Lump sum buyouts are a frequent source of questions from our clients and potential clients. With that in mind, the next few posts will address different aspects of the buyout process.
Buyouts typically occur in one of two situations: 1) after you’ve been on claim for several years, or 2) after a lawsuit has been filed. This blog post will focus on the first scenario.
Lump sum buyouts that occur outside of litigation normally won’t occur unless and until the insurance company decides that you are totally and permanently disabled under the policy definition. Typically, the insurer won’t consider whether this is the case until you’ve been on claim for at least two years. If the insurer determines that you’re totally and permanently disabled, it will then determine whether it makes sense financially for the company to offer you a percentage of your total future benefits rather than keep paying your monthly benefits for the entire duration of your claim.
To understand how the insurance company calculates whether a buyout is in its financial interest, you should understand how insurance company reserves work. The purpose of reserves is to ensure that the insurance company has the resources to fulfill its obligations to policyholders even if the company has financial difficulties. Thus, disability insurers are required by state regulators to keep a certain amount of money set aside, or “reserved,” to pay future claims. Any money required to be kept in a reserve is money that the insurer can’t spend on other things or pay out in dividends. The amounts required to be kept in the reserve are determined by the state, depending on factors like how much the monthly benefit is and how long the claim is expected to last.
For a disability insurance claim, a graph of the required reserve amount over time looks like a Bell curve: low at the beginning, highest in the middle, and low again towards the end of the benefit period. The ideal time for a settlement, from an insurance company’s perspective, is at or just before the high middle point–typically about five to seven years into the claim, depending on the claimant’s age and the duration of the benefit period. At this point, the company is having to set aside the highest amount of money in the reserve.
If the insurance company can pay you a percentage of your total future benefits, it can not only save money in the long run, but it can release the money in the reserve. The insurer can then use those funds for other purposes, including providing dividends for its investors. In addition, the insurance company will save all of the administrative expenses it was putting towards monitoring your claim.
In the next post, we’ll address how and why buyouts occur after a lawsuit has been filed.