Mind the (disability) gap 

Group Long-term disability (LTD) insurance plans are commonly provided by employers to offer income protection to employees in the event of a disabling illness or injury. However, it is crucial to recognize that employers and their employees may not fully understand the impact of the LTD plan’s limit, or “cap”, on the monthly benefit. This lack of understanding poses a hidden risk for employees at all levels as the growing financial hazard is often unknown to employees, who may assume that their group LTD plan will fully cover their income during a period of disability. The result is that they may encounter significant financial difficulties during an already challenging period.

For example, consider an employer with a group LTD plan that is designed to replace 60% of the base salary up to a maximum monthly benefit of $10,000. While this design may be sufficient for most employees, those who earn more than $200,000 annually would actually receive less than 60% of their income, resulting in a shortfall in coverage. As a result, the percentage of income covered for highly compensated employees is likely to fall far short of the amount necessary to sustain their standard of living and support their families. Without adequate income replacement, these employees would have to rely on other financial resources, such as savings or their 401(k), to bridge the gap. This could lead to significant disruption to their lifestyle and family needs, as well as derail their retirement planning.

Let's take a closer look at the financial consequences of a group LTD benefit shortfall. According to industry data on long-term disability claims, the average claim lasts for 36 months. If an employee with a base salary of $350,000 is unable to work due to a disabling illness or injury for this duration, and they only receive the maximum $10,000 per month benefit provided by the group LTD plan, they would need to dip into their personal savings or liquidate other financial assets to make up for the lost income. This could potentially exhaust almost $700,000 over the 36-month period. It's important to note that while the group LTD benefit shortfall may not seem significant initially, it can have a substantial long-term financial impact on employees.

Additionally, in the majority of group LTD plans (75-80%), variable compensation such as performance bonuses and commissions are not covered at all. This omission can have a significant impact on the coverage provided to highly-compensated employees, for whom performance-related compensation often makes up a substantial portion of their overall pay. In the prior example of an employee with a $350,000 base salary, the group LTD plan would only provide a 34% income replacement ratio, falling short of the intended 60% income replacement. When variable compensation such as bonuses and commissions are factored in, the income replacement ratio becomes even lower.

The Challenges of a Quick Fix through a Group LTD Plan Redesign

When employers do become aware of the hidden risks that employees will encounter they may be tempted to quickly address the issue by implementing a higher group LTD maximum benefit. However, this type of quick fix can lead to two potential complications and additional hidden financial risks.

1. Group LTD carriers often reinsure monthly benefit amounts above $10,000 - $15,000, depending on certain risk factors. This reinsurance cost is factored into the rates, resulting in higher group rates for ALL employees, not just those in need of the higher coverage level. These higher rates can create an additional financial burden for the employer and reduce the overall affordability of the group LTD plan.
2. A higher monthly maximum benefit in the group LTD plan can make the plan vulnerable to "shock claims", which are sudden and unpredictable claims that can severely affect the financial stability of the plan. If the plan lacks sufficient reserves to cover such claims, the carrier may have to raise the rates for the entire group in the future, resulting in rate volatility that can be difficult for both the employer and employees to manage and plan for.

Combining LTD and Supplemental Individual Disability Insurance for a Comprehensive Restoration Solution

An effective solution for ensuring comprehensive income protection is to combine supplemental individual disability insurance (IDI) with the group LTD plan. IDI is an additional layer of disability coverage that can work alongside group LTD plans to provide restorative coverage to employees whose incomes cannot be fully covered by the group LTD plan alone. This helps to bring their combined disability coverage back to the intended levels and equalize LTD benefits across all employees, without adding risk the group LTD plan.

Another benefit of IDI policies is their full portability, which enables employees to take their coverage with them even if they change jobs. This key feature can help employees maintain a cornerstone of financial wellness throughout their career.

It is crucial for employers to ensure that their employees have adequate long-term disability coverage regardless of their level in order to safeguard them and their families from financial instability and potential bankruptcy. Conducting a diagnostic analysis of the current group LTD plan is the first step towards identifying any gaps in coverage and implementing necessary changes to provide better financial security for employees.