LTD Buy Outs

A long term disability (“LTD”) benefit “buyout” is where the insurance company pays a lump sum instead of continuing to make monthly payments in the future.  Should you accept a buy out?  A buy out will always be less than the possible total amount of future benefits remaining, for which there are valid reasons.

The insurer will continue to reassess the claim.  The insurer may believe that it is possible for your condition to improve, at which point your benefits will be terminated.  That is why insurers do surveillance, and pay “IME” doctors thousands of dollars to opine that the claimant has improved.  The insurer will also want a discount to reflect the chance that you might die from some unrelated cause.

I typically advise my clients that their only concern should be if the buy out makes financial sense – could they invest the lump sum to earn approximately what the monthly payouts would equal. To determine if a buy out makes sense, you should always discuss it with your financial advisor, who can evaluate the present value formula that the insurer is using.  To oversimplify, if you win a lottery, you can choose a lump sum or annual installment payments.  The former is always smaller than the total amount of the jackpot.

The key to analyzing the present value is the “discount rate,” which is an interest rate.  A lottery uses a discount rate to reflect the annual rate of growth of the invested lump sum for a typical individual, which is what the present value of a lump sum is supposed to do.  Disability insurers knowingly misuse the term present value.  Instead of using an interest rate that reflects the expected rate of investment growth, the disability insurer uses the corporate bond rate because that supposedly reflects the cost to them of borrowing to pay for the lump sum.  However, that has nothing to do with the present value of a lump sum to you; only the cost of the lump sum to them.

Most of the time, we advise claimants that buy outs are offering far too little relative to the overall claim.  We negotiated a buy out for a Unum client today.  The claimant understood that there was a significant discount for Unum.  However, the claimant already had to relocate from Queens to Upstate New York where the cost of living is lower.  After discussing the buy out with financial advisors, despite the discount, the claimant felt she had to accept the buy out due to financial stress.