A guide to buying disability insurance for small business owners
My firm, Lasting Wealth Principles, does not sell any insurance products, but I still believe that disability insurance is a particularly important wealth protection tool, especially for small business owners. Deciding on the type and amount of disability insurance to purchase depends on an individual’s specific financial circumstances. As I go through the insurance planning part of my financial planning process with small business owner clients, I provide guidance to them throughout the disability insurance buying process. Income protection, business continuity, and long-term financial goals are all reasons why small business owners should obtain disability insurance, so it is important to understand how the buying process works. Disability insurance protects a small business owner’s most important asset, which is their ability to earn income. Disability insurance is a contract between an individual and an insurance company. An individual agrees to pay regular premiums, and in return, an insurance company agrees to pay benefits when applicable.
“Disability insurance protects a small business owner’s most important asset, which is their ability to earn income. ”
Disability insurance options for small business owners
Individual Disability Insurance
The goal of this coverage is to provide a level of income replacement if a small business owner becomes disabled. These insurance coverage options and benefits can be customized to fit a small business owner’s financial situation.
Business Overhead Expense Insurance
The goal of this coverage is to cover fixed business expenses (e.g., rent, utilities, salaries) if a small business owner becomes disabled. Fixed expenses are necessary for a business so having insurance coverage for these items allows the business to continue operating without interruption.
Key Person Insurance
The goal of this coverage is to provide financial protection to a small business owner if a “key employee” becomes disabled. A “key employee” can be an important part of a business’s success so their absence could have a negative impact on a business’s profitability. For example, this coverage can cover costs related to hiring a replacement for the “key employee” and loss of revenue due to their absence.
Disability definitions: Own-occupation vs. Any-occupation
Both disability definitions provide coverage if an individual is unable to work due to disability, but I note the differences between the two types of coverage below. Note that own-occupation provides broader coverage, so it is more expensive than any-occupation.
Own-occupation
Own-occupation coverage is for an individual’s specific occupation so if they are unable to perform the material and substantial duties of their pre-injury occupation, the insurance company will consider the individual disabled and pay the stated benefits. Note that insurance benefits will be paid regardless of whether the individual chooses to work elsewhere.
Any-occupation
With any-occupation coverage, if an individual is capable of still working, even at a lower-paying job, then the insurance company will not pay benefits However, if the disability prevents an individual from performing any occupation for which they are reasonably qualified (suitable for the individual based on education, experience, and age), then the insurance company will consider the individual disabled and pay the stated benefits.
Process of getting a disability insurance policy
Like any other type of insurance, getting disability insurance requires an underwriting process that is conducted by an insurance company. However, the process for obtaining disability insurance can be complex and specific to each individual insurance carrier. Each insurance company has their own way of assessing disability risk, and one company could be willing to insure a higher-risk policyholder, while another would not.
During the underwriting process, an insurance company could request medical history (including an exam) and income documentation. Insurance companies want to review an applicant’s health to evaluate the risk of a disability occurring (and probability of recovering if they were to become disabled). Income is verified by an insurance company because the maximum coverage offered by an insurance carrier is around 60% of monthly income. Note that this percentage (60%) provided is not higher (i.e., closer to 100%) because the insurance company wants to ensure that those who are receiving these insurance benefits (in the event of being disabled) still have an incentive to return to work (meaning the carrier no longer must pay the claim).
Given the complexities of disability insurance, it is prudent for small business owners to consult with professionals throughout the process. Before my small business owner client talk with an insurance agent, I provide them a recommendation on the type of and how much disability insurance they should purchase based on their financial situation (income, expenses, emergency cash available). Note that as a fee-only, financial planner, I do not receive commissions from any insurance company (i.e., I do not get compensation on the sale of disability insurance), which makes my advice and recommendations to clients objective and unbiased.
Supporting my clients
The buying process can be inconvenient, but disability insurance is such an important protection tool for small business owners, so I am here to support them throughout this process. Disability insurance provides peace of mind to small business owners because they know that if being unable to work were to occur, then their family and business would still be taken care of financially.