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

Disability Risk for Businesses

Disability income concepts extend beyond protecting an individual's paycheck. Businesses face their own disability exposures: a disabled key employee, a disabled owner whose share must be bought out, and ongoing office expenses that continue even when the owner cannot work. The national exam tests three distinct business disability products, and the most common errors involve confusing who owns the policy, who pays the premium, and who receives the benefit.

Key Person Disability Insurance

When a key employee — a top salesperson, a lead engineer, an owner whose skills drive revenue — becomes disabled, the business suffers lost productivity and may need to recruit and train a replacement. Key person DI pays a benefit to the business to offset that loss.

• The business is the applicant, owner, premium payer, and beneficiary; the key employee is merely the insured.
• Premiums are not tax-deductible to the business, and benefits are received income-tax-free.
• Benefits are typically a lump sum or monthly amount after an elimination period (often 60–90 days).

Disability Buy-Sell Insurance

A buy-sell agreement is a contract requiring that, on a triggering event, an owner's business interest be sold to the company or the remaining owners at a set price. Disability buy-sell insurance funds the buyout when an owner becomes totally disabled rather than dying.

Key features tested on the exam:

• Uses a long elimination period — typically 12 to 24 months — because partners want to be certain the disability is permanent before forcing a buyout.
• Benefits may be paid as a lump sum or in installments to fund the purchase price.
• Premiums are not deductible; the buyout proceeds are received tax-free, and the disabled owner's sale is generally treated as a capital transaction.
• Two structures: cross-purchase (co-owners own policies on each other) and entity (the business owns the policies).

Business Overhead Expense (BOE) Insurance

When a small-business owner — a dentist, attorney, or independent agent — becomes disabled, the business still owes fixed overhead: rent, utilities, employee salaries, leased equipment, insurance, and property taxes. BOE insurance reimburses these continuing expenses so the practice survives until the owner returns.

Worked Example — BOE Reimbursement

A dental practice has covered monthly overhead of: rent $5,000, staff salaries $8,000, utilities $1,000, equipment lease $2,000 = $16,000/month in covered expenses. The BOE policy has a monthly maximum of $18,000 and a 30-day elimination period.

• Because actual covered expenses ($16,000) are below the $18,000 cap, BOE reimburses the actual expenses of $16,000/month.
• BOE is reimbursement-based: it pays actual covered overhead up to the cap, not a fixed amount, and does not reimburse the owner's own salary or draw.
• Benefit periods are short (commonly 1 to 2 years) — long enough to recover or wind down the practice.

Tax point: BOE premiums are tax-deductible as a business expense, but the benefits are taxable to the business. However, the deductible overhead expenses offset the taxable benefit, so there is typically little net tax. This is the opposite of key person and buy-sell (nondeductible premiums, tax-free benefits).

Key-person and business overhead expense

Two business DI products complement the buy-sell. Key-person disability insures the business against the lost productivity of an essential employee; the business owns the policy, pays the premium, and is the beneficiary, using benefits to fund a temporary replacement or cover lost revenue while the key person recovers. Business Overhead Expense (BOE) insurance reimburses a disabled owner for the fixed operating costs of the business — rent, utilities, employee salaries, lease payments — but not the owner's own salary, which is covered by personal DI.

BOE typically uses a short elimination period (15–30 days) and a short benefit period (12–24 months), because overhead bills come due immediately and the goal is to keep the practice's doors open until the owner returns or sells. Distinguishing what BOE pays (overhead, not owner income) is the key exam point.

Disability buy-sell mechanics

A disability buy-sell policy funds the purchase of a disabled owner's interest in the business under a buy-sell agreement. Because a disability's permanence is uncertain at onset, these policies use a long elimination period — commonly 12 to 24 months — so the parties do not trigger a buyout for a condition the owner recovers from. Benefits may be paid as a lump sum or installments to the healthy owners (or the entity) to buy out the disabled owner at a pre-agreed price.

Premiums are not tax-deductible and the benefits are received income-tax-free, mirroring the tax treatment of life insurance used to fund a death buy-sell. The exam's recurring point: the long elimination period exists precisely to confirm the disability is total and permanent before the ownership transfer occurs.