Office Overhead Expense Disability Insurance

Most people who have thought about it own Disability Income Insurance.  That will protect your personal spending while you are unable to earn a living.  But, what about the business expenses that will carry on even while you are unable to attend?

Things like the lease, the bank loan principal and interest, the support staff, the heat and hydro, the association fees, the insurance, the municipal taxes and many more fixed expenses.  The telephone bill seldom can go away because you would like to keep the number.  The staff stays unless you want to train a new one when you get back.  The bank and the leasing company probably expect to get paid too.

Hiring temporary help might not leave enough margin to cover all the expenses, so you have implicitly selected other options.

After the fact, you have choices.

  • Kill off all the expenses quickly.  But that does not really work because in the short run you will not know for sure if you can come back to work.
  • Erode you savings.  Then what?
  • Sell.  At a good price?  Right.
  • Hire people to do what you do.  Difficult, more likely impossible.  Will you be up to finding them? How to terminate them when you come back?

Before the fact you have other choices.

  • Build depth so employees can run the business without you.
  • Have emergency succession arrangements so some other business can cover you for a while.
  • Own appropriate insurance.

Of the seven choices above, owning Office Overhead Expense insurance is by far the easiest to execute.  Better yet it does not get in the way of any of the other six should they develop over time.

It is relatively inexpensive and for self employed persons, it should be part of any well-constructed disability insurance plan.  This insurance protects your savings and the way you have constructed your business.  Both are hard to replace.

Ask your insurance adviser about it.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Why Did Henry Arrange Insurance?

Not just any insurance.  Why did Henry arrange Disability Income Insurance?  Because Henry is careful and because Henry can do arithmetic.

Let’s start with who Henry is.  HENRY is an acronym.

  • H – High
  • E – Earnings
  • N – Not
  • R – Rich
  • Y – Yet

Usually a young professional or executive.  Maybe a doctor, dentist, lawyer, computer architect, or engineer.  Really, anyone who has made a time and money investment in their knowledge and skill and expects to get a financial return for that investment.

Henry’s only valuable asset now is the ability to earn income.

If you are Henry and buy a nice Picasso for $4,000,000 at a Southeby auction, do you think you would tuck it under your arm and walk out?

Not likely.  You would arrange to have it insured before it left the premises.

If your career is worth $4,000,000 should you insure it?  Many do not, even though it is a perfect insurance situation.  Low risk of loss, but a big loss if it occurs.

The number that results here is just an example.  Probably one that is too simplistic, but the subject matter is complicated and I have to start somewhere.

If you have 35 years yet to work productively and earn $250,000 now, then, including inflation at 2.5%, you will earn $13,732,000 in your career.   After average taxes of 38%, you keep $155,000 ($12,916 monthly) and that will come to $8,514,000, again with inflation.

Assuming a standard health, male, non-smoker, aged 30 who is a top occupational classification, the most coverage that can be acquired is $10,450 per month ($125,400, insurers would prefer that there be an incentive to go back to work.) payable after 90 days of disability each month to age 65.

For $10,450 of coverage and assuming that capital earns 4.5% with a tax rate of 25% on investment earnings, the disability policy is worth, if you became disabled today, $3,688,001.65 and costs an annual premium of $2,889.61.

Two questions:

  1. Suppose you have the $3.7 million cash but the bank would only you to withdraw income and capital if you could work.  Would you take less yield, (give up say 0.08%, $2,960) to be able to withdraw while you cannot work?
  2. Do you have the $3.7 million?

Everyone I have asked question 2 says “No” and everyone who I ask question 1 says they would give up the yield (more even) to guarantee withdrawal.

When you think about it, your career is the capital and your ability to work creates the ability to withdraw the cash.  From a spendable cash point of view, it really is not different than a bank account that permits withdrawals only when you are able to work.

That ability to draw the cash is why Henry bought a disability income insurance policy.  The policy creates the ability to draw against the cash equivalent value of your career when you cannot work.

For the parameters above, you get coverage of $10,450 per month (paid tax free) plus inflation until age 65 beginning after 90 days of disability in exchange for an annual premium of $2,889.61.  Because you start picking up things that are transient, the price is higher if you choose 60 or 30 day elimination periods.  Notice that a large portion of disabilities lasting more than 90 days are forever.

The policy creates the capital you do not have yet, and the ability to withdraw it for a price that you agree is fair.  Why are we still talking about owning this policy?

Some reasons make sense.  The example likely does not fit you and is probably not your best design.  Maybe you have other factors or design issues.

The price above includes “own” occupation, CPI indexing and a future earnings protection option.  In my view, these “options” should always be selected if available.  You might like a return of premium option or perhaps some of the other choices.

Disability Income Insurance is subtle.  It is a contract of definitions and options.  Much more so than most other kinds of insurance.  You cannot do it yourself and you should not rely on group coverage or association plans.

They have a lower price but they are not cheaper.  If the price is lower you bought less.  They took something out.  Maybe something you should car about.

For example, the definition of “disabled” is crucial.  Low priced policies have a weak one.  Something like – after 24 months, unable to be gainfully employed in any occupation for which you have the training or education. That means if you are a dentist and after your disability appears, you could physically carry out the work of a neurologist, they cannot cut you off claim.  Because you don’t have the training to do the job.  If you could pack groceries, they could and would do so no matter how much your income fell.

There are several definitions that matter.  Loss of earnings, loss of time, loss of duties, distinctions.  Partial, accumulating days of disability, catastrophic loss of limbs or sight.  Rehabilitation.  Return to work payments.   And more.

Improperly insuring and under-insuring disability risks is just stupid.  Contact an adviser who has the expertise to arrange the proper insurance for you.  Henry did.  You should too!

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.