work. Similarly, if you are a business owner, offering your employees a couple different options on how to protect their most valuable asset – their income – will often lead to the best benefit packages for everyone.