Group long-term disability plans are prompting many employers tolook for ways to offer adequate income replacement to highlycompensated employees without increasing their exposure to risk andpricing volatility. The answer to cutting this risk might be easierthan they think.

Supplementing a group LTD plan by offering individual disabilityinsurance is an ideal way for employers to diversify risks,increase stability and enhance benefits. This integration of groupLTD coverage and individual income protection is an effective wayto balance risk that benefits employers and employees, particularlythose key, high-income executives.

The supplemental individual disability benefits industry hasgone through a dramatic change over the last decade. Enhancementsin products, underwriting and enrollment/communication haveimproved the offering and streamlined the process, opening accessto new channels such as group employee benefit brokers who alreadyhandle the base group LTD.

IDI distribution also has benefited as brokers look to diversityand grow revenue, especially given the uncertainty of health carereform.   

Employees assume a lot

While group plans provide solid income replacement for mostemployees, that might not be true for highly compensated employees.Income replacement in group plans is often based on an employee'sbase salary, not total compensation. Bonus and incentivecompensation often comprise a significant portion of earnings forhighly compensated employees, so the lack of coverage can create alarge gap that leaves their total compensation unprotected. Overallprotection also is limited by monthly benefit caps that are typicalfor group plans and by the need for employees to pay income tax onbenefits from employer-paid plans.

By supplementing their group plan with individual disabilityinsurance, employers can provide highly compensated employees withan extra layer of protection that provides greater incomereplacement. Integrated LTD and IDI coverage is an ideal solution:a group LTD plan covers all employees with basic protection at areasonable cost, and supplemental IDI offers any eligible employeepermanent IDI coverage with some value-added features not typicallyfound in LTD plans.

Highly compensated employees might not grasp the limited scopeof LTD plans:

• Salary-only protection: Most group plansprotect up to 60 percent of salary, with no protection for othercompensation.
• Benefit caps: Group LTD plans typically havebenefit caps based on more moderate income levels, which may limitthe amount of income replacement more highly-compensated employeescan receive.
• Taxes: Benefits from an employer-paid plan,like the usual group LTD plan design, are taxable, so the actualincome replacement may be significantly lower than expected.

These factors lead to unacceptably low income replacement ratiosfor highly compensated employees—often well below 40 percent ofincome.

To combat these misperceptions, carriers should provideeducation tools such as pre-enrollment communications andpersonalized enrollment kits or secure online enrollment tools tohelp highly-compensated employees understand their current incomereplacement and the necessity of IDI.

The stakes are high. Consider an employee who has a $200,000salary with a $50,000 bonus. A group plan typically covers 60percent of the base salary only, meaning that only 48 percent ofthe $250,000 will be protected. After taxes (assumed at 28percent), the insured amount falls to $86,400—only 35 percent ofthe employee's total compensation package.

Adding a supplemental monthly IDI benefit of $2,800 will bringthis employee's income protection up to 60 percent of totalcompensation.

Integrating IDI and LTD

In addition to providing more appropriate levels of incomereplacement for highly compensated employees, offering integratedIDI and LTD coverage can help employers reduce their exposure torisk, possibly lower future benefit costs and offer a moreattractive benefit package.

Diversifying risks

Offering individual disability insurance allows an employer toeither reduce the benefit maximum on group LTD plans with highmaximums (risk transfer) or maintain their current maximum and notincrease the group LTD benefit maximum (risk mitigation), whichreduces the impact on the employer of claims fromhighly-compensated employees. And that's just one of many benefitsof risk transfer and risk mitigation. Others include:

• Lower risk for employer: Individual plans are not impacted bygroup experience or pricing, so employers have reduced exposure torate increases due to claims experience.
• Greater rate stability: Group LTD premiums can increase atrenewal based on plan experience, but individual disabilityinsurance rates are non-cancellable and cannot increase until theinsured person is age 65.
• Value-added enhancements: Income protection benefits forhigh-income earners are enriched while equity in the plan design ismaintained.

Cutting future costs

Individual disability insurance can reduce the impact on anemployer's bottom line. Supplementing group LTD plans withindividual income protection and lowering the maximum LTD benefitproduces a “stop-loss” effect, isolating the potential impact thatone or more claims of a high-income earner has on the group LTDplan experience. As a result, this portion of the risk is shiftedto the individual disability insurance carrier without affectingthe 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 monthwill likely result in lower premium rates for the employer. Thesavings can be used to partially subsidize an individual programthat provides up to an additional $5,000 per month, bringingemployees who are capped at the $20,000 monthly maximum to thedesired $25,000 monthly benefit. A $25,000 monthly maximum meansthat employees earning up to $500,000 annually will have 60 percentincome protection. Depending on the need, the number of eligiblelives and the spread of risk, the individual disability insurancecarrier might be able to offer higher IDI coverage for employeesearning more than $500,000 annually.

Enhancing benefits

By supplementing their group plan with individual disabilityinsurance, employers offer highly compensated employees an extralayer of protection that provides greater income replacement. Thisintegrated coverage is a good solution because it provides a groupLTD plan for all employees at a reasonable cost, as well assupplemental individual disability insurance that offers anyeligible employee permanent individual coverage with somevalue-added features not typically found in LTD plans. Highlightsinclude level premiums and guaranteed standard issue.

In addition to protecting employees' total compensation andclosing income replacement gaps, other benefits of IDI typicallyinclude:

• Option for up to 100 percent income replacement coverage forcatastrophic disabilities
• Opportunity to exchange an individual disability policy for along 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 andunderwriting, employers need to be sure their broker is in syncwith their business needs. Research conducted for Unum by Greenwaldand Associates examined what brokers and employers look for in anIDI carrier. Brokers who sell IDI and corporate benefits decisionmakers who either have IDI or are highly aware of the product seemto agree on the overall key carrier attributes that wouldsignificantly enhance an IDI program:

• Experience and expertise in the employer-sponsored IDIoffering
• 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 foremployees
• Responsive and personal service
• Efficient claims processing

A clear benefit

The value of integrating group LTD and individual disabilityinsurance is clear. It's a long-term benefits solution that canstabilize group LTD plans, limit risk and volatility, and offerhigh-income earners the income replacement and enhanced coveragethat better matches their needs.

A number of carriers provide the right product at a competitiveprice. However, employers should look for a carrier that can tailora supplemental long-term disability solution for morehighly-compensated employees that best complements the group LTDdisability offering—and can back that up with other strong serviceattributes that include implementation, administration andenrollment with a keen focus on superior claimsservice. 

Branden Pierson is the national sales leader of executivebenefits for Unum and is based in Portland, Maine. He can bereached at [email protected].