Neil Paton cautions that small business owners walk a thin tightrope when they make the smart purchase of personal disability for themselves but rebuff guidance to also buy business overhead expense disability insurance (BOE).
Paton, president and CEO of Toronto-based Edge Benefits, tells a recent story of a small business owner who did just that: when the owner became ill he received $5,000 a month in disability payments which were greatly reduced when he had to pay the fixed expenses for his business and the administrative staff who worked there.
Paton says he realizes there are a number of insurance products small business owners have to keep in mind when setting up shop – everything from property and casualty insurance to critical illness, and decisions have to be made as to what to purchase. “But what tends to happen, unfortunately, is that business owners tend not to buy this [BOE] product,” says Paton. “They buy disability instead, which is good – but then the $5,000 or $6,000 a month they expected to take home through the disability insurance is used up to keep the business itself alive.”
Flexible and tax-deductible
Paton and others who sell BOE often refer to the flexible, tax-deductible, reimbursement product as a “door opener” for advisors catering to the small business market of up to five employees per firm. Its purpose is to provide enough cash flow immediately after an illness or disability to pay debts, including monthly expenses, like leases and hydro. (Once a business grows beyond the six-person complement, the financial impact of a disability is less direct to the company and others can jump in and help out with expenses.)
“You have a situation as a financial advisor where you have everyone going to them about their commercial insurance needs or life insurance needs,” says Mark Hardy, director of living benefits at RBC Insurance. “This is the different conversation that you get to have with the business owner. It needs to be understood that if they become disabled, their expenses don’t stop – the income supporting them does.”
The plans are not designed to be long-term: Edge Benefits’ plans last a year, while with RBC’s product, benefits can be paid over a period of either 15 or 24 months. Hardy classifies BOE as a bridge to give the small business owner time to determine whether she should sell the business or return to work when she is healthy.
Typical buyers of BOE are small business owners or white collar professionals like dental surgeons, ophthalmologists, doctors, accountants and engineers, who have large lease obligations for the equipment they use in their location, as well as those who have large fixed-expenses with their storefronts, says Hardy.
Paton says he looks at where the client is in the life cycle of their business to determine if and how much BOE should be purchased. “For example, if they are in the first few years of their business and they don’t have a really large, established business, disability is much more important for them than many of the other financial products. To me, if you look at a small business overhead policy that costs next to nothing, why would you not tack that on to a disability policy to make sure a small business owner is well looked after?”
Costs for BOE are based on age and income, but typically range from 1%-3% of earnings for the RBC product, says Hardy. He gives the example of a 44-year-old male, non-smoker, whose orthodontic private practice has total expenses of $478,000 a year ($39,900 a month). His gross income in 2014 was $1 million and he netted about $210,000.
Even though he has disability coverage, Hardy says the orthodontist would have to decide early on whether to fund the business from the disability payments, savings, or find a way to defer or eliminate the expenses.
The insured can buy $30,000 worth of BOE coverage, at $350 a month in premiums, which would defray about three-quarters of the continuing expenses, says Hardy. More importantly, it would help the orthodontist recover and give him time to decide his options for the future.
RBC also has certain options regarding the definition of disability, so for example, if a business owner can’t perform their regular duties at least half the time or can’t perform one or more of the important duties of their occupation, they would be eligible for up to half of the monthly benefit for three months.
Individual disability coverage
As well, the plan is non-cancellable until age 65 when it can be conditionally renewed, as long as the person remains employed at least 30 hours a week and is responsible for maintaining the expenses of the office.
There are also times when a small business owner decides to call it quits and work for someone else. In those cases, the RBC premiums for the small business can be exchanged for regular individual disability coverage, says Hardy.
To make the Edge Benefits product more cost effective for some, the company has split the product into two: the first is a guaranteed issue for injury, and then the client can pay the extra to also cover disability, says Paton.
The product can be sold to small business owners as a pool of funds they can take to use when they are sick or disabled. So, someone who has $6,000 a month coverage has access to $72,000 a year, says Paton. But if the owner only has $4,000 of expenses one month, then the $2,000 that wasn’t used, can be carried forward.
Clients who feel they don’t believe they get enough to cover their expenses with one policy, can buy more from a different insurer.