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

Disability income concepts extend beyond individuals to protect businesses. Three contracts dominate the national exam: key person disability, disability buy-sell, and business overhead expense (BOE). Each solves a different business risk, and the exam tests who owns the policy, who is insured, who receives benefits, and how proceeds are taxed.

Key Person Disability

A key person is an employee whose disability would cause measurable financial loss—a top salesperson, a lead engineer, or a founder. The business owns the policy, pays the premium, and is the beneficiary; the key employee is the insured.

• Benefits indemnify the company for lost revenue and the cost of finding/training a replacement.
• Because the business pays premiums and receives benefits, premiums are not deductible and benefits are received income-tax-free.

Disability Buy-Sell

A disability buy-sell funds the purchase of a disabled owner's interest in a closely held business, mirroring a life-insurance buy-sell. Without it, a disabled partner keeps drawing income while contributing nothing, straining the firm.

Structures

• Cross-purchase: each owner buys a policy on every other owner.
• Entity (stock-redemption): the business owns one policy on each owner.

Buy-sell DI uses a long elimination period—often 1 to 2 years—because owners want certainty the disability is permanent before triggering a buyout. Proceeds may be paid as a lump sum, installments, or a combination, then used to buy the disabled owner's shares at the agreed price.

Business Overhead Expense (BOE)

BOE reimburses the fixed business expenses of a disabled owner of a small professional practice—rent, utilities, employee salaries, lease payments, property taxes, and insurance—so the practice can survive until the owner returns or sells.

Covered vs. Not Covered

BOE pays actual expenses incurred up to a monthly maximum, has a short elimination period (15–30 days), and a short benefit period (12–24 months). Crucially, BOE does not replace the owner's personal income—that is the role of individual DI.

Worked Example — BOE Reimbursement

A dentist owns a BOE policy with a $12,000 monthly maximum. During a covered disability the practice incurs the following fixed expenses in one month:

Covered expenses total $12,600 but the monthly maximum is $12,000, so BOE pays $12,000. The owner's $9,000 draw is excluded entirely; it must be replaced by a separate individual DI policy.

Taxation Snapshot — Business DI

Trap: BOE premiums ARE deductible and benefits ARE taxable—the reverse of key person and buy-sell. The deduction is allowed because the benefits are taxable and the reimbursed expenses are themselves deductible, so the net effect is neutral.

Matching the Contract to the Need

Because the three business contracts solve different problems, a small-business owner often needs more than one. A solo dental practice, for example, typically layers:

• Individual DI — replaces the owner's personal income (the BOE gap).
• BOE — keeps the office open during a short-to-medium disability.
• Disability buy-sell — funds a partner buyout if disability becomes permanent.

The exam rewards candidates who can map a stated business problem to the single best contract rather than defaulting to ordinary income protection.

Funding and Valuation Notes

For a disability buy-sell, the agreement must fix a valuation method—a stated price, a formula, or a recent appraisal—so the buyout amount is not disputed when a claim occurs. The DI benefit is then sized to fund that agreed value, often paid as a lump sum after the long elimination period or in installments matched to a promissory note.

Key person benefit amounts are estimated from the economic loss the disability would cause: lost sales, the cost to recruit and train a replacement, and any creditor concerns about lost management. Underwriters cap key person coverage to a reasonable multiple of the key employee's contribution to avoid speculation.

Worked Example: BOE Reimbursement

A Business Overhead Expense policy reimburses covered fixed expenses (rent, utilities, staff salaries, lease payments) while the owner is disabled — not the owner's own salary. If covered monthly overhead is $9,000 and the policy limit is $10,000/month, BOE reimburses the actual $9,000, letting the practice stay open until the owner recovers or sells.

Trap: BOE is reimbursement up to actual expense, so it never overpays; key-person and disability buy-sell benefits are not taxable to the business because premiums are not deductible.