Closing gaps in group disability coverage

A senior executive came to see me after a colleague went out on leave for a serious illness. He was in his mid-40s, had three children in private school, and wanted to know whether his group disability plan would hold up. On paper, it looked substantial, at 60% of earnings up to $15,000 a month. But the plan counted only his $300,000 base salary, not the bonuses and incentive pay that took his total income past $1 million. Because his employer paid the premium, the benefit was taxable, and what was left wouldn’t cover his mortgage.

The disabled colleague’s case was worse. He did some consulting from home during treatment for the disabling condition, and when the group insurer learned he was earning income, they stopped his monthly benefit. He hired an attorney to try to recover it.

For the senior executive, the shortfall, only $300,000 of covered earnings against $1 million in income, results from the group disability plan's definition of covered earnings. For an employee paid mostly in bonus, that definition governs how much income the benefit replaces.

Three documents describe an employee’s group disability coverage. The benefits summary, an overview given at enrollment, states the share of covered earnings that long-term disability replaces, usually 60%, and does not define covered earnings. The certificate is the insurer’s full written description of the coverage, and it defines covered earnings. The plan document describes the benefit plan the employer offers.

In a report my firm published on how group plans define earnings, most of the group disability certificates we examined defined covered earnings as base salary and excluded bonuses, commissions and overtime. Fewer came closer to total cash compensation. Because the certificates came from public employers, they show how insurers write group plans, not the terms at any one company.

In 10 of those certificates, the definition of covered earnings appeared 2 to 18 pages after the page stating the benefit percentage, never alongside it, and insurers sometimes name it insured, predisability or monthly earnings. An employee can’t tell whether bonuses count without reading that far.

Consider a hypothetical regional bank vice president with a $150,000 base salary and a $250,000 bonus. An employer-provided group plan replaces 60% of base pay, $90,000 a year, or 22.5% of the $400,000 in total pay, before any monthly maximum. Where covered earnings means total cash compensation, the same 60% would pay $240,000 a year.

An individual disability policy, which the employee owns and keeps when changing employers, is underwritten on total earnings including bonus, and it pays the difference between the group plan and 60% of total pay.

Employer picks definition

Insurers draft the language and price the variants, and employers select one when buying group long-term disability, so two employers with the same insurer may provide different coverage.

The plan document may define covered earnings differently from the certificate, as one commercial bank we examined did. An employee can request the plan document in writing from the plan administrator, usually human resources or an outsourced benefits firm. Employees in private-sector plans are legally entitled to a copy.

Open enrollment is under way at most companies, so now is a good time to ask.

Filings are inconclusive

Private-sector employers with 100 or more plan participants file a Form 5500 with the Labor Department, and its Schedule A names the insurer and coverage type for insured benefits.

Of 2,912 financial services employers that filed an insured long-term disability contract in the 2023 filings, 37 (1.3%) reported an individual or multi-life layer above it. The filings don’t show the earnings definition, the replacement percentage, the monthly maximum or any individually owned policy, so only the documents show what an employee has.

For each bonus-heavy employee, write down three items from the certificate and plan document: the wording of the definition of covered earnings, the replacement percentage, and the monthly maximum.

The employee carries whatever the group plan doesn’t replace.

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Jamie K. Fleischner, CLU, ChFC, LUTCF, is president of Set for Life Insurance, an independent brokerage selling individual disability insurance. Contact her at jamie.fleischner@innfeedback.com.