The vast majority of people grossly under-estimate the likelihood they will suffer a significant disability that prevents them from working. In fact, the probability that a person will become disabled for three months or longer is a little over 25%. These probabilities increase significantly if a person is overweight, smokes, or has extant chronic illnesses such as diabetes, high blood pressure, and/or heart disease. It also depends on occupation: typically, physically demanding jobs present a higher risk than sedentary ones. However, disability due to illness is generally not career sensitive: for example, cancer does not care if you sit behind a desk of work in construction.
Fortunately, many people have disability insurance through their employer, so if they were unable to work for an extended period, a portion of their income would be covered, although there are often gaps in this coverage and will be covered in another article. But self-employed business people, especially those who’s expertise is the financial lifeblood of their organization, such as physicians, dentists, attorneys, consultants, have two problems if they are disabled: one, replacing their lost income while they cannot work, and second, keeping their business viable during their recovery. It is this second issue that I will cover in this article, since financials advisors and insurance agents rarely address it. The type of insurance that helps maintain a business while the primary revenue generator is convalescing is called Business Overhead Expense (BOE) Disability Insurance (DI), or Business Expense Insurance (BEI). For the sake of brevity, I will use BOE, as this is the most common initialism in the industry.
Sole proprietors and small groups of professionals are especially susceptible to complete or partial revenue loss when the primary revenue generator cannot work for an extended period. For example, a physician or dentist who is a sole practitioner has a huge financial exposure in the event he or she is disabled for an extended period, as that single person generates the entire practice’s revenue. In engineering parlance, the sole practitioner is a single point of failure in the business. If the likelihood of an extended disability is one chance in four, then the financial risk to the practice is the same. A business owner in this situation has to ask, “Is this financial exposure something I am willing to assume without a risk mitigation plan in place?” Let’s look at this another way. Would you assume a huge financial risk if you had a 25% probability of losing everything?
BOE typically covers the recurring expenses from your business or practice. These are the expenses that keep your business going even if you are disabled and cannot produce a revenue stream. Typically, BOE insurance covers a maximum of two years of disability, and can have elimination periods of 30 60, or 90 days, depending on how much reserve the business owner has and the premium he or she can afford.
BOE covers many of the expenses normally incurred by businesses, but only pays actual expenses, up to the maximum amount of the policy’s monthly benefit. The expenses typically covered by BOE include:
- Interest payments on some business debts
- Employees’ salaries and payroll taxes
- Postage and stationery
- Equipment maintenance
- Rental, lease, or depreciation of office equipment
- Taxes on the business property location
- Insurance premiums for Workers’ Compensation, employee medical, and liability
- Accounting fees
- Professional memberships and subscriptions.
As important as all of these are, I contend the ability to pay salary and benefits to your employees is a business owner’s priority. The inability to pay salaries leaves your staff-whether one or several people-with no way to cover their own expenses and forces them to seek new employment. And when the business owner returns from their convalescence, they are now faced with additional burden of hiring and training a new staff. This alone adds to expense and can result in decreased revenue during the ramp-up time. Additionally, business owners feel a sense of obligation to protect their employees from unforeseen circumstances: if they can’t, they feel they have not fulfilled an implicit moral agreement with them.
The tax consequences of BOE are also quite interesting. The premiums are generally considered a tax-deductible business expense, with any benefits treated as taxable income. However, because the covered business expenses are typically tax deductible, they can be subtracted from the benefits that are paid out when filing. Since the benefit only covers actual expenses, the business expense deductions should result in a zero net income to the business during this time, with no taxes owed. An accountant should be consulted for more details pertaining to this issue.
Premiums for BOE are calculated based on the same underwriting criteria as any disability policy: the age of the insured, occupation, and health. Bear in mind, there are situations where an insurance company cannot underwrite a BOE policy due to unfavorable ratings resulting from any one or combination of these factors, so there is no guaranty that a policy can be issued. Many insurance agents write policies with multiple companies, so they should be able to shop for the best alternative for their client.
There is one more important point to consider. If a business is a small partnership, it important to consider writing BOE policies on all of the partners, since the loss of any one of them will have a dramatic impact on the organization’s revenue stream during their absence. The policy benefits can be adjusted to reflect the impact of the loss of one partner or the simultaneous disability of multiple partners.
BOE is an extremely important part of a business’ contingency planning. It helps mitigate the high risk that business income will be disrupted due to the incapacity of the owner or owners, and allows the business’s expenses to be paid during the this time. It also protects the interest of employees by providing the ability to pay their salary and benefits if there is no business revenue. Finally, the premiums are tax-deductible, which can lower the business’ tax liability. Most importantly, BOE provides an a tremendous level of emotional security to business owners who are often only a few weeks away from not having the money to continue their business in the event a disability occurs.