If you have been receiving long-term disability (LTD) benefits for a while, and/or your medical condition is chronic and unlikely to improve, it is not uncommon to receive a letter from your LTD plan offering a lump sum settlement of your disability claim. Sometimes called a “policy buy-out,” these offers represent a calculated decision by the LTD carrier that the continued cost of administering your LTD claim is not justified. To reduce administrative costs and save money, LTD plans offer plan participants a lump sum of money – usually 50% or less of the total value of their LTD claim – in the hopes that the participant will accept, and the claim can be closed.
There are many reasons such offers may seem attractive to you, including:
- Freedom to control how you spend your LTD benefits (as opposed to having them meted out in monthly installments)
- Freedom from disability paperwork obligations
- Fear of future benefit denials.
But should you accept a policy buyout if one is offered? In general, we counsel clients against it. This article will examine the pros and cons.
(Note that this article does not address settlement in the context of litigation. See my colleague Mark DeBofsky’s article, “Should I Mediate My Insurance Claim?,” for a discussion of whether to accept a lump sum settlement once your case is in suit.)
What Is an LTD Policy Buy-Out?
An LTD policy buy-out is a lump sum payment offered by an LTD plan to a plan participant in exchange for his or her surrender of coverage. An LTD plan can offer a policy buy-out at any time. In general, such offers are commonly made after the initial approval of your LTD claim (if your diagnosis is one from which no improvement is expected). They can also be offered following a successful appeal of the denial of your disability benefits or after your LTD benefits have been paid for some time and there has been no improvement or change in your medical condition. If the amount of your LTD benefits is dramatically reduced by Social Security disability benefits or another source of deductible income, such that the ongoing claims administration expenses are not justified, that can also trigger an offer of a policy buy-out.
How Are LTD Policy Buy-Outs Calculated?
The amount of the policy buy-out is determined by actuarial assumptions that include a mortality factor (an estimate of how long you are likely to live). The offer is also discounted to present value to account for the time value of money. Even after adjusting for present value, most LTD policy buy-out offers range from 35-65% of the total value of the LTD claim, sometimes even less.
You can counter the insurance company’s initial offer to try to increase the amount of the settlement, but such negotiations rarely yield an increase of more than 10-15% above the initial offer. The limited negotiating room is a function of the calculated nature of the original offer amount and underlying actuarial assumptions.
Should You Accept a Long Term Disability Policy Buy-Out?
Given the economics, why would you accept an amount of money equivalent to half (or less) of the total value of your LTD claim? Here are some common reasons:
- Flexibility: Receiving your LTD benefits in a lump sum, even in a reduced amount, gives you greater flexibility in how you spend those benefits. You may choose to spend the money on a house or car; pay down debt; or invest in the stock market or a business venture.
- Opportunity Costs: You may be eligible for a pension or other source of income that would otherwise reduce the amount of your LTD benefits. If the LTD plan neglects to consider that income in its actuarial assumptions, the offer may become much more attractive.
- Closure: You or your doctors may be tired of dealing with your LTD claim adjuster’s requests for paperwork. You may be tired of worrying about surveillance of your daily activities. You may be tired of living under the constant stress and fear of having your LTD benefits terminated. Some people are willing to accept a significant discount of value of their LTD claim in exchange for peace of mind and closure.
While the forgoing considerations are important, it’s even more important that you have adequate resources to pay your monthly living expenses. If your LTD benefits are your main source of income, it is not usually prudent to accept an LTD policy buy-out, absent special circumstances. For that reason, we generally counsel clients to decline offers of an LTD policy buy-out.
Before accepting an LTD policy buy-out, you should contact an attorney and financial advisor to determine the impact of that decision on your financial future. You should calculate the total value of your LTD claim using a present value of an annuity calculator and a conservative discount rate (we recommend no more than 3%), and compare that amount to the amount you are being offered. If the amount offered is significantly less than the total value of your LTD claim (adjusted to present value), you should give serious thought before proceeding. You should also confirm whether the LTD policy buy-out will impact your other employee benefits, such as your health and life insurance, which can be tied to your LTD coverage.
Receiving an offer of an LTD policy buy-out can be exciting, but it’s important to approach the negotiations with a cool head. As tempting as it might be to accept the insurance company’s offer, remember that the offer is usually more advantageous to the insurer than to you. For that reason, it is always in your interest to consult a lawyer before accepting an LTD policy buy-out.
If you receive an offer of an LTD policy buy-out or have other questions about your LTD coverage, contact the experienced attorneys at DeBofsky Law