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Disability case: Andy and Jeff

By Doug Borrell

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Very few financial professionals ever ask about disability buy-sell.  It’s a very easy product to understand. Just think about it in terms of what might happen to your customers if they need it and don’t have it.

Here’s a hypothetical example: The story of Andy and Jeff.

Andy and Jeff had been best friends ever since they started dental school together.

When they finally graduated, they decided to team up to start a practice, and to  “bite the bullet financially” so that they could enjoy their success not only as best friends, but as dental professionals.

Because disability insurance companies know that someone like a medical doctor or a dentist has a high earning ability, they are willing to offer these professional people higher benefits than they would normally offer to those who are entering the business marketplace.

Andy and Jeff each bought about $5,000 per month of disability insurance coverage. They also knew that the first few years they likely would be paying out more money than would be arriving in the form of receivables. So, they also bought business overhead expense coverage, to protect them in the unlikely event that one of them became disabled.

Fast forward 20 years.

Andy and Jeff are now taking out $250,000 per year of income each from the practice. This particular practice is now worth more than $1 million, including the value of a building and equipment that they both own jointly. Over the years, they’ve added to their disability coverage to protect their growing income.

Jeff is in Aspen skiing during a winter vacation. Coming down a hill, he loses his balance and falls head over heel several times. While no bones are broken, he suffers some amnesia and constant headaches.

Jeff’s neurologist tells him to take six months off. His disability insurance policy is now paying him $10,000 per month, and his business overhead expense policy is covering his share of the expenses. For the most part, there are no big problems so far.

One huge exception: The hygienists, techs, and Andy are all working harder to keep up the revenue stream.

At the end of the six month layoff, Jeff tries to come back to work and but that just does not work out.

His neurologist again tells him to stay off his feet until he is completely well.

Andy is trying to pick up as many patients of Jeff’s as he can—but he is also getting frustrated. When will this scenario end?

Finally, at the end of one year, Jeff is told he likely will never be completely well again—certainly not well enough to work as a dentist. Jeff goes to Andy and tells him, “I would like my equity out of the business. My neurologist tells me I likely will never work again.”

Andy is startled. Where will he get the $500,000 he needs to buy Jeff out quickly?

Can this  practice borrow money with a key person  being disabled? What will the interest rate be? Will Andy be able to make the payments? Will Andy have to go to the expense of hiring another dental professional?

If Andy had disability buy-sell when he needed it, that would mean, very simply, that he wouldn’t have to worry about those questions. He could let the disability buy-sell coverage take care of that and worry about how to be a better dentist, or how to enjoy himself outside his practice.

While individual DI has a relatively short waiting period (60 to 90 days) and a relatively long benefit period (to age 65, age 70, or even lifetime) the DI buy-out benefit has a long waiting period—usually a minimum of one year.

The long waiting period is in the disabled partner’s best interest, because you want the disabled partner to have a reasonable amount of time to try to re-engage in the business, if the partner is able.

If you are disabled for one year, the overwhelming odds are that you are not coming back to your business or practice.The DI buy-out provision is triggered.

The contract clearly states the waiting period, and whether the proceeds will be payable in a lump sum or in installments.

Advantages of having a buy-sell:

  • You allow the disabled person to receive a fair share of the equity in a business that the disabled person helped grow.
  • You maximize the financial return when the business is transferred.
  • The emotional side of terminating someone’s employment is eased by the fact that the partner will be compensated for the partner’s  significant sweat equity in the business or practice.

By definition, partners can do their jobs or they can’t do their jobs. It’s black and white.

In this example the respective dentists had taken care of  protecting their individual incomes—and, by the purchase of overhead expense, the business was kept open.  What  had not been considered was the transaction of the business succession if one partner was unable to continue because of a disability.

When you are looking at a business or practice owned by more than one individual, ask your client if the organization has buy-sell protection in place.

If so, is that arrangement funded? In other words, does the arrangement have life insurance in it?

Does the organization have the old kind of arrangement or the new kind. (The old kind is funded for life only. The new kind is funded for life and disability.)

If the client does have a buy-sell arrangement, ask, “What is the definition of total disability?”

Many accountants and attorneys are completely unaware that this type of insurance  even exists. Maybe those are the first people you visit. They will be surprised at how inexpensive this type of insurance really is, and how very important it is for their future.

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