Should I Take a Lump-Sum Disability Insurance Buyout?

An insurance company may send an individual policyholder an offer to buy out the life of their policy or long-term disability claim. The deal has potential benefits and drawbacks.

If you agree to a lump-sum buyout, you extinguish your rights under the policy. You’ll no longer have a disability claim for which you’ll receive disability insurance benefits.

A disability insurance buyout may benefit you in the short term. But it could be to your detriment if the payout undervalues your policy’s future benefit.

Disability insurance claims can be a lifeline when you can’t work due to a health condition. A disability lawyer can review the settlement offer to make sure you get a fair amount.

Why Did the Insurance Company Offer a Buyout?

Typically, an insurance company may offer a disability claim settlement when it believes doing so will ultimately save the company money. Insurers consider many costs and factors when determining whether to buy out a policy. Sometimes, the reason may be as simple as avoiding the administrative costs of managing future claim benefits over the life of the policy.

By accepting, you’d release the insurance company from any further obligations under the policy. You’ll no longer have any rights against the insurance company.

A buyout can be a win-win scenario in some cases. Yet, you’ll need to weigh the value of the up-front lump sum against your ongoing and future needs with disability. Insurance buyouts are optional, but you can’t reverse your decision once you accept.

Why Consider A Lump-Sum Buyout?

There are many reasons to consider a buyout. All are unique to your financial situation. Carefully consider such an important decision.

The Ability to Invest Your Lump-Sum

A lump-sum buyout is often tax-free, but not always (consult a professional about tax implications). It allows you to invest the sum of money any way you see fit.

Rather than waiting for monthly payments from long-term disability insurance companies, you could use the buyout money to enlarge your retirement savings. Or you could make a financial investment that may bring large gains in the future.

You may want to enter into a new business. You may want to invest in new skills that don’t conflict with your disability and medical conditions. If you have children, you can invest in their future by paying for college tuition.

Security and Peace of Mind

Lump-sum buyouts can offer extra security for your family. As opposed to life insurance policies, disability insurance policies may not provide rights of survivorship.

Many insurance companies deny disability benefits after a period of time. A long-term disability policy often specifies the duration. After an initial period of receiving benefits because you cannot work at your “own occupation,” some providers allow you to continue getting benefits only if you cannot work at “any occupation.” This detail might reduce your disability payments.

A lump-sum settlement means the insurance company can’t deny your benefits or terminate your claim. If you negotiate a buyout, you’ll no longer have to submit supporting documentation from medical professionals to prove your need for long-term disability benefits.

Reasons to Reject a Lump-Sum Buyout

While there are many reasons to accept a buyout offer, there are also reasons not to take one. Continuing your policy might be more beneficial in certain cases.

For example, rejecting the lump sum may be favorable if all of the following apply:

• You’ve worked in an occupation with a “lifetime payout.”
• You’ve got a strong life expectancy.
• Your policy has a long benefit period.

Some people find it safer to spread out their insurance payouts because it creates a steady, reliable income. You risk wasting the buyout money if you exercise poor judgment by spending it immediately or making poor investments.

Maximizing your benefits can also be a reason to reject a buyout. The offer may undervalue the future benefits of your long-term disability insurance policy. Accepting an offer that is too low could mean you miss out on money that could have otherwise supported you.

Determining Your Policy’s Actual Worth

To reduce costs, insurance companies calculate buyouts based on the amount they project they’ll have to pay a policyholder in the future but at a reduced rate. Your insurance company will base your buyout offer on this reduced rate. This is your claim’s “present value.”

The present value of your policy is the amount you could invest now at a specified interest rate, so at the end of your policy’s term, you’d have the same amount of money the company would’ve paid you in benefits. The higher the interest rate used to calculate your policy’s present value, the smaller the lump-sum buyout offer will be.

If your policy includes a cost-of-living benefit, your insurance company may pay it as “simple” or “compound” interest. The company may also make another reduction based on when it believes you may die and if it thinks you may go back to work.

Your insurance company may also apply a final discount to make a profit and justify its buyout offer. Generally, if the lump-sum buyout amount is less than the expected future monthly payments, insurance companies will negotiate a buyout.

Should You Accept the Settlement Offer?

Getting a big check from your insurer may sound appealing at first. Sometimes, it is the right option. But it’s essential to consult with a disability insurance attorney or financial advisor before accepting a buyout offer.

A buyout negotiation is a complicated process. You’ll want legal advice from a long-term disability attorney before deciding. They can guide you through the process, especially if it involves ERISA regulations. They can also help if there’s a potential overlap with Social Security disability or workers’ compensation.