Agents looking for new business in the small-business owners marketplace should check out opportunities in disability buyout insurance, according to Michael Smith.
To get the conversation started, “just ask to see the client’s buy-sell agreement,” said the president of CPS Horizon Financial Group, an independent brokerage in Hales Corners, Wis.
The buy-sell agreement includes provisions for owners to buy out the interest of a co-owner in specific cases, such as in event of death or total disability. In the small business market, these agreements often include provisions to fund a buyout with life insurance (in event of death). But it is less common to find provisions that fund a buyout with disability buyout insurance (in event of total disability), Smith said.
Many agents don’t even look into the disability exposure, not even some life-licensed producers who have small business clients, he said. “Either they don’t know about disability buyout insurance or, if they do, they lack the confidence to bring the subject up.”
Why it’s important
What they may not realize is how important this insurance can be to the ongoing functioning of a business, he said. He pointed to his own family’s experience as an example.
“My dad was in business with my uncle until my dad had a stroke at age 58 and could no longer work. The two of them did have a buy-sell agreement, but it was funded only with life insurance. Because there was no disability buy-out insurance, my uncle wound up buying out my dad’s interest from current cash flow. The life insurance did pay — but that didn’t happen until nine years later when my dad died.”
To this day, that rankles Smith. “Yes,” he said, “my dad’s interest was bought out, and my uncle eventually did get the life insurance proceeds, and the business kept going. But my uncle missed opportunities all along the way because he was shelling out money to pay his partner, my dad, for his interest in the business.”
The kicker, from an insurance standpoint, is that the two partners were offered disability buyout insurance but decided not to buy it, he said.
Not thinking about it
Business owners may not be thinking about the possibility of disability when they are setting up a business succession plan, according to many advisors in the small business market. Many owners don’t even set up a succession plan or not until the later years.
The owners could be entrepreneurs, brimming with energy and excitement about their business. They may recognize that untimely early death may occur but believe that their chance of suffering a total disability are far too remote to consider, so they just let the disability buy-out plan slide (if they even know about it).
This tendency to ignore the disability exposure is not uncommon. Sixty-four percent of wage earners believe they have a 2 percent or less chance of being disabled for three months or more during their working career, according to a 2010 study from the Council for Disability Awareness (CDA).
Putting blinders on could be risky, though. In December 2012, 8.8 million disabled wage earners -- over 5 percent of U.S. workers—were receiving Social Security Disability (SSDI) benefits, according to Social Security data reported by CDA. (SSDI is for long-term disabilities and its benefits are subject to stringent qualifications; this means SSDI figures represent the tip of the disability iceberg.)
“Some owners are just not ready to sell the business,” Smith observed. “They need to be ready, from day one, but they aren’t. They also need to have a buy-sell agreement and review it every few years, but they don’t.”
Some small businesses do have buy-sell agreements, he added, “but about 90 percent of the ones we’ve seen have problems. They are not current or not funded, or they lack critical provisions — including a disability buyout agreement.”
Many owners have told him that a disability buyout agreement was “never even discussed.”
But when the topic does come up, along with the idea of using disability insurance to fund the buyout, some small-business owners push away. They say the insurance is too expensive, Smith said, “but I think an underlying factor is unwillingness to face one’s own morbidity.
Some producers say the owners don’t like that the disability buyout premiums are not deductible as a business expense. However, they brighten up upon learning that the active owner or the business will generally receive the benefits income-tax-free.
Smith said he now regularly educates agents on how to have the disability buyout conversation with clients. “They need to develop the confidence to go to the businessowners and recommend that the owners do this,” he said.
“We are training agents to ask to see the buy-sell or operating agreement so they can see what it says and what’s needed.”
Sometimes he gets called in on cases an agent has uncovered. “The smart businessowners get it,” he said. “And the attorneys say, ‘yes, you gotta do that, get the disability buy-out insurance.’”
Even if the client resists, having the talk and offering the coverage is still good for agents from an errors-and-omissions standpoint, he said. “If the owner rejects it or if their advisors advise against it, the agent will now have documentation that it was offered.”
Has increasing the awareness and education among agents made a difference in terms of sales? “I’ve been working on this education program for 2.5 years now, and our firm’s life and disability buyout business has definitely grown in that time,” Smith said.
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