As a corporate executive, you have the prospect of earning a significant amount of money during your working career through what is likely a robust executive compensation program. This amount of future earnings can be negatively impacted if you become disabled through illness or injury. It’s important to examine the type of disability benefits you have as an executive and confirm that your income is adequately protected.
Assessing your coverage
When considering the effects of a disability, you should first examine what existing coverage you have in place through your executive compensation program. There are two distinct types of employer-provided plans that can provide income protection: short-term and long-term coverage.
Short-term disability: Companies can provide short-term disability benefits to executives under one of two approaches. They may have a sick pay plan which usually covers the replacement of lost income for a limited period of time starting on the first day of disability. The other option is a short-term disability income insurance program, which usually provides benefits to replace a portion of the executive’s lost income and often requires a waiting period before the benefits start.
Long-term disability: Long-term disability income plans typically have a waiting period of between three and six months, with a six month waiting period more common. The length of the payment for the disability benefits is typically until age 65 for either sickness or accident.
Definition of disability
Most short-term disability income insurance contracts define disability as the total inability of the executive to perform each and every duty of his or her regular occupation. Long-term group disability income contracts typically will use the “own occupation” definition of disability where the executive would be unable to perform the duties of his or her regular occupation for the first 24 to 36 months of disability. If disability continues past 24 to 36 months, then the definition of disability changes to the inability of the executive to engage in any occupation for which he or she is qualified by reason of training, education, or experience.
Most employer-provided disability income plans base benefits on a single percentage of regular earnings, excluding bonuses, commissions, and incentive-based income. Short-term plans can protect between 50-100% of base income. Long-term plans will cover up to 66 2/3% of wages. During review of your long-term benefits, you will want to see if your plan has a monthly maximum. Some plans may cover up to 66 2/3% of your earnings but may have a monthly maximum of $10,000.
Example: Mrs. Executive has a wage of $200,000 and typically earns a bonus of $100,000. She has a long-term disability plan that pays 66 2/3% of her wages with a maximum benefit of $10,000 per month. Based on her total compensation of $300,000, she would only have income protection of 40%, since the plan has a maximum of $10,000 per month and excludes her bonus. If accounting for taxes, the income replacement ratio is even lower.
Some disability plans are designed to “carve-out” benefits for the corporation’s key executives that are different from what other employees are eligible for. This type of executive plan may provide enhanced benefits in the form of coverage for a larger percentage of earnings or a more liberal definition of disability.
Individual disability income protection
If you have reviewed your existing disability income insurance through your employer and determined that the coverage is inadequate, then you can enhance your coverage through an individual insurance plan. Provisions of individual policies include:
Definitions of disability: Individual policies provide the insured with the superior “own occupation” definition of disability. If you are totally disabled and unable to perform the substantial and material duties of your regular occupation, the insurance company will pay the full benefits even if you return to work in another occupation.
Partial disability: Unlike group plans, the advantage of individual disability policies is that they provide benefits for executives even if you are partially disabled or have residual effects from your previous disability. Residual disability is defined as a loss of income due to the loss of the ability to perform some of the duties of your own occupation.
Cost of living adjustment: In the event of a long-term disability, the cost of living benefit in an individual plan will increase the monthly payment based on the rate of inflation. This can help protect the benefit from the erosion of value due to inflation.
Age of corporate executive: The younger you are, the more detrimental a long-term disability can be to your financial well-being. Based on your work history, the Social Security disability benefit may be low or you may not even qualify for a benefit. The amount of retirement savings may also be low since participation in the plan has not been going on for very long. Even if you have a significant amount of disability income benefits, most plans only pay until full retirement age at which point you are then deemed to have retired. This could be problematic since the amount of retirement savings would be low due to lack of contributions during all the years of disability. If you are concerned about underfunding your retirement plan due to a long-term disability, you can obtain a separate disability income policy that would pay retirement contributions into your retirement plan.
Examining your disability income insurance is a necessary part of risk management in the financial planning process. It is important to identify the risks you face from a short- and long-term disability, and establish a plan to help reduce this potentially devastating situation.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.