ON CALL Disability/ Benefits

Long-Term Disability Protection for Executives

Stephen Karp Senior Managing Consultant Mullin Consulting, Inc. Heidi OBrien Vice President and Client Relationship Manager Mullin Consulting, Inc.

Sponsoring a supplemental plan is an increasingly popular way for employers to provide a crucial executive benefit.

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any employees are unaware that as they rise in their companies to higher income levels, an increasingly smaller percentage of total pay is covered by group disability plans. This unawareness can lead to an unexpected financial crisis when a disability occurs. Most employers provide group longterm disability (LTD) benefits that provide adequate protection to rank-and-file employees. However, by their nature, group benefits provide inadequate protection to executives. It is often only after an executive suffers a disability that the company becomes aware of how devastating this coverage gap can be. Fortunately, employers need only take a few simple steps to enable their executives the opportunity to be properly protected. Supplemental disability programs address this problem and are becoming increasingly more popular. Such plans can provide valuable coverage to executives at little or no cost to the company.

Group Disability Plans

For most employees, group long-term disability coverage protects between 60% and 70% of compensation against a prolonged loss of income resulting from an extended disability. Often, this typical group LTD arrangement severely discriminates against management and senior executives. This discrimination occurs for several reasons. The most common reason is that certain forms of important management compensation (e.g., bonus income and stock-based compensation) are not considered covered compensation and are thus unprotected. In many cases, these forms of compensation total more than salary itself. Consider an employee with a $100,000 salary and a $50,000 bonus whose group LTD plan provides 60% of salary. The employee has $50,000 of income that is completely unprotectedhis or her bonus. Thus, the employees ultimate income replacement ratio is now only 40%. One of the most alarming facts for HR personnel is that people simply are not aware of this risk. The second reason that many highly compensated employees are underprotected is that their salaries exceed the group LTD benefit maximum.

Keywords: disability; benefits; executive disability; executive benefits; voluntary disability; long-term disability; supplemental disability
DOI: 10.1177/0886368704273216

COMPENSATION & BENEFITS REVIEW

2005 Sage Publications

ON CALL Disability/ Benefits

EXHIBIT 1 Group Long-Term Disability Protection Gap

100% 80% 60% 40% 20% 0%

Most Employees Group LTD Coverage Sr. Manager VP/CEO Uninsured Income

33% 64% 75%

67% 36%

25%

of the existence or significance of their LTD plans coverage deficit. This is a good reason in itself to offer optional supplemental coverage. That is, in offering a supplemental plan, one must remind the executive about the current limitations of the existing LTD plan, something that may prevent unwelcome surprises at the time of a claim. The evidence that LTD is a valued benefit is in the participation rates experienced when voluntary supplemental LTD plans are offered. Depending on the group to whom the benefit is offered, between 30% and 45% of those eligible decide that the additional coverage is important enough to pay for it with their own money. That acceptance rate is staggering for a benefit for which virtually no one is clamoringor even inquiring.

Risk of Disability
Contrary to conventional thinking, the risk of disability has increased in recent years due to advances in medicine and technology. But the most important fact to consider may not be the incidence of disability but the financial tragedy that can result from a long-term inability to work. Consider the following: Due to advances in medical care, conditions that used to be fatal now cause extended disabilities. According to the National Safety Council, one disabling injury struck every 2 seconds in 2002; more than 20 million disabling injuries occurred in 2002 alone. Many managers and executives face compensation cuts of between 50% and 70% upon disabilityand most do not even know it. Although these facts are alarming, until recently there has been a dearth of information available to executives about possible strategies to resolve this problem.

Most group LTD plan benefits are capped at $10,000 per month or less. At a maximum monthly benefit of $10,000, any compensation over $200,000 ($10,000 x 12 / 60%) is not covered. As a result of this protection deficit, the real cost to a senior manager or executive is substantial when it comes to missing work due to illness or injury. Exhibit 1 illustrates this shortfall. What pressure is being put on HR departments to address this important problem? Apparently not much by the affected executives themselvesmost HR professionals report that they receive very few, if any, requests to shore up the LTD coverage deficits.

Knowledge of LTD Coverage

One answer for this lack of pressure may be found in survey data. The Consumer Federation of America and the American Council of Life Insurers released a survey in 2001 that indicated that 43% of those who have LTD coverage said they did not know the terms of their basic longterm disability insurance benefit. The survey also found that workers do not understand their disability income benefits nearly as well as they understand their work-related health insurance, life insurance, and retirement and pension benefits. As a result of this lack of understanding and knowledge about LTD plans, many managers, salespeople, and executives simply are not aware

What Can Be Done?

There are four primary ways to solve the reverse discrimination and underinsurance problem that exists at many companies today. Companies can 1. include bonus income and stock compensation as covered earnings in the existing group contract,

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ON CALL Disability/ Benefits

2. purchase individual insurance policies for a selected group of senior people, 3. add optional group LTD supplemental coverage that each person can pay for on his or her own, or 4. add a supplemental disability program that allows people affected by the group LTD design deficits to purchase an individual, portable disability contract. The first two options increase the cost to the company, sometimes significantly. As a result, the third solution (group-based supplemental coverage) was historically implemented due to its perceived simplicity and its usually lower cost. There are however several issues related to offering a group-based supplement that have increased the use of individual contracts (Option 4). They include the following: The addition of supplemental group coverage can have an immediate or delayed negative effect on the pricing of the underlying basic group LTD coverage. Group-based supplemental coverage is not guaranteed: Premiums may be increased, and the insurance company may change and/or cancel the coverage. The group supplement is rarely portable for the executive and if so is usually convertible to a less than desirable product. Group plans typically cover any occupation, meaning disability benefits are not paid if the employee is able to work in any job.

Finally, the contractual provisions of a group plan are not as comprehensive as those of typical individual contracts, often including offsets from other income sources (e.g., Social Security, company retirement).

Supplemental Disability
According to a recent Mercer compensation survey, 37% of the Fortune 1,000 has installed supplemental disability plans for senior managers and executives and/or sales force. Such plans give executives access to both superior and less expensive coverage than they could purchase on their own, and the coverage is portable. Exhibit 2 illustrates the differences between typical group LTD coverage and supplemental individual disability coverage. Employers that offer a supplemental disability program enable executives to increase protection for their families by insuring both salary and bonus and by increasing monthly benefits. In addition, supplemental disability coverage allows executives to purchase a more comprehensive product at discounted rates and to avoid medical exams and other underwriting requirements. Supplemental disability programs are among the fast-growing managerial and executive benefit programs being reviewed and offered today. A supplemental long-term disability program allows a company to provide a crucial benefit both inexpensively and with little ongoing administrative effort by already-taxed HR departments. This is an excellent way to improve the current benefits of top people at little or no cost to the company.

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ON CALL Disability/ Benefits

EXHIBIT 2 Differences Between Typical Group Long-Term Disability (LTD) Coverage and Supplemental Individual Disability Coverage

Plan Provision Benefit coverage Cost Coverage specifics Definition of compensation Definition of occupation Elimination period Partial disability

Typical Group LTD Coverage may be cancelled by the insurance company Rates are based on current age and increase annually

Typical Supplemental Individual Disability The insurance company cannot cancel the coverage Rates based on entry age and remain fixed over the life of the policy

Base salary only Own occupation for 2 years Any occupation 2 years to age 65 180 days None (typically requires total disability)

Base salary, bonus, commissions, fees, and deferred compensation Own occupation to age 65 (or 70) (includes jobs with similar dutieswith regard to position and earnings) Usually same as group LTD plan Benefits are payable if partially disabled and working in your occupation or unable to perform your occupation but working in another occupation Provides additional incentive to return to work Benefits will continue (to age 65) upon a return to full-time work so long as there is an income loss of at least 20% 2 years (to age 65 if confined to a hospital) Portable; employee can keep the coverage after leaving the company

Work incentive benefit Recovery benefits

None None

Mental and nervous disorders Portability

2 years Not portable; coverage ends when the employee leaves the company

Stephen Karp is a senior managing consultant at Mullin Consulting, Inc., a national firm that specializes in design, implementation, and administration of executive benefit programs. He specializes in market development and client consulting for public and private corporations. He has more than 20 years of experience in human resources and finance and holds an MBA from New York University. He can be reached at stephen.karp@mullinconsulting.com. Heidi OBrien is a vice president and client relationship manager at Mullin Consulting. She assists numerous clients, including Fortune 1,000 companies, with all aspects of their nonqualified benefit programs. She can be reached at heidi.obrien@mullinconsulting.com.

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