Guardian: The Only CBA Approved True Own-Occupation Plan for Attorneys

This narrative will address the key issues to focus on when considering disability insurance with a "Return of Premium" feature vs. a policy without this feature.

When making a financial planning decision, like the purchase of disability insurance, it is important to focus on the future financial implications and ramifications of your buying decision. The first and foremost consideration should be the quality of the underlying disability contract. The bottom line is this: the quality of the contract (and of course, the issuing company), will determine if, how, when, and how long you are paid income if you become partially or totally disabled. Isn’t this why we buy insurance coverage in the first place? Especially for an attorney, the quality of the underlying contract is the most important consideration.

The "Return of Premium rider" is an optional feature of a disability income policy that is issued by very few companies. Currently, Principal Mutual, Pan American, Mutual of Omaha and Ohio National offer this option in most states. The option on the disability contract basically says that the insurance company agrees to refund 80% of the total premiums paid into the plan after 10 years minus any claim dollars that are paid to the insured. The insurance company charges approximately 60% extra for this option over and above the basic cost of the insurance. There is no investment vehicle attached to the policy, and no real return on the extra money that is put into the plan.

When the insured enters into one of these "Return of Premium" contracts, they are merely paying about 60% extra for their coverage in the hopes that they’ll receive an 80% refund after 10 years. Any "return" on the investment that is shown by agents selling this coverage is "phantom" return. The insurance company is borrowing your money (in the form of the extra premium), and reducing their risk on the policy because the insured is funding their own short-term disability claim. The insurance company is certainly investing the extra premium dollars for their own account during those 10 years and is merely giving it back plus a percentage of the basic premium if no claims have been filed. Remember… the refund is reduced dollar for dollar for every claim dollar that the insured receives over the 10-year period. A 10-year period of time is much too long to assume that you’re not going to suffer any type of disabling accident or illness. It only takes a short-term claim (about four months of benefits) to wipe out a "Return of Premium" refund.

In my opinion, the "Return of Premium" option is a poor buy. In my years of experience in the disability insurance industry, I have never met a financial planner, accountant, or practice manager that endorsed this type of policy. Many of the financial professionals that I have talked with over the years feel very strongly that any extra money that the insured has should be invested outside the disability policy. If the insured becomes disabled anytime during the 10 years of the contract, their investment outside the policy will likely be intact. Inside the policy, the investment would be lost. With the "Return of Premium" disability policy, a relatively short claim of four months or longer will likely eliminate the entire refund – the extra premium that could have been invested elsewhere is gone. It’s just too risky. The opportunity cost that is lost with this option is significant. That extra premium could be at work in a real investment (like an IRA, Mutual Fund, individual stocks or bonds, or your own business!), which is not affected if you file a disability claim.

A few agents who encourage their clients to buy these "Return of Premium" policies play a dangerous game with numbers to make the sale. In their effort to show the phantom "rate of return" soar on these policies, they carelessly encourage their clients to violate IRS tax code regarding the deductibility of insurance premiums and tax treatment of the premium refund, if ever received.

The danger lies in three areas. First, these agents encourage their clients who own S Corporations to deduct their full personal disability insurance premium, which is specifically prohibited in the IRS tax code. Only owners of C Corporations may deduct personal disability insurance premiums. Secondly, even though the C Corporation can deduct the personal disability coverage premium, if the return of premium is received after ten years, then the refund is taxable income in the eyes of the IRS because it was fully deducted. These agents dangerously encourage their clients to hide this refund and not run it back through their business. They justify this recommendation because there is no 1099 issued by the insurance company for the refund. This activity is still careless and illegal and would be found in an audit….and guess who’s responsible….you are! The third danger is basically the same as the second above, but involves the Overhead Expense policy with the premium refund option. Although the premiums for Overhead coverage are deductible for any type of business entity, the refund after ten years, if received, is taxable because it was deducted previously as a business expense.

The bottom line is this: you don’t have to rely on gimmicks and tax evasion to realize a good return on your money. Simply buy the best coverage that you can for the protection it affords, and then take the savings and invest it in a real investment vehicle outside the disability policies. Taking dangerous and unnecessary risks is simply not necessary.

As I mentioned at the beginning of this article, quality of contract is our most important consideration when making an insurance or financial planning decision. Especially with disability insurance, having the best contract provisions available is what matters most. Why do we buy insurance coverage in the first place - to protect ourselves and reduce our risk? Unfortunately, in the insurance industry, some agents choose to sell gimmicks rather than the best quality policy. It can be compared to buying a car in some respects. Although it may look good on the outside, it could be a "lemon" mechanically.

The important features to look for in a quality disability contract are:

In conclusion, I am of the opinion that the "Return of Premium" option is dangerous for two reasons. First, the chances of disability over a ten-year period of time for the general population are significant. For professionals who work in specialty occupations like lawyers, dentists and physicians, the risk is even greater. If you become disabled during the ten-year period in which the refund is based, you lose big time. The entire refund would be gone with about four months of total disability or eight months of partial disability. Second, the quality of the policies that this option are attached to are not the best available. Although the companies mentioned are strong companies (which is important), the quality of the contract determines if and how you get paid. Isn’t this why we’re buying the coverage in the first place – for the protection it provides?

Be sure to ask you own accountant or financial advisor their opinion on this "Return of Premium" contract. Most will tell you to buy the best quality policy that you can and take any extra money that you have and invest it outside the policy. You can get real growth out of your money and won’t lose your investment because you have to file a disability claim.

If you’re really considering this policy, ask yourself this question: do I really want to lend an insurance company several thousand dollars over the next ten years and receive no interest on the loan… and if I become disabled, they keep the money I’ve lent them? I didn’t think so.