RSM Resources

When it rains, it pours for a company that loses a key employee tolong-term disability. Business costs continue mounting, as do theaffected employee’s living expenses — all while the business strugglesto maintain its earning power. But a business can take some veryconcrete steps to maintain continuity in the event of a disability.

Withthe long-term loss of a top executive, a business can suffer anythingfrom mild inconvenience to bankruptcy. The odds of losing a vitalemployee to disability are relatively high, so every business shouldprepare to protect itself and key employees.

"Some studies putthe chances of becoming disabled at nearly 50 percent before reachingthe age of 65," says Lorilee A. Schneider, an assistant professor ofrisk management and insurance in the J. Mack Robinson College ofBusiness at Georgia State University. "Those who are in essentialdecision-making or revenue-generating positions within a company areextremely valuable both figuratively and financially. The costsassociated with a long-term absence go further than medical bills. Theycan include the loss of current and potential business, the shakenconfidence of investors, and the expense of recruiting and training newleadership."

An underused asset
Many midsizedbusinesses are better prepared to deal with the death of a key employeethan a lasting disability, says Kevin Cloutier, a disability specialistwith Chicago-based Disability Resource Group.

"Businessdisability insurance is underused for a few reasons, none of which isparticularly connected to the products," Cloutier says. "For one,policy buyers seem to understand the need for life insurance, but theyreally don’t believe they will become disabled. Also, there seems to bea misconception among brokers that business disability polices aredifficult to underwrite, complicated and labor-intensive. None of it istrue."

These misconceptions actually benefit those in the marketfor business disability insurance. That’s because carriers have beenrestructuring pricing to attract more buyers, Cloutier says. Thestrategy is working — the use of business disability insurance isrising.

Protect your investment in people
Key-person life insuranceis a time-tested, common feature of corporate risk management andsuccession planning. However, the very real threat of businessdisruption due to a leader’s disability increasingly has led riskmanagers to recommend key-person disability coverage. This typeof safeguard protects the revenue lost when an employee central to thesuccess of a business becomes disabled and cannot work. Key-personcoverage also reimburses the business for expenses related to hiring areplacement for the disabled employee and helps the business continuepaying the salary of a disabled executive without having to fund twosalaries to get one job done.

As with key-person lifeinsurance, an insurance carrier evaluates the person you want to insurefor disability coverage and sets a premium on that person. The carrierbases the premium on the current health of the employee, healthhistory, age and salary.

The elimination period is the timebetween the onset of a disability and eligibility for benefits. Ashorter elimination period of 30 or 60 days typically carries a higherprice, while a longer elimination period comes with a price break. Inorder to install a replacement employee as soon as possible, key-personpolicies have a relatively short elimination period, typically 90 days.

Carriers typically base a key person’s benefit amount on theperson’s salary or the documented amount of revenue the person directlygenerates. The benefit generally equals one times the key person’sannual salary or the amount of documented revenue the employeegenerates. It is paid monthly over 12 months for one of the shortelimination periods (30, 60 or 90 days). A common alternative benefitis up to three times salary paid in a lump sum after a one-yearelimination period.

Beyond key-person coverage
Businessdisability insurance differs from personal disability insurance in avariety of ways. For example, under personal coverage, a single policyusually insures an individual’s income. But for business interests, adisability insurance program with a mix of products may be necessary.Such programs typically include at least one of the following solutions:

Business overhead expense (BOE) coverage. Thiscoverage reimburses the business owner for day-to-day operatingexpenses in the event he or she is disabled and cannot run thebusiness.

Business buyout coverage. This coverage can prevent disruption of a business when a disability or death forces the buyout of a partner’s share.

BOEinsurance is not the same as personal disability insurance, whichusually pays benefits up to age 65. A BOE policy pays a shorter benefitof one to two years after a waiting period. The basic premise behindthe length of coverage is that most businesses cannot stay open morethan two years if the owner is disabled.

"One good way to lookat BOE policies is that they function to keep your business healthyenough in your absence that if you’re able to return to work, yourbusiness is still viable," Cloutier says. "If you’re never able toreturn to work, a BOE should allow your business to remain healthyenough to allow you to recoup your investment upon the sale of thebusiness."

Business buyout coverage funds a disabilitybuyout agreement between business owners if a total disability forcesone of the owners to stop working. It reimburses the buyers of abusiness for the cost of purchasing the disabled person’s interest inthe organization.

The contract provides a benefit to reimbursethe buyout expense or the amount that actually has been paid to theinsured to purchase ownership in the business. Under all disabilitybuyout plans, premiums paid are not tax-deductible, but any benefitsreceived are income-tax-free. The new business owner will be liable forany taxable gain realized upon the sale of the disabled businessowner’s interest.

Create your own package
Isyour midsized company ready for a key person’s disability? Have youarranged to protect the individual’s income and your company’s revenuein the event of an unexpected tragedy? Experts advise you to determinewhat insurance coverage is right for your company. An independentadvisor can help you research the options and purchase the mostappropriate coverage.