Disability insurance: the 60% myth

Bob is the vice president of development at a software company, earning a $250,000 annual salary and $150,000 bonus. Bob suffers a stroke. The company’s group plan provides 60 percent of annual salary and the benefit is taxable. His original pre-disability, after-tax take-home pay was $21,667 per month, or $260,000 per year ($250,000 + $150,000 – 35% tax). Now his disability after-tax benefit is $8,125 ($12,500 – 35% tax) or $97,500 annually. Bob must now live on 37.5 percent of his pre-disability take home pay.

Fortunately, there are supplemental disability insurance products available to solve the problem, and they can either be firm-paid or voluntary. In the case of law firms, consulting firms and investment firms, there are other issues to face. In these types of businesses, it’s not uncommon for partners to earn well in excess of one million per year, with most benefits already structured as tax-free. For these companies, the biggest problem is the benefit cap, which is usually $25,000 to $40,000 per month. This is either group-only or a combination with traditional individual supplemental coverage.

Let’s look at another case study. John is a law firm partner, earning $1.2 million a year. He has multiple sclerosis and goes out on disability indefinitely. He has $35,000 per month of coverage (a group LTD policy of $25,000 and supplemental coverage of $10,000). This means his original pre-disability, after tax take home pay of $780,000 ($1.2 million – 35% tax) is now $420,000 ($35,000 per month). Now that he is disabled, he must now live on 46 percent less after tax income. Again, not a pleasant situation once you’ve established a certain lifestyle. But there are ways to avoid this happening.

The London insurance market, specifically Lloyd’s of London, has been proactively involved with developing specialty insurance products for over 300 years. About ten years ago, Lloyd’s recognized the opportunity to develop multi-life supplemental disability insurance coverage for the U.S. market to protect highly compensated employees that are otherwise limited by the benefit cap instilled by U.S. disability insurers. Now, highly compensated employees can obtain the additional coverage they need to more adequately protect their income. In John’s case, with this additional coverage, he would receive an additional $25,000 per month from Lloyds’ for a total combined benefit of $60,000 per month ($720,000 per year), representing a 60 percent income replacement (group LTD $25,000 + traditional supplemental $10,000 and Lloyds’ coverage at $25,000).

This new coverage has created a lot of confusion, however. The problem is that people are starting to refer to Lloyd’s disability products generically, like Kleenex tissue, when, in fact, Lloyd’s of London is actually a marketplace that consists of over 50 separate underwriters writing insurance coverage on Lloyd’s paper with 85 different syndicates sharing the risk. The result is that now there are several different products, some of which are dramatically more comprehensive than others. 

Employers should review their disability programs to understand what limitations currently exist. Equally important, employers should make it a priority to learn about the supplemental products and strategies available to fill the gaps in coverage, so that they are able to select the structure and definition of disability that best meets their firm’s needs.  

See also:

How to sell individual disability to the C-suite

Which STD claims turn into LTD claims?

Not all high-limit disability policies are created equal