The ability to earn an income is one of an individual’s most valuable assets. That’s something I learned in my first Disability 101 class, and it made a great deal of sense to me because one’s ability to earn an income provides the financial platform that funds most things we need in our lives.
Yet I am still surprised that disability income insurance for this valuable asset often is overlooked and undersold by financial professionals today. In fact, although more than 60% of Americans currently carry life insurance, only 28% of employees participate in long-term disability (LTD) benefits.
Disability income insurance is important for everyone, but a particularly underserved segment includes highly compensated managers and executives, whose skills, knowledge and experience are invaluable to your corporate clients. Unfortunately, while employer-provided group LTD plans usually offer sufficient protection for most employees, they may leave higher-income executives with inadequate coverage and lower replacement ratios. And companies that attempt to remedy this issue with an all-group plan, perhaps by raising benefit maximums or increasing replacement ratios, can face experience and pricing volatility that undermines benefit budgeting and planning.
What can insurance advisors recommend to help clients provide the amount of income protection executives need and help employers manage risk? One solution is to combine a supplemental individual income protection plan with a group LTD plan, using an integrated approach that meets the needs of employees at all income levels while addressing the costs and risks facing employers.
Coverage challenge for executives
There are several reasons why group LTD plans with standard income replacement often don’t adequately cover the income stream of higher compensated employees:
o Monthly benefit maximums may be insufficient, resulting in reverse discrimination;
o Most plans replace only salary, leaving executives with uncovered earnings that may include bonus, incentive pay, commissions, deferred compensation and stock options; and
o Benefits often are taxable, since most plans are noncontributory.
In addition, employer contributions to a qualified retirement plan are not protected by group LTD during the time a manager or executive is disabled and unable to work, further impacting the plan’s ability effectively to protect income and future assets.
Unfortunately, as incomes rise, coverage diminishes. For example, under a noncontributory plan that covers salary only and replaces 60% of income to a $10,000 maximum monthly benefit, an executive earning $400,000 (including incentive compensation) would have an income replacement ratio of less than 30% due to the plan maximum and the incentive comp not being covered.
Such low replacement ratios and significant uncovered income can represent a substantial threat to an executive’s financial well-being. Consequently, you may want to recommend that your clients consider enhancing their group LTD coverage by adding an individual plan, making the employee benefit package more appealing to attract and retain key employees in a competitive marketplace. Supplemental individual income protection is an excellent way for employers to provide a robust benefits portfolio, enhance the coverage of valued executives and effectively manage risk.
Meeting the challenge
By supplementing or replacing a portion of the group LTD plan for highly compensated employees with individual income protection insurance, employers can:
o provide enriched coverage for key employees and executives; and
o implement a risk management component by diversifying risk, which can help with long-term rate stability.
The larger the employer, the greater the role of actual claim experience in LTD pricing. Even one claim in the higher-income population of a large employer can impact plan experience significantly. With the addition of individual income protection coverage, however, employers can shift this portion of the plan risk to the insurance carrier in the event of a long-term disability claim. This approach isolates the potential impact of the executive claim on the group plan because the experience for the individual income protection portion of the plan does not affect the group rating.
And while group LTD premiums can increase from year to year based on several factors, including average age of the group, demographic changes, incurred claims, etc., transferring risk to an individual plan (which has a fixed rate that cannot be increased for insureds under age 65) enables an employer to reduce claim and pricing fluctuations.
Advantages of an integrated plan
Integrating supplemental individual income protection with a group LTD plan offers a number of value-added enhancements beyond a group-only plan:
o Coverage is individually owned so employees can take the coverage with them if they leave the employer;
o A catastrophic benefit for severe disabilities often can be added as an option;
o Some carriers offer long term care conversion built into the contract;
o There are no benefit offsets with workers’ compensation or Social Security;
o Large case multilife discounts usually are available; and
o Some insurers may offer return-to-work assistance.
Highly customized, full enrollment support options
o Most plans provide personalized enrollment kits for executives;
o In some cases, Web-based information and enrollment services are offered; and
o Call center services often are available for employee questions.
The best of both worlds
Although an integrated approach may not always be an alternative, in many cases it can be the right solution for your clients’ disability income protection needs. When it is appropriate, an integrated plan increases income replacement for executives while also enabling clients to capitalize on the best features of both group and individual coverage.
The above concepts and strategies offer alternative ways for you to help your clients resolve potential income replacement shortfalls and manage their long-term disability risk. A good starting point would be to evaluate proactively each client’s LTD program and test its design to ensure that it meets the employer’s current objectives.
In the end, protecting employees’ incomes is a serious responsibility–one as insurance professionals we should never take for granted.