A ruling by a federal judge in California offers new and significant insight into whether disability insurers properly offset dependents' Social Security disability benefits. Carstens v. United States Shoe Corporation's Long-Term Benefits Disability Plan, 2007 U.S.Dist. LEXIS 96094 (N.D. Calif., Oct. 31).

Group disability insurance policies typically offset the beneficiary's primary Social Security disability benefits to avoid double payment of benefits to cover lost income. However, it has been increasingly common for disability insurers to also offset Social Security benefits paid to the primary wage earner's dependents even though such benefits serve a different purpose.

The disability plan at issue in Carstens provided that monthly benefits are offset by ''payments or other compensation described in the applicable offset provisions below and which, for that month, are payable to the employee, or to his spouse or children, on the basis of the employee's employment and earnings record.''

The plan further allows an offset for ''periodic benefits, for loss of time on account of the employee's disability, under or by reason of … (1) any insurance or any health or welfare plan or other employee benefit plan where the employer, directly or indirectly, has paid all or any portion of the cost or made payroll deductions; (2) the U.S. Social Security Act as amended from time to time, exclusive of benefits paid to a former spouse of the employee or to a child of the employee residing with such former spouse.''

The key phrase in that provision is ''loss of time,'' and the court determined that Social Security dependent benefits do not properly fall under that heading. The term ''loss of time'' has been discussed in a leading insurance treatise to mean ''income a person can no longer earn after sustaining either a permanent or temporary disability. Insurance policies can compensate for both 'loss of time' and the disability itself, and many cases have found that 'compensation for the disability and compensation for the lost time are two different things.' '' Couch on Insurance, section 182.9, (3d ed. 2007).

The court added citations to cases that insure against both total disability and ''loss of time,'' which are intended to encompass protection against disabilities ''that result in the insured's inability to perform any occupation and those that prevent the insured from performing the duties his current employer requires.'' Id. (citing Snelson v. Penn Life Insurance Co., 65 Ill.App.2d 416 (5th Dist. 1965)).

Although the court acknowledged that many cases have allowed offsets of dependent Social Security benefits, the court pointed out that such payments are not a substitute for the disabled parent's lost income — ''i.e., 'loss of time.' Rather, they are payments to children ''for the purpose of their support and maintenance.''

Further, even though Lawrence v. Prudential Insurance Company of America, 2005 WL 2671357 (W.D. Wash., Oct. 19, 2005), found dependent benefits to constitute ''loss of time'' benefits, the Carstens court noted that there was no challenge made by the plaintiff as to the propriety of the offset. Another case cited by defendant, Cooperative Benefit Plan Administrator. v. Whittle, 989 F. Supp. 1421 (M.D. Ala. 1997), was also distinguished because the court never considered the issue of whether dependent benefits qualify as ''loss of time.''

The court relied on the Social Security statutory scheme as supporting its conclusion that children's benefits may not be classified as ''income replacement.'' Such benefits are ''designed to replace the support the … children would have received had their parents continued to work.'' Citing Matthews v. Lucas, 427 U.S. 495, 507-508 (1976); Mornes v. Chater, 91 F.3d 1403, 1404-1405 (10th Cir. 1996); Trammel v. Bowen, 819 F.2d 167, 169 (7th Cir. 1987).

That conclusion is further supported by the fact that the benefits continue even after the parent dies. In addition, because the law mandates specific uses for the children's benefit, that buttresses a conclusion that there was no congressional intent to have the benefits considered ''loss of time.''

The court explained: ''Although the benefit check is sent to the parent, it is specifically for the dependent child's use. Id. The parent can only spend the Social Security benefits on the child's needs and must complete an annual accounting to document how the money was used. Id. Further, if there are remaining funds, the parent must place them in an interest-bearing account and cannot simply put them to the family's use. Id. at 12. Finally, if the dependent child dies, the remaining funds go to his or her estate, not to the parent.''

Citing In re Unisys, 97 F.3d 710, 717 (3d Cir. 1996), the court pointed out that the parent, acting as representative payee, ''is not the recipient of the benefits, but rather a person the SSA can trust to administer the funds in the child's interest.''

Finally, the court dismissed the defendant's argument that the benefit is calculated based on the disabled parent's income by finding that the method of calculation was ''not dispositive. Congress intended to replace the support a child with disabled parents recently lost, and could reasonably choose to do so by relating benefits to the parent's former income.'' Thus, the court held that the children's benefits could not be offset under the policy.

This ruling makes it very important for counsel who represent disability claimants to carefully examine the policy provisions that relate to benefit offsets. Although several court rulings have found that policy provisions that allow dependent benefits to be offset are permitted (See, for instance, Lopez v. Commonwealth Oil Refining Co., 833 F.Supp. 86 (D. P.R. 1993); Godwin v. Sun Life Assurance Company of Canada, 980 F.2d 323 (5th Cir. 1992)), none of those rulings has addressed the issue presented here.

In the face Carstens, though, in situations involving comparable policy language, the right to take the offset of dependent benefits should not be assumed.

In addition to Carstens, a similar ruling was issued by the Illinois Appellate Court. In Meeks v. Mutual of Omaha Insurance Co., 70 Ill.App.3d 800, 802, 388 N.E.2d 1362, 1363 (3d Dist. 1979), the court disallowed an insurer's deduction of benefits awarded to the dependent of a Social Security disability benefits recipient, holding, ''Social Security regulations require that such payments to a relative on behalf of a beneficiary must be used for current maintenance of the beneficiary and any not needed for that purpose must be conserved or invested on the beneficiary's behalf. (Social Security Reg. No. 4 — subpart Q, sections 404.1604, 404.1605.) Hence, the payments made on behalf of plaintiff's daughter, while triggered by plaintiff's disability, nevertheless were not income to plaintiff or available for her needs. If the daughter were capable of receiving such payments in her own behalf, then the benefits would have been paid directly to her, and there would be no question of reducing plaintiff's disability income by the amount involved.''

Accordingly, because dependent benefits are not considered income to the insured, offsets for such benefits should be disallowed as a matter of public policy.