Chapter 6 — Special Coverage Disability Insurance Policies

A salaried employee has one budget. A small business owner or professional has two: a personal budget and a business budget covering rent, salaries, utilities, professional publications, and so forth. Overhead Expense insurance funds that second budget during disability.

Two versions exist:

• Professional Overhead Expense: Includes employees’ salaries as eligible overhead expenses.
• Business Overhead Expense: Generally excludes employees’ salaries from eligible expenses.

Both reimburse eligible overhead expenses, typically including: rent, telephone, professional publications, dues, office supplies, utilities, and accounting fees. The cost of inventory is generally excluded.

Key policy features:

• Monthly benefit: As high as $25,000/month.
• Benefit periods: Typically 12, 18, or 24 months — shorter than income replacement policies.
• Elimination periods: 30 or 60 days are most common.
• Reimbursement basis: Benefits equal actual expenses incurred, up to the policy maximum.

Since business expenses vary month to month, Overhead Expense policies address this through carryover provisions:

• Expense carryover: When expenses in a month exceed the monthly maximum, the excess is carried forward to be reimbursed in a later month when expenses are lower.
• Benefit carryover: When expenses in a month are less than the monthly maximum, unused benefit capacity is carried forward for use in a later month when expenses exceed the monthly maximum.

Example assumes a $10,000/month Overhead Expense policy with both expense and benefit carryover provisions.

Many buy-sell agreements address death but overlook disability — even though at most ages disability is 3 to 4 times more likely to occur than death. Disability Buyout insurance funds a buy-sell agreement triggered by a partner’s or stockholder’s disability.

Key distinctions from other disability policies:

• Elimination period: Typically 12 to 24 months rather than 30–90 days. The long period allows time to confirm the disability is genuine and lasting.
• Benefit payment: Most commonly a lump sum, though installments are possible — determined by the buy-sell agreement.
• No continued disability required: Once the elimination period is satisfied, the full benefit is payable even if the insured recovers. This prevents disputes over ongoing disability status.
• Documentation required: Insurers generally require the buy-sell agreement to be furnished before issuing the policy.

The policy may be owned by the business (entity/stock redemption plan) or by the other partners/stockholders (cross-purchase plan). Two important outcomes:

• Business succession is planned for in the event of disability, with funds provided to meet the buy-sell obligation.
• Determination of disability lies with the insurance company rather than the remaining partners — removing a significant source of conflict.

Keyperson Disability insurance functions like keyperson life insurance — it compensates the employer for the economic loss resulting from the disability of a key employee. The employer is the policy owner, beneficiary, and premium payor; the key employee is only the insured.

Benefits are typically of short duration but large in amount. Four methods for valuing a key person:

• One year’s profits: Average annual profit over the prior 3–5 years, divided by 12, equals the monthly keyperson benefit needed. Provides time to find and train a replacement.
• Contribution to earnings: Estimates management’s contribution by subtracting the return attributable to invested assets from average annual income, dividing by the number of key persons, then multiplying by the estimated replacement time in years.
• Excess salary: Subtracts the estimated cost of replacing routine duties from the key person’s total compensation. The excess reflects special expertise. Multiplied by estimated replacement time.
• Present value of lost earnings: Applies a discount rate to the estimated lost earnings for as long as the key person’s disability would affect results.

Keyperson policies typically use a conditionally renewable provision — with the condition being the insured’s continued employment. The disability definition is usually pure own occupation: if the key person cannot perform the substantial and material duties of their job, they are not functioning as a key person and benefits should be paid.

Pay disability income benefits only when the disability results from a sickness or injury not related to the insured’s occupation. Most common in group insurance, but available individually. Often used to supplement Workers Compensation for workers in high-risk occupations who are already covered for on-the-job disabilities but have no off-the-job coverage.

Pay benefits based on the monthly debt service on outstanding debt. When issued on a group basis, the beneficiary is usually the lending institution (commonly used with mortgage debt). When issued individually, the beneficiary is almost always the debtor rather than the creditor.

Special coverage disability policies serve both business and non-business needs beyond basic income replacement. Business applications include Overhead Expense coverage to keep a practice or business running during disability, Disability Buyout insurance to fund partner transitions, and Keyperson coverage to compensate for lost executive contributions.

Non-business specialty policies include non-occupational coverage for high-risk workers and debt protection policies tied to mortgage or loan obligations.