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Should you consider a disability insurance policy buyout?

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If you have long-term disability insurance, it is possible you will be presented with an opportunity to take a lump-sum buyout and surrender your policy.

This course of action has many advantages, but may not be the right decision for every policyholder. Before you agree to a lump sum buyout, it is important to be aware of the terms and conditions and carefully consider the pros and cons.

What is a buyout?

Also referred to as a settlement, a disability insurance buyout is exactly as it sounds - the one-time, lump-sum payment buys out the life of an individual's policy or claim.

If you receive a buyout, you agree to relinquish your rights under your disability insurance policy and release the insurer from any further obligations stated in the policy.

Why insurers offer buyouts

The reasons for offering a buyout can differ from insurer to insurer and from case to case. Some insurers may not offer them at all.

Common reasons for proposing a buyout include cost-saving measures in a variety of scenarios, including:

  • A lawsuit has not yet been filed to fight a denied or terminated claim
  • A lawsuit has been filed, but has not progressed far yet
  • A lawsuit has been filed and the case has been litigated extensively
  • A policyholder has been on claim for a substantial amount of time

How buyouts are calculated

How do insurers calculate a policy buyout? Each company has its own methodology to determine the exact amount.

Insurers will generally look at your mortality rate - whether you will live to your policy's maximum payable benefit period - as well as your morbidity rate, or the likelihood that you will recover before you reach the maximum benefit period.

Insurers may also consider the following in their calculation:

  • Your current age
  • The likelihood that you will remain totally disabled or residually disabled
  • The current corporate bond rate
  • The amount of reserves set aside by the disability insurance company for your policy
  • The present value of future monthly disability income benefits potentially owed to you

The present value is a calculation insurers use to account for the time value of money. It determines what amount of money you would need to get today, by assuming a specific interest rate, in order to equal an amount in the future.

In other words, if your benefits amounted to $150,000 per year, and you had 10 years remaining on your policy, you might think your policy would be worth $1.5 million.

However, your policy would be worth the present value of $1.5 million, or how much money you would have to invest right now in order to get to $1.5 million over the next 10 years.

Your buyout offer will be discounted to this present value of your policy or claim.

Keep in mind, this offer will not amount to 100 percent of the present value, because there is no financial benefit for insurers to do so. Insurers will likely deduct for any applicable offsets, such as Social Security disability insurance (SSDI).

While they may pay for any applicable cost of living adjustments (COLA), this amount will vary based on whether the insurer chooses a compound or simple interest rate.

Your insurance company may apply one final discount in order to make a profit and justify the buyout offer.

The multitude of factors that are considered in calculating a buyout can sometimes make it difficult to know if you are receiving a fair and reasonable offer.

Learn more about potential deductions and discounts insurers may take from your benefit amount to determine your policy's actual worth.

Pros of a buyout

There are many reasons you may consider accepting a LTD insurance buyout from the insurer, rather than filing a claim or staying "on claim" if you're already receiving benefits.

Buyouts can provide your loved ones with extra security that your policy may not. Generally, LTD insurance policies do not contain rights of survivorship, meaning that your disability benefits cease when you die and cannot be inherited by surviving relatives.

However, a lump-sum payout is yours to keep and to pass on to family upon your death, if you so choose. This money is also tax-free and can be invested in the manner you prefer, such as paying down debt or creating a retirement fund.

Furthermore, a buyout eliminates a common concern many disability claimants have: that the insurer will deny or cut off benefits.

The legal fight to restore wrongfully denied benefits can be a lengthy process that saddles many claimants with emotional distress and financial woes.

If you accept the buyout, you will no longer be required to continually provide medical documentation supporting your state of disability, an often-difficult aspect of being on claim.

On the other hand, a buyout may also make it possible for you to pursue other forms of employment (that do not conflict with your medical symptoms) without losing your benefits.

Cons of a buyout

You may find that a buyout, despite its many advantages, is not favorable to you and your specific situation. Fortunately, you do not have to accept one, as buyouts are considered voluntary, extra-contractual arrangements.

For example, it is possible you may receive an offer that undervalues the remaining benefits of your policy.

If you happen to have 'a "lifetime payout" in your occupation and a family history of longevity, you may not consider a buyout to be advantageous.

There is also the concern of financial management; if you worry about your ability to manage a large sum of money - as opposed to the monthly payments a disability claim would provide - it may be prudent to turn down the buyout.

Have questions about your buyout offer?

The buyout negotiation process can be challenging to navigate on your own. If your insurance company has offered you a buyout, it can be beneficial to consult a top-rated disability insurance attorney about your options in order to make a confident, informed decision.

Contact our experienced legal team today for a free consultation on your disability insurance matter.

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