Business Owner's Disability Insurance
Overhead, Loan and Buy-Sell Protection
by Gary Fegan
As a business owner, you have put your blood, sweat, tears and likely your financial backing on the line. You feel like you will never become disabled and your business will thrive and prosper until you decide to call it quits. Let’s hope that is true, but what if it is not true? Consider the following three concerns:
What if you become disabled and cannot pay for your overhead expense costs to keep the business open?
What if you cannot repay on your business loan?
What happens if you have a business partner, and the business cannot afford to buy you out when disabled?
Consider the first concern above- As a business owner, an Overhead Expense Disability Insurance policy1- provides benefits to help reimburse a disabled owner for their monthly business expenses during a disability. Consider this- If you were to become disabled and unable to fulfill the needs of your clients, they will likely go somewhere else. But, the business expensed will not stop. The expenses include rent, utilities, real estate taxes, interest on debt, and payroll.
Without a policy stepping in to pay these expenses, a disabled business owner may find themselves in serious jeopardy of losing their business. The following are a few key benefits that should be part of an Overhead Expense Disability Policy:
- Accelerated Benefit - which advances ½ of the first maximum monthly benefit before proof of the covered overhead expense is required.
- Supplemental Benefit - which provides an additional pool of coverage that is available to reimburse covered overhead expenses for both total and residual disabilities.
- Salary Replacement - which considers 50% of a replacement’s salary to a monthly maximum of either $10,000 or one-half of the maximum monthly overhead expense benefit, whichever is less as a covered overhead expense.
- Return to Work Benefits - which, subject to an agreed upon plan, the Occupational Rehabilitation and the Modification and Access Benefit will provide benefits to help totally disabled owners return to work.
- There are many other features that should be included in your coverage. These features include a residual benefit, and automatic increase in coverage option, a waiver of premium benefit, a legal and accounting fee benefit, a waiver of elimination benefit and a future increase option rider.
Let’s look at the second concern above- As a business owner, you may have some financial obligations that require regular payments expiring at a given time. Such obligations may include purchase agreements, employment contracts, and business loans. You should seriously consider obtaining a disability policy (a Business Reducing Term –BRT- policy from The Guardian Life Insurance Company of America) that would help pay these obligations in the event of a disability to you, the owner.
This type of policy should cover up to 100% of monthly loan payments or other fixed-term obligations. The idea is to have a policy like this pay until your obligation is paid in full, or you are no longer disabled- whichever comes first.
The business reducing term1 which was designed to cover fixed monthly business obligations works for you whether you are a radiologist looking to obtain a 5 year, $1,000,000 loan to cover the purchase of a second practice or an optometrist looking to protect a 10 year guaranteed contract to a key employee - this product will provide that specific amount of coverage each month if the insured suffers a long term total disability. Most carriers offer a duration range from 5 to 30 years. This BRT policy may sound very similar to another form of disability insurance coverage called business overhead expense. While the two forms of coverage are similar, they are very different products that work differently in one key way: overhead expense insurance coverage generally has a benefit period of up to 24 months, which may be in adequate when it is used to protect obligations of long duration.
Banks generally prefer to have coverage that provides them with a direct payment from the insurance company, unlike business overhead, which pays the insured who then needs to turn around and pay the bank. On your end, you should benefit with a lower premium as business reducing term coverage is, in most cases, less expensive for the same coverage amounts than business overhead. This is certainly not to diminish the importance of having business overhead expense insurance as a business owner but simply to realize the business reducing term product was constructed to handle fixed monthly payments of a long duration.
If you are in the process of taking out a business loan, it is important to understand everything that is going to be required of you by your lending institution. Most lenders will require some form of a life insurance policy to protect your loan. In addition, many are now requiring that some form of disability insurance also be obtained. If this is the case, it is important that you understand all of the options available to you.
Many insurance agents are not aware that a policy such as Guardian’s Business Reducing Term insurance policy even exists. Many individuals get stuck paying a higher premium because they are uninformed, and purchase a policy that is not specifically designed to meet their needs. The BRT policy is typically the least expensive way to satisfy the disability insurance requirement that is established by a lending institution.
It is extremely important to be aware of all of your options, and that you speak with an agent who specializes in disability insurance policies. He or she can review all of your options with you, and advise you as to the best solution for your particular situation.
As a business owner, business reducing term coverage generally offers the best way to help protect fixed loan obligations. Keep this in mind when constructing a business plan that involves you paying a fixed bank loan or any guaranteed employment agreement.
Now, to consider the third concern above- This is only needed if you as a business owner have one or more business partners. In the event that one of the partners becomes disabled and unable to return to work, a buy-sell agreement should spell out the terms for the non-disabled partner(s), or the business, to buy out the disabled partner. This sounds easy enough, but what if there is not enough money (current savings or short term cash flow) to buy out the disabled partner? What would happen then? - It could become a legal mess- The last thing anybody wants!
The easiest way to handle this situation is for each owner/partner to obtain a disability buy-out policy that will cover their share of the business. The buy-out policy will fund the terms set forth in the buy sell agreement that every business with partners must have. There can be a problem valuing the company both today and in the future. It is important to decide on a system to value the company that is fair, makes sense and that all partners agree on. If you use a Berkshire Life Insurance Company disability policy, a valuation formula is included in the policy.
This makes it easier for all concerned to understand how the business is valued at the time of the policy purchase as well as at a time in the future when a disability may occur. It is important when funding the agreement with a disability buy-out policy to factor in the future growth of your company and add a future purchase option rider to your policy. This rider will allow you to add benefit to your policy based solely on the value of your company, and without regard to your health status at that time.
What are the chances that at least one partner in a business becoming disabled for more than a year if there are 4 business partners? 2
A long term disability suffered by a business partner has the ability to cripple a business. And, a poorly written disability buy-out agreement on the other hand, may severely disrupt a business at the worst possible time. You have a share in your business, and you deserve to be compensated for your share of the business should a disability prevent you from working any longer.
The same is true for your partners, but have you ever looked closely at your existing buy-sell agreement? Is there a provision for disability? Does it lock you into buying out your partner’s shares, and is there a maximum dollar amount in the agreement?
You must make certain that funding the buy-out is realistic and possible for the business should you or your partner become totally disabled. We have seen too many plans that value a partner’s share based on a number from 10 years ago, that was funded with insurance, and today’s valuation would put the business out of business if the partner was disabled.
If you do not have a buy sell agreement funded with insurance to deal with this possibility, there would be a huge burden placed on everyone involved- partners, family and self. If you become disabled and cannot work or contribute to the company and your share of the business is $1,000,000, how is your partner going to pay you for your share of the business? It is imperative to plan for this. You do not want to use business profits or personal savings to buy out the disabled partner!
In the event of a disability, the company, or its remaining and healthy partners, would need to buy out the disabled partner for his or her share of the company. This would take place after the partner has been disabled for a significant period of time, or is permanently disabled. The period of time before the policy and buy out would kick in, or trigger, is usually a minimum of one year. You can extend your elimination, or waiting, period to an 18 or 24-month waiting period.
The disability buy out policy is a great way to leverage your company dollar. If you became disabled and the partners were going to buy you out, and your share of the company was worth $600,000, where would the money come from? The most efficient way to fund this is through the disability policy – which may amount to pennies on the dollar to fund the obligation. The buy out can be paid in one lump sum or monthly over a period of time- one to five years.
It is important when funding the agreement with a disability buy-out policy to factor in the future growth of your company and add a future purchase option rider to your policy. This rider will allow you to add benefit to your policy based solely on the value of your company, and without regard to your health status at that time.
It is also imperative to have a buy sell agreement drafted by a professional that spells out the valuation process for the business and all other details of a buy out in the event of death, disability, termination, or voluntary departure. I would consult your business advisers- accountant and attorney on all these issues. Please do not put this off. We have seen many times where business owners procrastinate, and then it is too late.
One of the owners suffers an illness or is in an accident. Then everyone scrambles to find a solution to the buy out need that has been created. The option to use insurance is gone, and the company must use its reserves, profits, and/ or personal assets to buy out the disabled partner. This could bankrupt the company that everyone worked so hard to build.
These are three very important things to consider as a business owner. These coverages can be critical in your financial well-being (and may mean the difference between surviving and sinking financially) in the event of a disability.
2. NAIC Commissioners Disability Table. The statistics displayed are based on information collected from independent disability companies and reflect only people with disability insurance policies.
OE: Policy Form 4200 underwritten and issued by Berkshire Life Insurance Company of America, Pittsfield, MA, a wholly owned stock subsidiary of The Guardian Life Insurance Company of America, New York, NY. This policy provides disability insurance only. It does not provide basic hospital, basic medical or major medical insurance as defined by the New York State Insurance Department. The expected benefit ratio for this policy is 50%. This ratio is the portion of future premiums that the company expects to return as benefits, when averaged over all people with this policy.
DBO: Policy Form 3100 or 3200 underwritten and issued by Berkshire Life Insurance Company of America, Pittsfield, MA, a wholly owned stock subsidiary of The Guardian Life Insurance Company of America, New York, NY. This policy provides disability buy-out insurance only. It does not provide basic hospital, basic medical or major medical insurance as defined by the New York State Insurance Department. The expected benefit ratio for this policy is 55%. This ratio is the portion of future premiums that the company expects to return as benefits, when averaged over all people with this policy.
If you choose to have an optional rider on your policy your premium will increase.
James Fegan holds a Financial Representative contract with The Guardian Life Insurance Company of America based out of New York, NY. This web page is provided for informational purposes only and should not be considered tax or legal advice. Please contact your tax or legal advisor regarding the tax treatment of the policy and policy benefits. You should consult with your own independent tax and legal advisors regarding your particular set of facts and circumstances. The information provided is not intended or written to be used, and cannot be relied upon, to avoid penalties imposed under the Internal Revenue Code or state and local tax law provisions.
2018-66509 Exp 09/2020