Most small businesses with more than one owner would face significant financial challenges if one of the owners became disabled and was no longer able to contribute to the company, insurance brokers say.
And few of those businesses are prepared to face such a possibility.
Many business owners have buy-sell agreements to establish how a partner’s ownership share would be bought out if he or she died. A life insurance policy typically provides funding for the other partners to buy the share that belongs to the deceased partner.
In some cases, those buy-sell agreements also specify what should be done if a partner becomes disabled and cannot perform his or her job duties for the company.
Minority have disability buyout coverage
Mike Noonan, brokerage general agent for Brookfield-based Cyganiak Planning, estimates only about 25% of businesses have disability buyout insurance to provide funds to pay for the transfer of a disabled partner’s ownership share.
"A lot of times (a disability buyout) never gets funded, which can be a problem," Noonan said.
Steve Bartholomew, vice president of sales for Highland Capital Brokerage, an insurance brokerage wholesale firm in Brookfield, estimates only about 10% of small businesses have disability buy-out insurance.
Peter Krahn, senior account executive for UnumProvident in Elm Grove, said only about 5% of small, privately held companies with two to five owners have disability buy-out insurance.
"It’s just not done very often," Bartholomew said. "Of the businesses that have a legal buy-out agreement in place, most of them have language that addresses the disability issue. The problem is, it’s often not funded properly."
Business partners who become disabled often want to sell their ownership share of the company to receive a return on their capital investment. But that can place a significant financial burden on the other business partners if they don’t have disability buyout insurance to pay for the disabled partner’s share in the company.
"I’ve seen businesses that have to make payments (to buy out disabled partners) for years and years and years, and it builds up a lot of animosity," Donald Levings, senior account executive for R&R Insurance Services, Waukesha.
In some cases, the cost of buying out a disabled partner has forced companies out of business.
"We’ve definitely seen that happen," Krahn said.
Planning for the disability of a business partner is even more important than planning for the death of a business partner, insurance brokers say, because it is more likely they will become disabled.
"The chance of disability is five times more likely than death," Noonan said. "The stuff that used to kill us doesn’t kill us anymore."
Disability more likely to occur than death
Other experts agree with Noonan that business owners are more likely to become disabled than they are to die, before turning 65.
According to the National Association of Insurance Commissioners and the UnumProvident Corp., a company with two partners, both 35, has a 67% chance that one of the partners will be disabled for three months or longer before age 65.
Without a disability clause in a company’s buy-out agreement, a partner that becomes disabled and is unable to work would still receive his or her salary and share of the profits. Meanwhile, the business likely will need to hire and pay someone to do the work that partner had done when able. That could place a significant financial burden on a business, especially a small company with little margin for error.
"Can the business really afford to pay you (if you are disabled)?" Noonan said. "How long can that really last? How long can a (disabled) partner be paid his half of the profits? Not too long. Most small businesses are usually pretty tight."
Levings said he has seen three businesses in 23 years that decided to go out of business rather than continue to pay a disabled partner who could no longer work.
Premium can be costly
In many cases, the cost of disability buy-out insurance discourages businesses from getting covered, Bartholomew said. The cost varies based on the size of the businesses and the age and health of the business partners. Bartholomew said a small two-person business could have a disability buy-out insurance premium of $3,000 to $7,000 per year.
"It’s not cheap," Krahn said. "(But) the benefit you get is well worth the money you spend for it."
Many business owners only get life insurance coverage for buying out their partners because it costs less than disability buy-out insurance, Bartholomew said. Disability buy-out insurance costs more because it is more likely to be used, he said.
The insurance industry doesn’t do a good enough job of selling business owners on the importance of disability buy-out insurance, Bartholomew said.
"A lot of the blame I’m going to put on us," he said. "We as the insurance industry don’t tell (business owners) enough. Most advertising addresses life insurance issues. Very few address disability insurance."
Policy for each partner
Disability buyout insurance policies are purchased for each partner. If one of them becomes disabled, they receive benefits based on a predetermined payment plan and compensation amount for the ownership share. The benefits buy out the disabled employee. Meanwhile, the other partners can move forward and avoid the burden of buying out the disabled employee.
"Disability buy-out insurance can make the buy-out of a business so clean and so smooth," Levings said.
There are several types of disability insurance coverage available for businesses and business owners. Disability insurance can insure an employee’s own income if he or she becomes disabled. Disability buy-out insurance pays for the cost of business partners to buy the share of the company owned by a disabled partner. Another form of coverage, called key man coverage, provides funds for businesses to replace a critical employee, not necessarily an owner.
Insurance is also available to temporarily cover the overhead expenses of a business while the owner is disabled. That type of coverage expires after a year or two, Noonan said.
Business owners should seriously consider getting disability buy-out insurance coverage to protect their business from a disability that could devastate not only the partner suffering from it, but also the company, insurance brokers said.
"You put your own investment at risk (without the insurance)," Bartholomew said. "(Business owners) spend so much of their time and blood and sweat and tears. You have to understand what the risk is and what you need to do to address that risk."
April 2, 2004 Small Business Times, Milwaukee