Insuring your earning power

Nation's Business, April, 1997 by Abby Livington

Bridging income lost to disability; finding angels; figuring a firm's worth; allocating assets in 401(k) plans.

As a small-business owner, you've probably insured your property against fire and theft. You probably also have life insurance to provide for your family when you die. But what have you done to protect another important asset--your ability to earn an income?

Accidents and illnesses that prevent people from going to work do happen--and more often than you may think.

A 35-year-old, for instance, has a 50 percent chance of becoming disabled for three months or longer before he or she turns 65, according to the National Association of Insurance Commissioners. In a partnership of two 35-year-olds, the likelihood that one person will become disabled for three months or longer before age 65 is 75 percent.

Such odds suggest you should think about buying another type of insurance--long-term-disability coverage that would replace a portion of your income if you're too ill or disabled to return to your job.

The insurance industry offers two I basic types of long-term-disability (LTD) policies: group and individual coverage. Group LTD coverage, which replaces 40 to 60 percent of the insured person's income, is a relatively inexpensive benefit that can be a significant recruiting tool when it is paid for by a company. Only 23 percent of companies with fewer than 100 employees offer group LTD coverage, according to the U.S. Bureau of Labor Statistics.

The typical LTD group plan costs $180 per employee per year, and the premium usually is paid by the employer, says Jay Menario, vice president of Group LTD Product Development at Unum Life Insurance Company of America, a Portland, Maine, firm that provides disability-insurance products and services.

Individual policies, on the other hand, are costlier but come with better coverage, namely a higher percentage of replacement income (up to 70 percent), portability from job to job, and noncancelable coverage. Individual policies are sold solo or to individuals within a group. The latter are called employer-sponsored individual policies.

Sole proprietors who go shopping for individual policies are likely to get hit with sticker shock. A 45-year-old sole proprietor would have to pay about $3,300 in annual premiums for an individual LTD policy that would provide $6,000 a month in replacement income.

The cost drops considerably when individual policies are sponsored by an employer and at least three people purchase a plan. Individual coverage under an employer-sponsored LTD plan costs about $1,500 annually.

Why the price differential between solo and employer-sponsored individual policies? "In the past five years, insurance companies have been faced with claims on [solo] individual policies that they never expected, like carpal-tunnel and chronic-fatigue syndrome," says Lee Alper, a principal in MA&S, an insurance and estate-planning firm in New York City. "So some companies have increased rates or changed their definitions of disability to limit their liability. Others are phasing out the business."

Given the changing landscape, it's important to understand some basics before you buy any group or individual policy. Generally, the cost of a policy is driven by the definition of disability, the level of income replacement, the length of the waiting period before coverage takes effect, and the length of time that benefits are payable.

With those factors in mind, you should ask your insurance agent questions such as these:

How does the policy define disability?

There are two broad definitions of disability, and their differences are significant. "Own-occupation" coverage pays benefits if you can't perform the important duties of your occupation. "Any-occupation" coverage pays benefits only if you can't work in an occupation that is consistent with your education, training, or experience.

Most group policies provide own-occupation coverage for the first 24 months and then convert to any-occupation coverage. This narrows the insurer's risk and provides an incentive for the disabled person to make a transition to another occupation.

Although most existing individual policies are written with own-occupation coverage for the entire benefit period, such coverage is becoming harder to find. One of the largest issuers of individual disability policies, the Paul Revere Insurance Group in Worcester, Mass., which is merging with Provident Companies Inc. in Chattanooga, Tenn., recently announced that it would no longer issue own-occupation policies.

The reason, says James Johnson, a spokesman for Paul Revere. is that own occupation policies--originally intended for highly specialized occupations--provide too rich a benefits package. A classic example, according to Johnson, is a thoracic surgeon who can no longer practice thoracic surgery. He collects full disability benefits under his own-occupation individual policy but goes into another field of medicine or even teaches at a salary relatively close to his predisability income.