37. Disability Insurance in Business Agreements

Sole proprietors, partners, and shareholders in a small corporation accept the need for insurance-funded buy-sell or stock redemption agreements to provide for continuation of the business in the event of a death or retirement. Less recognized, but perhaps even more important, is the need to provide for continuation of the business in the event of
disability. The 1958 C.S.O. Mortality Table indicates that for a 30-year-old man, the probability of death prior to age 65 is only 29%. According to statistics based on the 1964 Commissioner's Disability Table, however, a man at age 30 has a 52% chance of becoming seriously disabled before reaching age 65. For a 40-year old, the figures are a 27% chance of premature death and a 47% chance of disability.

Business owners may need two-way protection in the event of disability. First, they have to consider providing for adequate income to meet routine personal expenses, including increased medical expenses, through a disability income program. Then, they must protect the value of their ownership interests, which can most easily be accomplished by
expanding a buy-sell agreement to cover the risk of total disability.

An Owner's Disability May Jeopardize the Continued Existence of the Business. Similar to a death or retirement that has not been adequately provided for, the loss of an owner of a business because of total
disability can create the following hardships:

Impair credit standing and cause forced sale at a distressed price.

Necessitate sale to parties not compatible with the interests or
philosophies of remaining management.

Reduce employee morale because the future of the business may be in
doubt.

Cause economic hardships to the business if a totally and permanently
disabled owner continues as an employee.

Create future problems if a totally disabled owner retains a decision-
making position.

Impose adverse tax consequences.

Advantage of Having a Buy-Sell Agreement in Event of Disability. Tied in with the importance of continuing the business are the personal advantages to the remaining owners, as well as to the disabled owner and
his family. On the remaining owners' side, an agreement:

Guarantees that a disabled owner's interest in the business can be
obtained at a definite price.

Guarantees that the active owner can continue control of the
corporation.

Guarantees that the active owner can keep the family of the disabled
owner out of the business.


Enables the active owners to participate in the future growth of the
business.

Guarantees that a competitor cannot purchase ownership interest in the
business from the disabled owner.

Guarantees continuity of management in the business, which makes the
business more attractive to customers, creditors, and employees.


FOR THE DISABLED OWNER, AN AGREEMENT:

Guarantees a market for ownership interest in the business at a
definite price, so that he can convert the appreciated value of his
business into cash.

Guarantees that the disabled owner's family does not have to become
involved in the business in order to protect the total family's
interest.

Frees the disabled owner and his family from the risk of future
business losses.

Creates funds which may be used to pay medical bills and living costs
of his own family, thus protecting the rest of the family's estate.

Creates peace of mind--the disabled owner can rest in comfort knowing
that he has retrieved his investment in the business organization and
does not have to continue to worry about its future.


FORMS OF AN AGREEMENT:

CROSS-PURCHASE OR ENTITY-PURCHASE: As under a buy-sell agreement funded by life insurance, a disability buy-sell agreement may provide either for the surviving individuals or the business to purchase the owner-
ship interest.

CROSS-PURCHASE: Under this arrangement, the owners agree that if one of them becomes disabled, the others will purchase his interest at a stipulated price. They own the policies on one another, pay the premiums,
and receive the benefits if an owner's disability triggers the buy-sell agreement.

A cross-purchase arrangement is best suited for a business with only a few owners. As an example, six policies are necessary when there are three principals. The number of policies increases geometrically as more persons are involved.

ENTITY-PURCHASE: Under this arrangement, the business organization and the owners agree that the business organization will buy the disabled owner's interest. The business organization owns the policies, pays the
premiums, and receives the benefits. Under this method, all owners share the cost of premium payments.

Tax reference verification 1-800-829-1040

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