For the New Year . . . Items to Check in Your Group Long Term Disability Policy
Vol. 2 No. 4
With any new year comes resolutions. One that is recommended for 2012 is to review your school’s group Long Term Disability insurance plan. Unlike your group Life insurance policy, group LTD insurance has many benefit nuances. Life insurance is not complicated—upon death, a specified benefit is paid to the designated beneficiary. Disabilities are rarely as straightforward. Issues that impact claims include limited return to work, claim recurrence, how disability is defined in terms of loss of duties and/or income, and more.
Here are a half dozen things for you to check. Each can be of significant impact to a claimant.
1. Do you fully understand your policy’s definition of disability? Most LTD plans require both loss of earnings AND loss of duties of one’s own occupation to be eligible for benefits. One that reads “loss of earnings OR loss of duties is better, because it allows for payment of benefits to an employee who must, because of disability, have a significant shift in duties. For example, a senior faculty member who is also Department Chair and coach may be medically required to give up all non-teaching duties. As a result, salary is significantly reduced, but the employee still works enough hours to be considered 100% full-time equivalent. With an “AND” definition, the claim would likely be denied. With an “OR” definition, the employee would qualify for partial disability benefits because of loss of earnings … even though the employee is still full time. The result is that the employee gets closer to being “whole” (financially).
2. Limitations can apply to school administrators who regularly work more than 40 hours a week. How extra hours factor into determining eligibility for benefits when a partial disability occurs is critical. Consider a Head of School who regularly works 65+ hours a week and, because of illness or injury, must cut back to a “relatively normal” 45 hours a week. Under most LTD policies, hours worked in excess of 40 are not considered as part of the formula for partial benefit eligibility, and the Head would not qualify for benefits. In other words, the Head would have to reduce to less than 32 hours a week (80% of a 40-hour week) before any benefits would be payable. If your school’s LTD policy does not specifically address this, such a circumstance will most likely result in a claim denial. Ask your carrier about adding a provision to include those excess hours. While you are at it, consider increasing the benefit cap in order to be able to fully insure the highest salaried personnel. A cap of $7,500, for example, covers salaries of up to $150,000 for the standard 60% benefit plan, and a $10,000 cap would cover a salary of up to $200,000, again for a benefit amount of 60%.
3. Group LTD policies also distinguish between the inability to perform one's own occupation and the inability to perform any occupation for which one is trained, educated, or experienced. The "own occupation" part of the definition normally limits benefits for a period of up to 24 or 36 months before reverting to the "any occupation" definition. Some policies will allow you to extend the own-occupation benefit period to Social Security normal retirement age. However, the cost of having this expanded definition of disability is high, with premium surcharged by 20% or more, and almost totally unnecessary. ISM’s experience has been that independent school faculty and staff are committed to their profession, and the likelihood of an employee still being unable to do his/her own occupation after two or three years but being able to do other jobs commensurate with his/her training, education, or experience is very remote—and actually moot, if an employee is working part time.
4. Are your employees covered during the summer months? And, how about during sabbatical leave? Many schools have faculty who are under contract for less than 12 months (typically September 1 through June 30). If so, they may not be covered should they become disabled during the months of July and August. Make sure that you have written verification from the carrier that employees who are not under contract during the summer are still insured. Or, consider putting all salaried employees under 12-month contracts. If you have a formal sabbatical program, and you want to continue covering an employee during sabbatical leave, formally add policy language to permit this.
5. Does your disability plan insure employer contributions to the school’s retirement plan? And, do LTD benefits index to help keep pace with inflation? Most benefit-eligible employees participate in a school’s 403(b) plan. In the event of disability, contributions to that plan, by both the employer and employee, typically cease. Disabilities can last for many years. If a disabled employee’s retirement fund has no continued contributions during the years that LTD benefits are paid, there will likely not be enough funds to provide the necessary income for the employee’s remaining years beyond Social Security normal retirement age. Ask your insurance carrier about a provision to insure employer and/or employee contributions to the employee’s 403(b) plan during a period of disability. Having this enables a disabled employee’s retirement fund to continue to grow during the months/years that benefits are being paid. Retirement plan assets have eroded in recent years, so additional funding during a period of disability would make a significant difference. Also, ask if your LTD plan can include an annual cost-of-living adjustment (COLA) provision. For an employee who is disabled for many years, a COLA (typically 3%) is a very valuable provision.
6. ISM has long recommended that schools have employees pay their LTD insurance premium instead of making it non-contributory. The IRS says that LTD benefits paid are taxable as income to the employee when the school pays the LTD plan’s premium. When a typical 60% LTD benefit is taxable, the net worth is closer to 40%. If the employee pays the entire LTD premium (with after-tax dollars), any disability benefits received are non-taxable income.
On June 9, 2004, the IRS issued a Revenue Ruling (2004-55) that clarifies the taxability of disability benefits. This ruling is an across-the-board decision that applies to all taxpayers. The previous general ruling determined taxability based on a three-year rule, which looked back at the three years prior to disability. Benefits were deemed taxable to the extent of the total employer premium contribution versus the total employee premium contribution during those three years. (If the premium was split between the employee and the employer over the three years, the portion of the benefit attributable to the employer would be taxable and the portion attributable to employee post-tax contribution would be tax-free.) The main content of the new ruling indicates that when an employer switches from a 100% employer paid plan to a 100% employee paid plan, the change constitutes a new plan, and the three-year rule does not apply. However, the three-year rule would continue to affect a situation if, in the plan year the disability occurs, contributions are shared between employer and employee.
The ruling also gives employers the ability to structure a plan such that the employer-paid premiums are annually included on an employee’s W-2 (Box 14) as imputed (and therefore taxable) income. In effect, the employer is "grossing up" each employee's wages on an individual basis. If the employer does so, and an employee subsequently becomes disabled, any benefits are received tax-free. Another route is to deduct each employee’s LTD premium on a regular monthly payroll deduction basis (but not via payroll reduction; i.e., through a Section 125 Plan).
The small amount of tax paid each year by an employee is insignificant when compared with the significant advantage of receiving tax-free benefits should a disability occur. Employers should consult their own counsel for further guidance based on their individual situation.
The above items are some of the more important variables in a group Long Term Disability plan design. Some may not be available with your in-force insurance carrier. Your insurance broker will be able to assist you with both the availability and the cost.
Additional ISM resources of interest
Private School News Vol. 8 No. 3 Long-Term Disability Policies Part One
Private School News Vol. 8 No. 4 Long Term Disability, Part Two
ISM's Long Term Disability Coverage