Are you considering a buyout of a disability insurance policy? Are you wondering how lump-sum payouts work for disability insurance policies? Want to know if a buyout makes sense in your situation?
I answer all these questions in this article. And I cover the three things you must know before you even mention the word “lump-sum buyout” to your insurance company.
DISCLAIMER: We do not represent people in lump sum buy-out negotiations if they are on an approved LTD claim.
What is a Lump-Sum Buyout?
Quite simply, a lump-sum buyout is when your disability insurance company agrees to make a one-time payment to you. They do this in exchange for you agreeing to sign away your rights under the policy.
This lump-sum payment represents the value of future disability payments. But, you receive a one-time payment rather than a series of monthly payments in the future.
It is referred to as a buyout because the insurance company is buying you out of the policy. Once you accept a lump-sum payout, the insurance company no longer has a financial liability to you under the policy.
Lump-sum buyouts are not right for everyone. Also, you have no right to get a buyout. This is something the insurance company agrees to do voluntarily. In all cases, a lump-sum buyout is something the insurance company will look at on a case-by-case basis.
Most major disability insurance companies in Canada will consider lump-sum buyouts in some situations. This includes Manulife, Great-West Life, Sun Life, Blue Cross Life, RBC Life, Desjardins Financial, Industrial Alliance, and others.
This article is part of our Ultimate Guide to Long-term Disability Benefits in Canada.
3 Things to Know Before Mentioning a Buyout of a Disability Insurance Policy to Your Insurance Company
Lump-sum buyouts need to be handled very delicately. If you don’t, then the whole situation can blow up in your face. The following are three things you must know before you ever say the words “lump sum buyout” to your insurance company:
1. How do insurance companies calculate the value of lump-sum buyouts for disability benefits cases
A lump-sum buyout is a negotiation. Insurance companies are in the business of making or saving money. In order for your insurance company to agree to a buy-out, it has to make financial sense for them.
With this in mind, you have to understand that you are never going to get 100% of the value of your future benefits. Think about it. Why would an insurance company ever do that? People would get fired. For example, at the very least, there is a chance you would die before the end of the benefit period. Long-term disability insurance benefits do not pass on to your family after your death. If you died tomorrow, the insurance would no longer have to pay you.
So, insurance companies decrease the value of future benefits to reflect your mortality risk.
When calculating the value of a lump-sum buyout amount, the insurance company will consider the following factors:
- Your life expectancy and mortality risk
- The present value of your future benefits
- The current yield of commercial bonds
- The reserves set aside for your claim
- How strongly do they view the current proof of your disability?
- How likely is it they could convince a judge or jury that you could do some type of work
When negotiating a lump-sum buyout, the insurance company will take into account all of these factors. This can result in a wide range of possible buy-out offers. But, even in the best-case scenario, the buy-out offer will rarely exceed 75% of the present value of your future benefits.
Present value is a key concept that most disability claimants do not understand. Most disability claimants vastly overestimate the value of their future benefits.
Calculating the value of future benefits is tough. You do not simply multiply the monthly benefit amount x 12 months x years left to pay. This will result in an overinflated figure. The proper method is to calculate the present value of your future payments over the benefit period. You need to use a calculator to calculate the present value.
For example:
Let’s assume that you get paid $3,500 per month. You are 50 years old, and the benefit period under your policy is to age 65. Let’s look at the wrong and right ways to calculate benefits so you can see the difference.
Wrong way: $3,500 / month x 12 months x 15 years = $630,000
The right way: The present value of $3,500 per month at an interest rate of 4% to age 65 = $432,478
As you can see, the difference between the straight calculation ($630,000) and the present value calculation ($432,478) is almost $200,000. This shows the extent to which you can overestimate the value of your future payments.
You can also check out our long term disability payout calculator to get a better idea of this.
2. Beware of letting the cat out of the bag
If you’re receiving monthly long-term disability payments, you need to be cautious in how you approach your insurance company for a lump-sum buyout of your policy. You don’t want the insurance company to take this the wrong way. You don’t want to inadvertently say things that may invalidate your right to disability benefits.
I have seen people create an absolute dumpster fire of their claim by mishandling their inquiry regarding a buyout. The problem is when you approach an insurance company about this on your own; the conversation always turns back to: “why?” Why do you want a buyout? The insurer will feign interest. What they’re really doing is getting you to say all kinds of things that make you look bad. They are trying to make you give them grounds to stop paying your benefits.
For example, you don’t want to tell them you want the money so you can start a business. Even if your intentions are pure, and you are truly disabled, this type of statement makes it seem like you can work — and you just want the insurance company to pay for your business. This doesn’t look good. This can lead to a cut-off of your benefits because they will say you obviously believe you can work.
Oftentimes, an inquiry alone will trigger alarm bells and red flags. The insurance company will question your motives and think maybe this person really can work. They will assume you just want a payout so you can get the money and return to work. The insurance company will be very concerned about this. This is because they don’t want to get duped. In this situation, it’s easier for them to attribute ill motives to you and to look for ways to cut off your payments.
3. Does a lump-sum buyout of your disability insurance policy make sense for you?
A lump-sum buyout of a disability insurance policy is not the right choice for everyone. As we discussed above, you will not get the full value of your future payments. You will only get a percentage of your future payments.
If your proof of disability is absolutely rock solid (this is very rare, and your claim is probably not as solid as you think it is), then you will potentially get more money if you get the monthly payments over time. If you know, you are bad with money or have a spouse who is bad with money; then you may be better off keeping the monthly payments. Once you spend the lump sum, that is all you get. You can’t come back for more.
If you have been receiving disability benefits for less than two years, most insurance companies will not consider a buyout beyond paying you to the two-year mark. You have to have been receiving benefits for more than two years before insurance companies will consider a buy-out.
Finally, if your long-term disability benefits are taxable as income, then you need to be very careful with negotiating a lump sum buyout. You don’t want to be taxed on the entire lump sum in one year.
There are situations, however, where negotiating a lump sum buy-out of your long-term disability policy makes sense:
- You think your health could improve, and you could return to some type of work if you had a period of financial security
- Your benefits are non-taxable as income
- There are concerns about your life expectancy (monthly payments end when you die, but your family keeps a lump sum after it is paid)
- You want to try and return to work without having the insurance company looking over your shoulder
- You want the insurance company out of your life
- The uncertainty of benefits being cut off or delays in payments into the future are stressing you out, and you want that worry gone
- Your proof of disability isn’t rock-solid
- You want the lump sum of money to use for a new business venture that could accommodate your disability or limitations
Final Thoughts
A lot of people come to us and ask for help negotiating a lump-sum buyout. However, we do not represent people in lump sum buy-out negotiations if they are on an approved LTD claim.
In our opinion, buyouts are rarely a good idea for people on an approved disability claim — unless the insurance company has approached them. Even then, it is rare that a buyout makes sense for most people.
We do not give specific advice about lump-sum buyouts in a free consultation either. However, we do offer paid services to provide legal advice / a document review for those who have been offered a lump-sum buyout from their insurance company.
If you are appealing a denial of disability benefits, we can represent you and will negotiate buyouts in the context of an appeal or denied disability claim.
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