Thinking outside the benefit period box

The last time you sold a disability income (DI) policy or reviewed a client’s existing DI coverage, did you discuss protection for your client’s ability to save for retirement? It’s a topic that’s often overlooked, but one that can have a material impact on someone’s long-term financial wellbeing. For many policyholders, the first time the subject will be considered is after they are already disabled. Unfortunately, there may be no remedy to the problem at that point, other than to put aside some of the DI benefits being received. This may be a difficult choice for some claimants and financially impossible for others.

Typically, DI benefits protect an insured individual’s ability to earn an income during his or her normal working years and offer maximum benefit periods to ages 65, 67 or 70. A disability that begins early in a person’s career may result in lost Social Security and retirement plan contributions. In addition, many other financial opportunities may be lost during a period of disability, including college savings and personal or business investments. The longer the period of disability, the greater the financial impact will be.

Fortunately, there are a number of disability product solutions available in today’s marketplace that can help address this problem, including graded lifetime and extended disability benefits, disability retirement contribution protection and lump-sum disability benefit features.

Graded lifetime benefit products extend benefits for a total disability beyond the maximum benefit period or expiration — expiry — date of the policy. The amount payable after the expiry date is based on a graded schedule of benefits. Basically, one’s age when he or she experiences a total disability is correlated to a percentage of the regular policy benefit payable before the policy expiry date. In cases where the onset of total disability occurs when the client is quite young (e.g., 45 or younger), the graded lifetime benefit amount may not change at all. However, an insured individual who becomes disabled at 55 may receive just 50% of the original policy benefit, beginning at age 65.

This approach assumes that as the insured individual ages and his or her earnings increase, more money can be put aside to provide income after the policy expires. Thus, for someone who becomes disabled after 45, only a portion of the original policy benefit is payable after the policy’s expiry date. Once broadly available, DI products with graded lifetime benefit features have lost favor with insurers in recent years. As of the writing of this article, only two individual DI carriers continue to offer such a product.

Another product concept designed to pay benefits after the maximum benefit period is an extended total disability benefit rider. With this offering, the insured individual chooses one of three benefit factors, which is applied to the monthly benefit amount when the policy is issued to establish the maximum aggregate benefit payable after the maximum benefit period has ended. It is important to note that this benefit is payable only if the insured individual was totally disabled prior to age 55 and remains totally and continuously disabled through the end of the policy’s maximum benefit period. In addition, the extended total disability benefit is payable only if the insured remains totally disabled and is subject to the maximum aggregate benefit amount.

If coverage would normally go to age 65, for instance, the monthly amount payable after 65 would be equal to the monthly total disability benefit that was being paid at 65, subject to the maximum aggregate benefit amount. In effect, a pool of money is created to be paid out in installments during a continuous total disability. For a period of time, this pool of money could help replace the lost savings or contributions that would have supported the insured individual’s retirement needs.

Retirement contribution protection has gained popularity over the last decade as a way to accumulate benefits that can be used as a source of income when disability benefits are no longer payable. Sold as either a stand-alone policy or a rider, retirement contribution protection generally covers contributions to certain qualified retirement programs, including 401(k)s and other defined contribution plans. Benefits are payable only during periods of total disability, when the insured individual would not be permitted to make contributions to such a plan.

At the time of claim, policy benefits are paid to a trust rather than directly to the insured individual. As benefits are accumulated in the trust, they may be invested on behalf of the claimant to create an alternative retirement savings vehicle. At age 65, the accumulated trust assets are distributed to the insured individual. It is important to note that this type of trust is not a “qualified plan,” so benefits paid to the trust are not treated like qualified retirement plan contributions. In addition, any interest, dividends or capital gains related to trust investments may create a current tax obligation to the insured individual.

A distinct advantage of the retirement contribution protection approach relates to how benefits are treated should the insured individual die prior to normal retirement age. As trust beneficiary, he or she can designate a contingent beneficiary. Then, if the insured individual dies before the trust assets are distributed, the accumulated trust assets may become payable to the contingent beneficiary, in line with the client’s wishes.

Finally, a relatively new concept in the marketplace is the lump-sum benefit. Like the other product concepts described in this article, the lump-sum benefit can provide benefits after 65. Over the lifetime of the policy, any total or residual disability benefits paid will “contribute” toward the lump-sum benefit amount. To receive a lump-sum benefit payment, the sum of “contributions” paid over the life of the policy must be equal to or greater than 12 times the policy’s monthly benefit. The lump sum will equal 35% of cumulative benefits paid for total and/or residual disability prior to age 65, or policy expiry if longer.

This structure recognizes that many financial opportunities are lost during a period of disability, whether it’s a total or residual disability — something that sets the lump-sum benefit apart from other programs. While the policy must be in force on the date the benefit becomes payable, the insured individual need no longer be disabled to receive these benefits. For some people, a feature that generates potential benefits in more claim scenarios and pays out those benefits as a one-time, lump-sum benefit may hold greater appeal than other types of lifetime-structured benefits. It all depends on the individual, which leads to my final point.

Clearly, there are different ways to address the need for disability benefits that extend beyond the maximum available benefit period. As trusted professionals, your role is to help your clients understand and consider this need as part of their overall long-term planning process and then work with them to determine the approach that best accommodates their situation. There may also be some tax considerations your client should consider, so you may want to recommend that he or she consult with a tax advisor to determine what makes sense for his or her individual situation.

By Mark R. Ameigh, CLU.  From the September 1, 2012 issue of Life Insurance Selling. Mark R. Ameigh, CLU, is senior competition analyst with Berkshire Life Insurance Company of America, the Guardian company that issues its individual disability insurance policy

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