Why it is important for small business owners to have disability insurance
“Disability insurance is a particularly important wealth protection tool, especially 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. Disability insurance protects a small business owner’s most important asset, which is their ability to earn income. Deciding on the type and amount of disability insurance to purchase depends on an individual’s specific financial circumstances. Many times, people think that their chances of becoming disabled at some point in life are very low, but the chances are higher than most people think. As I go through the insurance planning part of my financial planning process with small business owner clients, I let them know these three reasons that they should have disability insurance: Income protection, Business continuity, Long-term financial goals.
Income Protection
The financial success of a business is what determines the income level for a small business owner, which means that in the event of being unable to work, disability insurance can provide a source of income to cover living expenses. The hypothetical example below explains further.
Lauren is a sole proprietor and has run a successful business for over 15 years. Through the advice of her financial planner, Lauren purchased an individual disability insurance policy that would provide a benefit (60% of her income) to her if she became disabled and was unable to work. Having this insurance protection in place gives her peace of mind, knowing that she would be provided some level of income to pay living expenses if this type of unfortunate circumstance were to occur.
Business continuity
There are disability policies (e.g., Business Overhead Expense Insurance) available to small business owners that provide coverage of the business’s fixed expenses such as rent/mortgage, utilities, employee salaries, and other overhead costs in the event the owner becomes disabled. This type of protection is designed to help keep the business operating without disruption even when the owner is unable to work.
Long-term financial goals
In addition to growing and running a business, small business owners also have personal financial goals (e.g., saving for children’s education and retirement, paying off mortgage on home). A disability could negatively impact income and lessen cash flow availability, but having disability insurance provides the flexibility to still allocate money towards these personal financial goals even if the owner is unable to work.
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 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.
Understanding how to get a disability policy
Like any other type of insurance, there is an underwriting process conducted by an insurance company before they provide any offer for coverage. 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 has to pay the claim).
Evaluating options
Disability insurance is sometimes a topic that gets overlooked, but it is such an important protection tool for a small business owner. I explain to all my small business owner clients the importance of disability insurance and how it can safeguard the financial future of their family and business. Disability insurance also provides peace of mind knowing that if being unable to work were to occur, then their family and business would still be taken care of financially.