Disability Business Buy-Out Insurance

Disability buy-out insurance is designed to provide the funds necessary to purchase an owner’s or partner’s interest in a small business if that person becomes disabled. This type of insurance should be integral to any business continuation or succession plan because it will assure that the disabled owner or partner receives fair market value for his or her share of the business. By allowing the remaining owners to buy the disabled owner’s interest at a pre-arranged, agreed upon price, disability buy-out insurance also will protect all owners from the threat and distraction that the disability of one owner may impose on a business.

How does disability buy-out insurance work?

The first step is a thorough and accurate valuation of the business. The owners then must enter into a buy-sell agreement, once a fair market value has been established for the business and the parties agree upon a sale price. Finally, a disability buy-out insurance policy is purchased on each business owner or partner to provide the funds needed to buy out that share in the business in the event of disability.

When disability occurs, an elimination, or waiting period, must be satisfied before any benefits are paid. The length of this period is decided upon at the time of application for the policy. The elimination period begins at the date of initial disability and can extend for 12, 18, 24 months, depending on the terms of the buy-sell agreement, which will be driven by the needs of the company. The longer the elimination period, the less expensive will be the cost of the insurance.

Under this type of plan, benefits are paid once the elimination period has been satisfied with no need to confirm continuing disability. In other words, once the payment of benefits begins, the terms of the buy-sell agreement will be fulfilled and the policy will pay benefits accordingly. A buy-out policy can be custom designed to meet the specific needs of each company, but lump sum or scheduled payments over a two, three or five year period are the most common benefit payment options.

Why would a business consider this type of policy?

The statistical probability of becoming disabled is greater at any age than the likelihood of death in that same year. The total disability of an owner active in the day-to-day operations of any business can present serious financial problems.

Any business should address the following questions as it considers disability buy-out insurance:

--What impact would the disability have on the company’s income?

--Where will the money come from to pay an income to the disabled (now non-contributing) owner?

--Does the business have adequate funds to buy out the disabled owner/partner?

--Will the firm need to borrow money to do this?

--What defines a disability from the business perspective?

--How long must an owner/partner be disabled (the elimination period of the policy) before the buy-out is executed and the share is sold to the remaining owners/partners?

--Will the benefits to fund the buy-out be paid as a lump sum or over time?

--What if the disabled individual recovers after the buy-out is triggered under terms of the buy-sell agreement and, as a result, the policy stops paying disability benefits?

A disability income policy can be a useful key element of a buy-sell agreement, as well as in other business settings, but a small business must be sure to ask the right questions as it plans for the future.