Are you considering a lump-sum buyout of a disability insurance benefits policy? Are you wondering how lump-sum pay-outs work for disability insurance policies? Want to know if a buyout make sense in your situation?
I answer all these questions in this article and cover the three things you must know before you even mention the word “lump-sum buyout” to your insurance company. What is a lump sum buy out of a long-term disability policy?
Quite simply, a lump-sum buyout is when your disability insurance company agrees to make a one-time lump-sum payment to a you, in exchange for you agreeing to sign away your rights under the policy.
This lump-sum payment represents the value of future disability payments, but is paid to you now, in a one-time payment, rather than being paid to you as a series of monthly payments into the future.
It is referred to as a buy-out because the insurance company is buying you out of the Policy. Once you accept a lump-sum payout, the insurance company no longer has a financial liability to you under the Policy.
Lump sum buyouts are not right for everyone. Also, you have no right to get a buyout, this is something the insurance company agrees to do voluntarily. In all cases, a lump-sum buyout is something the insurance company will look at on a case-by-case basis.
Most of the major disability insurance companies in Canada will consider lump-sum buyouts on a case-by-case basis, including Manulife, Great-West Life, Sun Life, Blue Cross Life, RBC Life, Desjardins Financial, Industrial Alliance, and others.
Related Guide: Ultimate Guide to Long-term Disability Benefits in Canada
Three things you must know before you mention the word “lump-sum buyout” to your insurance company:
Lump-sum buyouts are something that you need to handle very delicately so the whole situation does not blow up in your face. Following are the three things you must know before you ever mention the words “lump sum buy-out” to your insurance company:
1. How insurance companies calculate the value of lump-sum buyouts for disability benefits cases
A lump-sum buyout is a negotiation. Insurance companies are in the business of making or saving money. For your insurance company to agree to a buy-out, it has to make financial sense for them to do so.
With this in mind, you have to understand that you are never going to get 100% of the value of your future benefits. Think about it. Why would an insurance company ever do that. People would get fired. For example, at the very least there is a chance you would die before the end of the benefit period. Long-term disability insurance benefits do not pass on to your family after your death. If you died tomorrow, the insurance would no longer have to pay you.
So, at the very least insurance companies decrease the value of future benefits to reflect your mortality risk.
When calculating the value of a lump-sum buy out amount, the insurance company will consider the following factors:
- Your life expectancy and mortality risk
- The present value your future benefits
- The current yield of commercial bonds
- The reserves set aside for your claim
- How strongly they view current the proof of your disability
- How likely it is they could convince a judge or jury that you could do some type of work (whether it is true or not)
When negotiating a lump-sum buy out the insurance company will take into account all of these factors. This can result in a wide range of possible buy-out offers, but even in the best case scenario, the buy-out offer will rarely exceed 75% of the present value of your future benefits. In reality their
Present value is a key concept that most disability claimants do not understand. Most disability claimants vastly overestimate the value of their future benefits.
When you calculate the value of your future benefits, you DO NOT simply multiply the monthly benefit amount x 12 months x years left to pay. This will result in an overinflated figure. The proper method is to calculate the present value of your future payments over the benefit period. You need to use a calculator to calculate present value.
Let’s assume that you get paid $3,500 per month. You are 50 years old and benefits the benefit period under your policy is to age 65. Lets look at the wrong and right way to calcuate benefits so you can see the difference.
Wrong way: $3,500 / month x 12 months x 15 years = $630,000
Right way: The present value of $3,500 per month at an interest rate of 4% to age 65 = $432,478
As you can see the difference between the straight calculation ($630,000) and the present value calculation ($432,478) is almost $200,000. This shows the extent to which you can over estimate the value of your future payments.
2. Beware of Letting the Cat Out of the Bag
If you are receiving monthly long-term disability payments, it is critical that you be cautious in how you approach your insurance company for a lump-sum buyout of your policy. You don’t want the insurance company to take this the wrong way. You don’t want to inadvertently say things that may invalidate your right to disability benefits.
I have seen people create an absolute dumpster fire of their claim by mishandling their inquiry about a lump-sum buyout. The problem is when you approach an insurance company about this on your own, the conversation always turns to “why do you want it”. The insurer will feign interest, while all the time getting you to say all kinds of things that make you look bad or give them grounds to stop payment of your benefits.
For example, you don’t want to tell them you want the money so you can start a business – even if your intentions are pure, and you are truly disabled, this type of statement makes it seem like you can work, you just want the insurance company to pay for your business. Not good. This can lead to you being cut off because they will say you obviously think you can work.
Often, simply the fact a claimant is inquiring about a lump-sum buyout will trigger alarm bells and red flags. The insurance company will question your motives and think maybe this person really can work. They just want a payout so they can get the money AND return to work. The insurance company will be very concerned about this because they don’t want to be made a fool of or to overpay you. In this situation, it’s easier for them to attribute ill motives to you and to look for ways to cut off your payments.
Your can avoid these problems by hiring an experienced disability claim lawyer to make inquiries and to negotiate on your behalf. Not any lawyer will do. You actually need a lawyer who has had experience with this and knows what he or she is doing. The lawyer can approach the insurance company anonymously, to make inquiries if a lump-sum buyout is something they would even consider. The lawyer can describe the situation but protect your identity until it is known if a buy-out is something the insurer would even consider.
I have seen inquiries about a lump-sum trigger a claim review, even after the person had been receiving long-term disability benefits for many years. Much like a tax audit, the new claim review may dig up something to use to justify cutting off payments, or to send you through a new round of medical examinations, work rehabilitation and/or return to work programs.
This is critical because if the insurer won’t consider a lump-sum buy out, then you will not be marked with a red flag or tarnish your claim. They won’t ever know you inquired about it.
3. Does it make sense for you to even consider a lump-sum buyout?
A lump sum buyout of a disability insurance policy is not the right choice for everyone. As we discussed above, you will not get the full value of your future payments. You will only get a percentage of your future payments.
If your proof of disability is absolutely rock solid (this is very rare, and probably yours is not even though you think it is), then you will potentially get more money if you get the monthly payments over time to the end of your benefits period. If know you are bad with money, or have a spouse who is bad with money, then you may be better off keeping the monthly payments. Once you spend the lump sum, that is all you get. You can’t go back for more.
If you have been receiving disability benefits for less than 2 years, then most insurance companies will not consider a buyout beyond paying you to the 2 year mark. You have to on benefits for more than 2 years before insurance companies will consider a buy-out that takes into account a substantial amount of the future value of benefits.
Finally, if your long-term disability benefits are taxable as income, then you need to be very careful with negotiating a lump sum buyout. You don’t want to be taxed on the entire lump sum in one year.
There are situations, however, where negotiating a lump sum buy-out of your long-term disability policy makes sense:
- You think your health could improve, and you could return to some type of work, if you could have a period of financial security and not have to deal with the insurance company
- Your benefits are non-taxable as income
- You have concerns about your life expectancy (monthly payments end when you die, but your family keeps a lump sum after it is paid)
- You want to try and return to work without having the insurance company looking over your shoulder
- You want the insurance company out of your life
- You want to remove the uncertainty of benefits being cut off or delays in payments into the future
- Your proof of disability is not rock solid
- You want the lump sum of money to use for a new business venture that could accommodate your disability or limitations
We get lots of requests for help regarding potential lump sum buyouts. We do not represent people in lump sum buy-out negotiations if your are on an approved LTD claim. If you are on an approved claim, it is our opinion that buyouts are almost never a good idea unless the insurance company has approached you. Even then it is rare that a buyout makes sense for most people.
We do not give specific advice about lump sum buyouts in a free consultation. If you want general advice about a potential buy out in your situation, we do offer a paid service for legal advice by phone.
If you are appealing a denial of disability benefits, we can represent you and will negotiate buyouts in the context of an appeal or denied disability claim. We do this as part of our appeal services.