Addressing Gaps in Executive Disability Coverage

January 26th, 2018

Risk continues to be an important issue for the banking industry. But what about the personal risk facing a bank’s valued executive? How should personal risks be addressed within a banker’s executive compensation plan and more specifically, what is the impact to the compensation plan if the executive becomes permanently disabled?

The Income Replacement Problem
Group long-term disability (LTD) plans provide excellent coverage for most workers, but leave gaps for highly compensated employees (HCEs). This is due to limitations on the amount of base salary covered, and the lack of coverage for bonuses, stock-based compensation and retirement plan contributions, including 401(k) plans and nonqualified plans such as supplemental executive retirement plans (SERPs). As a result, HCEs often end up with only 30 to 50 percent of their earnings protected, while most broad-based employees achieve more significant income protection. The following chart, which is an example, provides an illustration.

Title Base Salary Base Total Annual Compensation Total Monthly Compensation Monthly Group LTD* % Comp. Replaced
CEO $200,000 $150,000 $350,000 $29,167 $10,000 34%
SVP $175,000 $100,000 $275,000 $22,917 $8,750 38%
VP $100,000 $30,000 $130,000 $10,833 $5,000 46%
AVP $75,000 $15,000 $90,000 $7,500 $3,750 50%
Manager $50,000 $5,000 $55,000 $4,583 $2,500 55%

*60 percent of base salary to a maximum of $10,000 monthly benefit

Many HCEs are unaware of this potentially significant loss in earnings should they become disabled.

As another complication, retirement plans stop being funded when a disability occurs. For example, an HCE no longer contributes to the 401(k), and therefore no longer receives the matching company contribution. If the HCE has a nonqualified plan like a SERP, the plan normally provides for vesting in the accrued liability at the time of disability but does not provide additional credits to the account after the disability occurs. With a drastically reduced monthly income, it is difficult, if not impossible, to save for retirement.

While it can be an uncomfortable topic, and most people do not think it will happen to them, the fact is that disabilities do occur. But bankers are in the risk mitigation business: Once they understand this risk, they typically want to do something about it.

An Integrated Solution
Combining group LTD coverage with individual disability coverage provides the executive with a solid, well-thought out plan that can solve the gap in coverage, help attract and retain top talent, and keep the bank’s costs in check. By using company-sponsored individual policies rather than retail individual policies, the policies can be issued on a guaranteed issue basis and at a significant discount. Furthermore, the premiums are fixed, and the policies are portable and can’t be cancelled. Below is an example:

Title Total Monthly Compensation Monthly Group LTD* Individual Disability Income Total Disability Income % Comp. Replaced
CEO $29,167 $10,000 $11,875 $21,875 75%
Sr. VP $22,917 $8,750 $8,438 $17,188 75%
VP $10,833 $5,000 $3,125 $8,125 75%
AVP $7,500 $3,750 $1,875 $5,625 75%
Manager $4,583 $2,500 $938 $3,438 75%

The policies can be offered on a voluntary basis, and paid for by the employee or by the company. If company-paid, many banks invest in bank-owned life insurance (BOLI) as a way to offset and recover the cost, while others feel the expense is not that significant. In either case, it is well worth the expense as another tool to attract and retain top talent.

The shortfall in income replacement is a real problem for higher income earners should they become disabled. With the recent decrease in corporate tax rates, now would be a great time to explore solving this issue. Corporate-sponsored individual disability programs, when integrated with a group disability program, can protect HCEs from this risk in a cost-efficient manner for the employee and the company, while also providing one more important element in the ongoing desire of the bank to attract and retain key officers.

dshoemaker

David Shoemaker, CPA/PFS, CFP®, is a consultant of Equias Alliance, an NFP Company, which through consultants has assisted over 800 banks in the design of nonqualified benefit plans, performance based compensation and BOLI. To learn more, contact David Shoemaker at 901-754-4924 or dshoemaker@equiasalliance.com.

kderks

Ken Derks is a consultant of Equias Alliance, an NFP Company, which through consultants has assisted over 800 banks in the design of nonqualified benefit plans, performance based compensation and BOLI. To learn more, contact Ken Derks at 469-252-1037 or kderks@equiasalliance.com.