10.3 Business Disability (Key Person, Buy-Sell, BOE)

Disability income concepts extend beyond individuals to businesses. The exam tests three business DI products: Key Person (Key Employee) disability, Disability Buy-Sell, and Business Overhead Expense (BOE). Each answers a different business risk, and the most common errors come from confusing what each one pays for and who owns, pays, and benefits.

Key Person (Key Employee) Disability

A business depends on certain employees whose disability would cause lost revenue, hiring costs, and disrupted operations. Key person disability indemnifies the business for that loss.

Premiums are not tax-deductible to the business, and the benefits are received income-tax-free (mirrors the personal-DI tax rule because the business cannot deduct the premium). The amount is based on the employee's economic value to the firm, not a fixed income-replacement ratio.

A frequent point of confusion is that key person disability does not pay the disabled key employee anything — the employee may also carry a separate personal DI policy for income replacement. The business proceeds simply cushion the firm against revenue interruption and the substantial cost of recruiting and training a successor for a hard-to-replace role such as a top salesperson, lead engineer, or founder.

Disability Buy-Sell

A buy-sell agreement funded with disability insurance ensures that if an owner becomes totally and permanently disabled, the remaining owners (or the business) can buy out the disabled owner's interest at a pre-agreed price.

Key design features the exam tests:

• Long elimination period — commonly 12 to 24 months — because the buyout should occur only once the disability is clearly permanent, not for a temporary absence.
• The benefit is usually paid as a lump sum or installments to fund the purchase of the business interest, not as monthly income replacement.
• Two structures: cross-purchase (co-owners buy and own policies on each other) and entity (stock-redemption) (the business owns the policies and buys the interest).

Trap: Buy-sell does NOT replace the disabled owner's income — it transfers ownership. Income replacement for that owner would come from a separate personal DI policy.

The valuation method in the buy-sell agreement matters as much as the funding. Agreements commonly fix the purchase price by a formula (book value, a multiple of earnings, or a periodically updated stated value) so the disabled owner and the survivors do not dispute price at the moment of buyout. The disability insurance simply supplies the cash to honor that agreed price, converting an illiquid ownership interest into liquid dollars for the departing owner and a clean ownership structure for those who remain.

Business Overhead Expense (BOE)

Business Overhead Expense insurance reimburses a disabled owner (typically of a small professional practice — a doctor, dentist, attorney) for the fixed business operating expenses that continue while the owner cannot work. It keeps the doors open until the owner recovers or sells.

What BOE Covers vs. Does Not Cover

Distinctive BOE features for the exam:

• Premiums ARE tax-deductible as a business expense, but the benefits are taxable to the business (offset by the deductible expenses they reimburse, so often a wash).
• BOE is reimbursement-based up to the actual covered expenses, not a fixed monthly check — if actual expenses are below the monthly limit, only actual expenses are paid.
• BOE has a short elimination period (often 30 days) and a short benefit period (commonly 1-2 years) because overhead is an interim need, the opposite design of buy-sell.

Think of the three products as answering three different questions. Key person asks, "What does the business lose if a vital employee can't work?" Buy-sell asks, "How do we buy out a permanently disabled owner so the survivors keep control?" BOE asks, "How do we pay the rent and keep the lights on while the owner recovers?"

The elimination periods reflect those purposes: BOE pays quickly (30 days) because bills come due monthly, while buy-sell waits a year or more because an ownership transfer is irreversible and should follow only confirmed permanent disability.

Funding Business Risks: Key Person, Buy-Sell, BOE

Three business uses of DI recur on the exam, each solving a different problem:

BOE is the distinguishing case: it reimburses actual overhead expenses (not the owner's salary), runs a short benefit period (often 1-2 years), and because the premium is a deductible business expense, the benefit is taxable — the mirror image of personal DI. A disability buy-sell typically carries a long elimination period (often 12-24 months) because a buyout should not be triggered by a short illness, and it pays either a lump sum or installments to fund the purchase under the buy-sell agreement.

Worked logic: if the question asks what keeps the doors open while the owner recovers, the answer is BOE; if it asks what buys out a permanently disabled partner, the answer is disability buy-sell.