Group long-term disability plans are prompting many employers to look for ways to offer adequate income replacement to highly compensated employees without increasing their exposure to risk and pricing volatility. The answer to cutting this risk might be easier than they think.
Supplementing a group LTD plan by offering individual disability insurance is an ideal way for employers to diversify risks, increase stability and enhance benefits. This integration of group LTD coverage and individual income protection is an effective way to balance risk that benefits employers and employees, particularly those key, high-income executives.
The supplemental individual disability benefits industry has gone through a dramatic change over the last decade. Enhancements in products, underwriting and enrollment/communication have improved the offering and streamlined the process, opening access to new channels such as group employee benefit brokers who already handle the base group LTD.
IDI distribution also has benefited as brokers look to diversity and grow revenue, especially given the uncertainty of health care reform.
Employees assume a lot
While group plans provide solid income replacement for most employees, that might not be true for highly compensated employees. Income replacement in group plans is often based on an employee’s base salary, not total compensation. Bonus and incentive compensation often comprise a significant portion of earnings for highly compensated employees, so the lack of coverage can create a large gap that leaves their total compensation unprotected. Overall protection also is limited by monthly benefit caps that are typical for group plans and by the need for employees to pay income tax on benefits from employer-paid plans.
By supplementing their group plan with individual disability insurance, employers can provide highly compensated employees with an extra layer of protection that provides greater income replacement. Integrated LTD and IDI coverage is an ideal solution: a group LTD plan covers all employees with basic protection at a reasonable cost, and supplemental IDI offers any eligible employee permanent IDI coverage with some value-added features not typically found in LTD plans.
Highly compensated employees might not grasp the limited scope of LTD plans:
- Salary-only protection: Most group plans protect up to 60 percent of salary, with no protection for other compensation.
- Benefit caps: Group LTD plans typically have benefit caps based on more moderate income levels, which may limit the amount of income replacement more highly-compensated employees can receive.
- Taxes: Benefits from an employer-paid plan, like the usual group LTD plan design, are taxable, so the actual income replacement may be significantly lower than expected.
These factors lead to unacceptably low income replacement ratios for highly compensated employees—often well below 40 percent of income.
To combat these misperceptions, carriers should provide education tools such as pre-enrollment communications and personalized enrollment kits or secure online enrollment tools to help highly-compensated employees understand their current income replacement and the necessity of IDI.
The stakes are high. Consider an employee who has a $200,000 salary with a $50,000 bonus. A group plan typically covers 60 percent of the base salary only, meaning that only 48 percent of the $250,000 will be protected. After taxes (assumed at 28 percent), the insured amount falls to $86,400—only 35 percent of the employee’s total compensation package.
Adding a supplemental monthly IDI benefit of $2,800 will bring this employee’s income protection up to 60 percent of total compensation.
Integrating IDI and LTD
In addition to providing more appropriate levels of income replacement for highly compensated employees, offering integrated IDI and LTD coverage can help employers reduce their exposure to risk, possibly lower future benefit costs and offer a more attractive benefit package.
Offering individual disability insurance allows an employer to either reduce the benefit maximum on group LTD plans with high maximums (risk transfer) or maintain their current maximum and not increase the group LTD benefit maximum (risk mitigation), which reduces the impact on the employer of claims from highly-compensated employees. And that’s just one of many benefits of risk transfer and risk mitigation. Others include:
- Lower risk for employer: Individual plans are not impacted by group experience or pricing, so employers have reduced exposure to rate increases due to claims experience.
- Greater rate stability: Group LTD premiums can increase at renewal based on plan experience, but individual disability insurance rates are non-cancellable and cannot increase until the insured person is age 65.
- Value-added enhancements: Income protection benefits for high-income earners are enriched while equity in the plan design is maintained.
Cutting future costs
Individual disability insurance can reduce the impact on an employer’s bottom line. Supplementing group LTD plans with individual income protection and lowering the maximum LTD benefit produces a “stop-loss” effect, isolating the potential impact that one or more claims of a high-income earner has on the group LTD plan experience. As a result, this portion of the risk is shifted to the individual disability insurance carrier without affecting the group LTD plan experience.
Consider an example featuring an employer with 3,000 employees. Its group LTD plan covers 60 percent of an employee’s salary, up to $25,000 per month. Reducing the benefit cap to $20,000 per month will likely result in lower premium rates for the employer. The savings can be used to partially subsidize an individual program that provides up to an additional $5,000 per month, bringing employees who are capped at the $20,000 monthly maximum to the desired $25,000 monthly benefit. A $25,000 monthly maximum means that employees earning up to $500,000 annually will have 60 percent income protection. Depending on the need, the number of eligible lives and the spread of risk, the individual disability insurance carrier might be able to offer higher IDI coverage for employees earning more than $500,000 annually.
By supplementing their group plan with individual disability insurance, employers offer highly compensated employees an extra layer of protection that provides greater income replacement. This integrated coverage is a good solution because it provides a group LTD plan for all employees at a reasonable cost, as well as supplemental individual disability insurance that offers any eligible employee permanent individual coverage with some value-added features not typically found in LTD plans. Highlights include level premiums and guaranteed standard issue.
In addition to protecting employees’ total compensation and closing income replacement gaps, other benefits of IDI typically include:
- Option for up to 100 percent income replacement coverage for catastrophic disabilities
- Opportunity to exchange an individual disability policy for a long term care policy after age 60
- Custom designs that complement most group LTD plans
- Fixed employer-sponsored discounted premium (up to 35 percent) and non-cancellable coverage to age 65
- Individually owned permanent disability coverage
Getting on the same page
Before even beginning to talk about pricing, plan design and underwriting, employers need to be sure their broker is in sync with their business needs. Research conducted for Unum by Greenwald and Associates examined what brokers and employers look for in an IDI carrier. Brokers who sell IDI and corporate benefits decision makers who either have IDI or are highly aware of the product seem to agree on the overall key carrier attributes that would significantly enhance an IDI program:
- Experience and expertise in the employer-sponsored IDI offering
- Flexibility to tailor plan designs to the employer’s needs
- Multiple funding options that are flexible and transparent
- Benefits administration that makes HR’s job easier
- Strong benefits education, enrollment and communication for employees
- Responsive and personal service
- Efficient claims processing
A clear benefit
The value of integrating group LTD and individual disability insurance is clear. It’s a long-term benefits solution that can stabilize group LTD plans, limit risk and volatility, and offer high-income earners the income replacement and enhanced coverage that better matches their needs.
A number of carriers provide the right product at a competitive price. However, employers should look for a carrier that can tailor a supplemental long-term disability solution for more highly-compensated employees that best complements the group LTD disability offering—and can back that up with other strong service attributes that include implementation, administration and enrollment with a keen focus on superior claims service.
Branden Pierson is the national sales leader of executive benefits for Unum and is based in Portland, Maine. He can be reached at firstname.lastname@example.org.