Business Expenses Continue after Disability
Personal disability income insurance and a buy-out agreement funded by disability income insurance help solve only part of the problem when disability strikes a business owner. What about the ongoing business expenses? Many of these expenses, such as rent, phone, and utilities, continue without regard to the business owner’s disability. Business owners are likely to need additional protection to help meet their routine business expenses if they become disabled.
What may be appropriate for these business owners is a disability income insurance policy that will help pay these business expenses during a disability, allowing their businesses to remain open while a disabled owner recovers.
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There is an insurance product that can provide a solution: Business Overhead Expense Protection using a disability income policy. This policy reimburses the owner for covered overhead expenses up to a specified limit on a monthly basis during a disability. In addition, the purchase of this policy can help assure the company employees that, in the event of the owner’s disability, the business will continue to operate and their jobs will be secure. The last thing a disabled business owner needs is an exodus of employees who fear that they could be laid off.
If you’re selling individual disability income insurance and/or disability income insurance to fund a buy-out agreement, it only makes sense to also provide the owners with an arrangement that helps pay for covered business overhead expenses during the disability.
Covered Overhead Expenses
The following is a list of business expenses which are covered by most disability income policies intended to help cover business overhead expenses:
- Employee salaries
- Employee fringe benefits and payroll taxes
- Rent
- Heat
- Water
- Electricity
- Telephone and telephone answering service
- Interest and principal on business indebtedness (including interest on mortgage loans for premises used in operating the business)
- Association dues
- Accounting, billing, and collecting fees
- Premiums for business insurance (including malpractice insurance)
- Postage and stationery
- Laundry, maintenance, and janitorial service
- Other fixed expenses normally incurred in managing and operating the business.
It is important to read the policy to verify which expenses are covered and which are not.
Noncovered Expenses
The list of covered expenses is usually large and benefits will help provide sufficient revenue to keep the business running during the disability of the owner. There are, however, some business expenses that are
not covered:
- Salary, fees, draw account, or other remuneration for the owner (individual disability income coverage is designed to cover the owner’s personal income needs)
- Depreciation of furniture and equipment (some companies will cover)
- Merchandise and cost of goods sold.
The cost of these items are not covered expenses since they are contributing to the asset base of the company and are really investments rather than expenses.
It’s important to know which expenses are covered and which are not, since business overhead protection with disability income insurance is a “reimbursement” policy, and thus works differently than an individual disability income insurance policy. Once an individual disability income insurance policy has been issued, and as long as premiums are promptly paid, when the insured is totally disabled for the period of time specified in the policy, he or she becomes entitled to the benefits—regardless of the insured’s actual income at the time of disability or even whether the insured was employed at the time of disability.
On the other hand, disability income insurance intended to help cover business overhead expenses will only reimburse the insured for the actual covered overhead expenses for which the owner is liable incurred on a month-to-month basis, usually up to a stated limit. If the policy has a $4,000 monthly benefit for total disability and the actual covered expenses incurred in a month are only $3,000, the insured will only receive $3,000. The owner is reimbursed for actual expenses for which he or she is liable only.
When co-owners are involved, it is important that each insured owner understand what will be covered in the event of his or her disability. For example, John and Susan each own 50% of the business. Each has business overhead expense protection using disability income insurance for up to $5,000 in monthly benefits. John becomes disabled. If actual covered expenses incurred in a month are $8,000, John will receive $4,000 for his 50% share of expenses.
In discussing business overhead expense protection using disability income insurance with your client, it’s imperative that you explain how he or she qualifies for benefits at time of claim, and that documentation is required to establish the insurance company’s liability each month.
The Policy
Definition of Disability
Most policies will define total disability as the inability to perform the duties of the insured’s occupation in the business. This is logical since the income generated by the business is directly related to the owner’s ability to perform his or her normal duties in the business. It’s important to review the policy definition to be sure coverage is appropriate. The fact that the insured may be able to work in some other occupation is not relevant when measuring the impact of the injury or sickness on his or her ability to contribute to the business.
Elimination Period
Many companies offer a 30-, 60-, or 90-day elimination period under a disability income insurance policy designed to help cover business overhead expenses. However, the 30-day elimination period is often used since many businesses do not have sufficient cash to cover overhead expenses for an extended period of time.
Benefit Period and Amount
Benefit periods offered are typically 12, 18, or 24 months. This policy is designed to keep the business running until the owner is able to return to work; and if he or she has not returned within 24 months, it is doubtful whether the owner will ever return. The amount of monthly benefit which the insurance company will issue depends upon the owner’s occupational class and the type of business being covered. If the insured is a highly skilled professional, has a close and regular relationship with clients, and the insured’s services cannot be provided by his or her employees, then the disability of the insured would be likely to cause a near-total loss of business income.
The self-employed doctor, dentist, or attorney are good examples of this type of situation. For these individuals, a large amount of business overhead expense protection with disability income insurance is available for qualified individuals. On the other hand, there are insured’s whose active participation is essential to the continuation of the business and whose disability would cause significant loss of income, yet there would not be a total loss. The owner of an auto body shop may play a major role in the operation of the business; but in the event of disability, the mechanics and their foreman could still perform their duties and generate income for the shop.
If co-owners also have a buy-sell agreement funded with disability income insurance in place, it is important to coordinate the benefit period with the trigger date provided in the agreement. In other words, if the buy-sell agreement was triggered by 15 months of continuous disability, a policy with an elimination period of 90 days and a 12-month benefit period is likely to be appropriate.
Monthly Benefits
All business overhead expense policies have a maximum monthly benefit and a maximum benefit period—but that’s where the similarity ends. The overhead expenses in a business are not the same exact amount from month to month. There are certain expenses which may come due on a quarterly, semiannual, or annual basis, and even monthly expenses (i.e., utilities) will vary from month to month.
Disability income insurance policies intended to help cover business overhead expenses differ in the way the payment of benefits are made when the actual expenses change each month:
Policy 1:
This policy pays only up to a maximum monthly benefit and only for expenses incurred before the end of the benefit period. The client loses all benefits not used within the maximum benefit period.
Policy 2:
This policy goes a step further than Policy 1. Here, the client can draw on his or her unused benefits (if any) to pay expenses incurred after the end of the benefit period. However, the benefit paid in any given month cannot exceed the total monthly benefit stated in the policy.
Policy 3:
This policy goes two steps further. The insured can draw on his or her unused benefits (if any) to:
- pay expenses incurred after the end of the benefit period, and
- pay expenses that exceed the maximum monthly benefit.
Partial Disability
Some insurers offer a partial disability option for their disability income insurance policies intended to help cover business overhead expenses. If the insured is working on a part-time basis, he or she is eligible to receive 50% of the otherwise payable benefit for a specified period of time. If the monthly benefit in the policy is $4,000 and actual covered expenses in a month total $3,000, the partial benefit is 50% of the covered expenses, or $1,500.
Conversion Privilege
Most disability income insurance policies intended to help cover business overhead expenses (BOE policies) offer a conversion privilege to individual disability income coverage if the insured leaves the business. The policy can be converted without evidence of medical insurability. The elimination period cannot be less than that in the BOE policy, and the benefit period cannot exceed the benefit period in the BOE policy.
Some policies allow the full benefit amount to be converted if the insured meets underwriting guidelines, while others will place a limit of $1,000, $2,000, etc., on the amount that can be converted. Some policies even allow the policy to be converted based upon the insured’s original issue age. Thus, if the insured purchased the BOE policy at age 35 and sold the business 20 years later, he or she could convert to an individual policy and pay premiums for the contract based on the original issue age of 35.
Taxation of BOE Insurance
Under a disability income insurance policy intended to help cover business overhead expenses, the business owns the policy, pays the premiums, and receives the benefits when the owner is disabled. The premiums for this insurance are tax-deductible as an ordinary and necessary business expense.
When the owner becomes disabled, the benefits received are considered income to the business and are, therefore, includible in gross income. However, the company or owner can deduct the corresponding business expenses, thus offsetting the policy benefits with expenses.
Disability Buy-Out Insurance Provides the funds for a buy-out if one of you becomes disabled
You and your partners have grown your business from day one… so it’s hard to imagine what would happen if suddenly one of you were disabled. Many partners realize from the beginning that they need to plan for a buyout in the case of death, and purchase life insurance to fund for that possibility. But few are as well prepared for disability.
Provides a Ready-Made Solution to an All-Too-Common Problem
Chances of one of the owners in a multi-owner business becoming disabled for 90 days or more before age 65:
With 2 owners, aged 35-34% chance*
With 3 owners, aged 35-47% chance*
Furthermore, many disabilities are very lengthy, or permanent: Of all 45-year-olds disabled for one year, 5 years later . . .
19.9% will have died*
57.5% will still be disabled*
*1985 Commissioners Disability Table (Statistics shown are based on data collected from independent disability carriers and reflect only individuals with DI policies.)
Life Goes On…Even After a Disability.
(And so can your business).
Fund a Buy-Out that’s Fair . . .
Keep Your Business Up & Running . . .
with Disability Buy-Out Insurance
Business Disability Buy-Out Insurance – The Best Way to Meet the Needs of All Owners – and of the Business Itself.
How it Works:
The company purchases policies on each eligible owner (entity purchase); or each owner purchases a policy on the lives of the other owners (cross purchase). If one of you becomes totally disabled and a buy-out is triggered, benefits are paid according to the pay method selected – lump sum, monthly, or a combination of the two.
These benefits are paid to the company or the active owners for the purchase of the disabled owner’s interest. Payment is based on the pre-determined fair market value of the business. See your agent for more information.
With the disabled partner recompensated for his or her share of the business, the others are then left free to rebuild the company-without the crushing financial obligation of funding the buy-out from the company’s reserves.
How can the conflicting needs be met satisfactorily, cost-effectively and amicably?
Here’s how each interested party might see things.
The Remaining Owner’s Point of View . . .
How long can we afford to operate without our partner’s help?
When should we begin to think about hiring a replacement?
What happens now to the business loans the bank made us both sign for personally?
Will our creditors and customers or clients begin to lose confidence in our viability?
How can we continue to include our partner in our decisions when he or she can no longer participate in our operations?
Will the spouse or children of the disabled partner want a say in running things?
Will our disabled partner sell his or her interest to a competitor?
The Disabled Owner’s Concerns . . .
How can I hope to recover my capital investment?
Why should I have to let someone else use my money to run my business?
Where is the return on my money that I should be receiving, considering I helped found the business?
The Business’ Best Interest . . .
Last but not least, it’s important to consider what’s best for the business overall. Obviously if the business goes under while affairs are being reorganized, it will certainly not help any of the principals . . . the employees . . . or the customers or clients. That’s why a buy-out agreement specifically designed to cover the possibility of a disability is a vital. And so is the insurance specifically designed to fund that buy-out.