Monday, January 11, 2021

Does My Small Business Need Disability Buy Out Insurance?

Disability buy out insurance is something that small businesses need. Unlike a large business, small businesses can sometimes be crippled by the absence of a key person - someone who is so critical to the company that the business could fail if that person is unable to work. Depending on the job of that key person, their disability can leave work undone or have a financial gap in the business income that a business may not recover from without disability buy out insurance. Disability buy out insurance is designed to provide the funds necessary to purchase an owner or partner's interest in a small business if that person becomes disabled.

Disability buy out insurance should be an integral part to any business continuation or succession plan. Small business owners need to agree to buy any disabled owner's interest in the business at a pre-arranged, agreed upon price, and fund the purchase with disability buy out insurance. The buy out will allow the remaining owners to continue operations by financially replacing the key person whos disability prevents them from returning to the business.

The first step in purchasing disability buy out insurance is to have a thorough and accurate valuation of the business. Once a fair market value has been established for the business upon which the parties agree, the owners must then into a buy-sell agreement setting conditions that will automatically generate a sale of a disabled owner's interest. Finally, a disability buy out insurance policy is purchased on each owner or partner to provide the funds needed to buy out that share in the business in the event of a disability. 

When a 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 the disability buy out insurance application. the elimination period begins at the date of the initial disability and can extend for 12, 18 or 24 months, depending on the terms of the buy sell agreement. Choosing the length of the elimination period is determined by the needs of the business. The longer the elimination period, the less expensive the premium will be. However, the longer a business would have to sustain itself before the benefit or buyout occurs.

Under this type of small business insurance, benefits are paid once the elimination period has been satisfied with no need to confirm continued 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 disability buy out insurance 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.

Small businesses may not have the resources that a large business has. With that in mind, they should have contingency plans including small business disability insurance, business overhead expense policies, disaster recovery plans and other risk transfer components. The total disability of an owner active in the day-to-day operations of any business could present serious financial problems. To determine your small business disability insurance needs, ask yourself the following:

  • What impact would the disability have on the company's income?
  • Where will the money come from to an income to the disabled (non-contributing) owner?
  • Does the business have adequate funds to buy out the disabled owner?
  • Will the company need to borrow money to do this?
  • What defines a disability from the business' perspective?
  • How long must an owner be disabled (the elimination period of the policy) before the policy is executed and the share is sold to the remaining 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 the terms of the buy-sell agreement and, as a result, the policy stops paying benefits? 
A small business disability insurance policy can be useful and a key element of a buy-sell agreement, but a small business must be sure to ask the right questions as it plans for the future. Doing so will enable the remaining owners to purchase or buy out key persons without having to seek outside investors. A disability buy out policy will allow a business to continue in its normal operations without having to financially drain the company to keep control. 

If you would like your small business disability insurance plan to include disability buy out insurance, ask us about it. We'll be happy to put together a quote for you. In the meantime, please stay healthy!

Chris Castanes is the president of Surf Financial Brokers, helping people find affordable life and disability insurance coverage. He's also is a professional speaker helping sales people be more productive and efficient and has spoken to professional and civic organizations throughout the Southeast. And please subscribe to this blog! Thanks!

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