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Journal of Financial Planning - August 2001 "I define quality as how well a company treats people who bought policies many years ago, not what wonderful things are being promised today." Time to Change Disability Income Policies?by Peter Katt, CFP, LIC Unlike life insurance, whose benefit is paid one time for a definite occurrence, disability income (DI) payments can continue for many years based on an occurrence that may be periodically reinterpreted. This ongoing nature of DI payments makes policy decisions very important. My comments about individual DI update similar comments made in my June 1997 column. Selecting the right company from which to buy DI is very important as financial woes plague companies that were the biggest sellers of DI during the 1980s and early 1990s. I recommend DI be purchased from quality insurance companies whose core business is life insurance, not DI. In assessing companies, I am not particularly interested in comparing premium cost and promised benefits as I am quality. I define quality as how well a company treats people who bought policies many years ago, not what wonderful things are being promised today. For me, the easiest measure of this is to look at how they have treated life insurance policies as a surrogate for reaching a judgment about their DI ethics. Based on these criteria, companies on my preferred DI list are the old-line mutual companies whose dividends have remained strong. I do not favor purchasing DI from companies whose core business during the 1980s and early 1990s was individual DI, because press reports indicate that they have been experiencing profitability problems apparently due to a mismatch between premiums and claims. Because premiums are guaranteed, the way to attack too-low profits is by denying claims. Indeed, the press has reported incidences of very tough claims assessments, with too many disabled insureds getting denials instead of checks. The most cautious clients who can qualify for new coverage should consider replacing existing DI policies from companies whose profits are being pinched. The difficult decision is whether to replace existing DI policies from these because such action certainly will substantially increase premiums and probably limit what were initially sold as attractive features. Selection of the right features and benefits is important for new purchases but also as a review of existing coverage. Two important DI features are an own-occupation definition of disability and residual coverage. Own-occupation means an insured can earn as much as possible from a new occupation and still receive disability benefits. This has always seemed more like winning the lottery than insurance to me, but many clients seem to love this feature. Keep in mind that the own-occupation DI feature is probably the leading cause companies use to reject the payment of claims. I do not recommend own-occupation coverage. Residual coverage means that the DI policy will pay a proportionate benefit if the insured returns to work but is earning less because of the disability. I recommend this coverage. The waiting period is another factor. Clients who have accumulated few assets may want a shorter waiting period, say 30 or 60 days. However, as assets are amassed, extending the waiting period is probably a good idea because it can substantially reduce the premium. Typically, a 90-day wait produces the optimum premium savings. The benefit period can range from two years to lifetime. When few assets have been compiled, taking the longest benefit period (lifetime if available) is a good idea, though when assets have been banked, reducing the benefit period might be examined, especially if this will produce a significant premium savings. While cost-of-living (COL) benefits are very expensive, they are beneficial, notably when few assets have yet to be acquired. However, again, when sufficient assets have been accumulated to offset the need for COL, it might be dropped to reduce premiums. Individual DI premiums can be tax-deductible when paid as a business expense. Insurance agents frequently promote this DI tax-deduction, but there are two very significant drawbacks. The first problem is certain, the second problem only occurs when a lawsuit is necessary to force a company to pay benefits. Whenever DI premiums are taken as a tax deduction, the benefits are taxable. Conversely, if DI premiums are not taken as a tax deduction, the benefits are tax free. As a simple matter of personal financial logic, clients are financially much better able to withstand paying non-deductible premiums than having their DI benefits taxed after a disability. In other words, clients are financially strong while working and paying premiums, but they are financially vulnerable if disabled, making the right to receive tax-free DI checks very significant. The second problem deals with having the DI transaction subject to ERISA (Employee Retirement Income Security Act) jurisdiction because the premium has been expensed as an employee benefit, even if it is a one-person professional corporation. If ERISA jurisdiction is accepted by a court (as recently happened in a Cincinnati case), no punitive damages are generally allowed, which will cause most plaintiffs to have to pay for legal representation. Without punitive damages, lawyers aren¯t likely to take a case on a contingency basis. In practical terms, this will likely preclude legal action to force the payment of claims. This knowledge may embolden insurance companies interested in contesting claims. I do not recommend taking tax deductions for DI premiums. Selecting a quality company from which to purchase DI is far more important than analyzing prices and promised features. Selecting various DI features should take into consideration other financial factors and should be periodically reviewed, making changes when warranted. Finally, while promoting tax-deductible DI premiums may be a good sales feature, it isn¯t a prudent thing for clients to do. åI Wouldn¯t Let a Client Get Away with That¯ This is the impassioned comment I recently got from an insurance agent while discussing a client situation. The comment stemmed from the question of whether we should assist a client with a financial planning action that we may disagree with, but is the client¯s clear and informed choice. My client, Mr. Nelson (age 50) owns a very successful manufacturing business. He has a substantial amount of life insurance for estate liquidity. Upon review, it was clear that his universal life (UL) policies were performing poorly, so we decided to replace them with participating whole life, whose projected pricing would produce significantly better results. While doing a final review of the steps we were about to take, Mr. Nelson, whose father, grandfather and uncles had all passed away in their fifties, suddenly decided that the most important consideration was his adamant belief that he would not live past 70. As I reflected on this just before giving the go-ahead to the insurance agent involved with the replacement policy, I realized that retaining the much poorer-priced UL policies was the best match because UL can be intentionally underfunded, whereas whole life can¯t. This meant that no further premiums would need to be paid to the UL policies that were projected to continue into Mr. Nelson¯s mid-seventies. I explained the risk that UL underfunding would cause huge premiums if Mr. Nelson remained alive and healthy as he approached his seventies. Being very astute and confident, Mr. Nelson quickly made the decision to continue the UL policies and I supported it with the knowledge that I would continue to review and monitor this situation in the years ahead. This is the decision that I "let" my client make but which the insurance agent (not the one involved in the sale) claimed he would never let a client get away with. Even when I disagree with a client¯s decision, I will help them implement it and monitor the situation because I believe they are better off with my help than for me to stomp off in a fit. When a financial planner opposes a client¯s planning decision, I suppose it can be for one of three reasons: sincere professional disagreement, ignorance based on years of only hearing ourselves, and commission protection. Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, August 2001.
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