By GARY F. TERRY, the Braintee, Mass.-based executive vice president and managing director of The Westport Group, who has more than 28 years of corporate planning expertise associated with executive benefits
Highly compensated lawyers, investment professionals and corporate executives all have the same financial problem, one that becomes more serious as each year goes by. It's also one that receives far too little attention, which may be why so few are aware of their predicament.
It's the gaping hole in their disability protection. And that's no exaggeration.
Here's just one example. A portfolio manager in a large investment firm who earns $1 million per year is diagnosed with a severe case of multiple sclerosis and goes out on disability indefinitely. His disability plan will pay 60 percent of earnings to a maximum of $25,000 per month (a combination of group disability of $20,000 and a traditional supplemental plan of $5,000). That means that his original predisability, after-tax, take-home pay of $650,000 is now $300,000. His disability income benefit is 54 percent less than he took home after-tax before becoming disabled.
As strange and ironic as it may seem, the disability insurance market for those in this group has been frozen for the last two decades. While salaries, annual bonuses and long-term incentive payments have increased dramatically during this period, the available amount of disability income protection hasn't changed at all.
The irony is that the more income these individuals earn, the less coverage they can obtain as a percentage of their total compensation. Thus, the gap between needed disability coverage and what U.S. insurance companies are willing to provide continues to widen.
YESTERDAY VS. TODAY
It wasn't always this way. Back in the 70s and 80s, the disability insurance market was young, aggressive and growing by leaps and bounds. A number of insurance companies were determined to gain market share, no matter what it took to reach their goal.
To accomplish their objective, they went so far as to broaden their definitions of disability and figuratively hung out the welcome sign for the members of certain professions. Sales went up, of course, but so did the claims. The major losses some insurance carriers experienced led to a major industry consolidation.
Today, the disability income insurance market is concentrated in a handful of companies that write most of the business. Their actuaries develop the guidelines and set the rules on how much coverage (i.e., the amount of the monthly benefit) they will write based on an individual's income. These are known as the "issue and participation limits," which is usually an amount based on replacing 60 percent of earnings with a maximum monthly benefit not to exceed $15,000 to $20,000.
The only exceptions are the largest legal and accounting firms, where they will write a combination of group and individual supplemental coverage up to $40,000 or more a month.
The maximum benefit amounts available tend to be nearly identical from one insurance company to another. Therefore, if one carrier determines that an individual with an annual income $1.2 million should be covered for a maximum of $20,000 per month, then the other companies will follow its lead and impose the same limit, even if the individual genuinely needs a total of $50,000 to $60,000 per month to be adequately protected.
CLOSING THE GAP
As compensation continued to climb, there have been efforts at creating new products to help solve "the widening gap" problem. This was initiated with specialty disability insurance for highly compensated professional athletes and entertainers. Then came a migration to a multilife guaranteed insurance product offered through specialty underwriters for highly paid, white-collar professionals. These products evolved rapidly.
Yet the first wave is already looking dated and somewhat antiquated relative to the most recent products, which were introduced in 2010 by a couple firms (including The Westport Group). These products have improved definitions of disability, policy terms and ease of administration.
Now, for a disability income protection product to pass muster for highly compensated employees, it must address several key issues.
At the very top of the list in importance is the definition of disability, which should give participants maximum protection by specifically covering them in their current occupation in the event of partial or total disability and not requiring that they change occupations to accommodate a disability. In addition, the legal community frequently requires specialty own-occupation definitions, such as for individuals who are litigators.
It should also have the ability to duplicate exactly what the existing group plan offers to ensure seamless integration and ease of administration at claims time. This is extremely important because it's possible to have three separate insurance companies paying claims: i.e., group long-term disability, traditional supplemental disability and the specialty product.
At the same time, a plan should include substantial amounts of guaranteed issue, which wouldn't require the typical medical exams and underwriting that is necessary to get individual disability coverage (no medical underwriting) for both firm-paid and voluntary alternatives, combined with a rate guarantee of at least five years.
Using the initial example, we can see how the amount of disability income protection can be improved. The same individual earning $1 million per year can now be protected up to 60 percent of earnings, which would equal $50,000 per month, versus the existing amount of $25,000 per month.
A substantial increase in the amount of disability coverage available for highly compensated individuals has been long over due. New products offer an exciting and refreshing solution to solving this old problem. As one might expect, the renewed energy driving these innovations will undoubtedly produce even more intriguing and beneficial solutions.
November 1, 2010
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