10.3 Business Disability (Key Person, Buy-Sell, Business Overhead Expense)

Business Uses of Disability Insurance

Businesses face the same earning-power risk for owners and key employees that individuals face. Three specialized DI products address distinct business exposures: Key Person DI, Disability Buy-Sell, and Business Overhead Expense (BOE).

Key Person (Key Employee) Disability

A key person DI policy protects the business against lost revenue and recruiting/training costs when a key employee or owner becomes disabled.

Benefits help fund a temporary replacement, lost profits, or cover obligations during the key person's absence. Coverage typically uses a longer elimination period (e.g., 30-90 days) and a shorter benefit period (often 12-24 months) than personal DI, because the business need is to bridge a transition, not replace lifetime income.

Disability Buy-Sell

A disability buy-sell policy funds the purchase of a disabled owner's interest under a buy-sell agreement, ensuring the remaining owners obtain the disabled owner's share and the disabled owner (or family) receives fair value.

• Funds are paid as a lump sum or installments after a long elimination period, commonly 12 to 24 months, to confirm the disability is permanent before triggering a buyout.
• Premiums are not deductible; benefits are received income-tax-free.
• Structures parallel life-insurance buy-sell: cross-purchase (owners insure each other) or entity (the business owns the policies).

Worked Example, Buy-Sell Funding

Three equal partners value the firm at $3,000,000 ($1,000,000 each). A disability buy-sell with a 24-month elimination triggers a $1,000,000 buyout of a permanently disabled partner. The insurance provides the cash so the surviving partners need not liquidate assets or borrow.

Business Overhead Expense (BOE)

BOE insurance reimburses a disabled business owner for the fixed operating expenses of running the business so the doors stay open during recovery.

• BOE is a reimbursement contract, it pays actual covered expenses up to the monthly maximum, not a flat benefit.
• Elimination periods are short (often 30 days) and benefit periods are short (typically 12-24 months), matching the goal of keeping the practice viable during recovery.
• Premiums ARE tax-deductible as a business expense; therefore the benefits ARE taxable to the business. (Because benefits reimburse deductible expenses, the net tax effect washes out.)

Trap: BOE does NOT cover the owner's salary or lost income, that is what a personal DI policy is for. The owner often carries both a personal DI policy and BOE simultaneously.

Carve-Out and Salary Continuation

Larger firms sometimes use an executive DI carve-out, layering an individual policy on top of group LTD for selected executives to raise their effective replacement percentage and apply a more favorable own-occ definition.

A salary continuation plan is an employer's formal, written promise to continue paying a disabled employee's salary for a stated period. When funded by employer-paid DI insurance, premiums are deductible to the employer and benefits are taxable to the employee, identical to ordinary employer-paid group LTD.

Choosing the Right Business Product

Integrated Example

A solo dental practice owner earns $20,000/mo and has $12,000/mo of fixed overhead (rent, staff, lab fees). If disabled, she needs two policies: a personal DI policy (replacing roughly 60% of her $20,000 income, tax-free if she pays after-tax) to support her household, and a BOE policy reimbursing up to $12,000/mo of overhead so the practice survives until she returns or sells it. Relying on either policy alone leaves a major gap, the exam often tests this either/or fallacy.

Memory aid: Key person and buy-sell follow the life-insurance tax pattern (premiums not deductible, benefits tax-free). Only BOE flips it (deductible premiums, taxable benefits) because it reimburses already-deductible business expenses.

Sizing and Structuring Business Coverage

Key person DI benefit amounts are justified by the employee's contribution to revenue and the cost to recruit and train a replacement; underwriters request financial statements rather than relying on a flat multiple. Disability buy-sell amounts equal the agreed business value of the disabled owner's share, established in the buy-sell agreement and updated periodically so the funding tracks the firm's worth.

BOE benefit limits are set to actual documented monthly fixed expenses; because it is a reimbursement contract, an owner cannot profit from over-insuring, the insurer pays the lesser of the policy maximum and actual covered expenses incurred. Many BOE contracts also allow carry-forward of unused monthly benefit: if covered expenses in some months are below the maximum, the unused amount can be applied to later months with higher expenses, within the overall benefit period.

Buy-Sell Structure Comparison

A long elimination period (12-24 months) on buy-sell coverage is intentional: it prevents triggering an irreversible ownership buyout for a disability the owner ultimately recovers from. Only after disability is confirmed permanent does the funded buyout proceed, protecting all parties from a premature, costly transfer of the business interest.