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

Key person disability insurance

When a critical employee, owner, or partner becomes disabled, a business can lose sales, miss deadlines, and incur costs to recruit and train a replacement. Key person (key employee) disability insurance protects the business against that financial loss.

Structure:

• Owner / premium payer: the business.
• Insured: the key employee.
• Beneficiary / payee: the business.
• Use of proceeds: offset lost profits, fund a recruiting search, and cover the cost of a temporary or permanent replacement.

Because the business owns the policy and pays the premium for its own benefit, premiums are not tax-deductible and the benefits are received income-tax-free. The employee's consent is required, but the employee has no rights to the benefit. Key person policies often carry a longer elimination period because the business can usually absorb a short absence.

Disability buy-sell insurance

A buy-sell agreement is a contract among co-owners specifying that, on a triggering event, the remaining owners (or the entity) will purchase a departing owner's interest. Death is the familiar trigger, but total disability is just as disruptive: a permanently disabled partner still owns the business, may still draw income, and cannot contribute.

Disability buy-sell insurance funds the purchase of a disabled owner's share. Distinguishing features:

• Long elimination period (commonly 12 to 24 months) so the parties are certain the disability is permanent before the buyout triggers.
• Benefit is usually a lump sum (or installments) equal to the agreed purchase price, not a monthly income stream.
• Funding arrangements mirror life buy-sell: cross-purchase (owners buy policies on each other) or entity / stock-redemption (the business owns the policies).

Exam trap: Disability buy-sell is not income replacement for the owner. Its job is to provide cash to buy out the disabled owner's equity so the business can continue with clear ownership.

Business Overhead Expense (BOE)

While a disabled owner of a small professional practice (dentist, attorney, accountant) cannot generate revenue, the practice's fixed expenses keep coming due: office rent, utilities, leased equipment, employee salaries, and insurance. Business Overhead Expense (BOE) insurance reimburses those continuing costs so the practice stays open until the owner recovers or sells.

Characteristics:

• Reimburses actual covered expenses, up to a stated monthly maximum (an indemnity, not a fixed benefit). If actual overhead is below the limit, only the actual amount is paid; unused amounts may carry forward in some contracts.
• Covered: rent/mortgage interest, utilities, employee wages, leasing costs, depreciation, professional dues, business insurance premiums.
• Not covered: the owner's own salary or draw (that is personal DI), inventory, and the cost of goods.
• Short benefit period: typically 12 to 24 months with a short elimination period (e.g., 30-90 days) - long enough to bridge to recovery or an orderly sale.

Comparison table

BOE worked example

A dentist's BOE policy has a $12,000 monthly maximum. While disabled, actual covered overhead is $9,500 in month one and $13,000 in month two. The policy reimburses $9,500 in month one (actual, below cap) and $12,000 in month two (capped at the maximum).

Taxation and ownership of business DI

Business disability coverage is taxed by the same who-paid-the-premium logic as personal DI, but the answers differ by purpose, and the exam tests each separately.

The BOE result looks like an exception but is internally consistent: the firm deducts the premium and deducts the overhead the benefit reimburses, so the taxable benefit and the deductible expense wash out. Key person and buy-sell premiums are not deductible because the business buys them for its own protection, mirroring the rule for key person life insurance.

Funding methods for disability buy-sell

• Cross-purchase: Each owner buys and owns a disability buy-sell policy on every other owner. Works well with two or three owners; the number of policies grows quickly as owners are added.
• Entity / stock-redemption: The business owns one policy per owner and redeems the disabled owner's interest. Simpler administration for larger ownership groups.

Putting business DI together

A well-protected closely held business often layers all three: BOE keeps the doors open during the elimination period, key person coverage offsets revenue loss and replacement cost, and disability buy-sell funds the eventual buyout if the disability proves permanent. Each addresses a different exposure, so they are complementary rather than redundant.

Exam trap: BOE is the only common business DI coverage whose premiums are tax-deductible - and consequently the only one whose benefits are taxable. Key person and buy-sell follow the personal rule (no deduction, tax-free benefit).