A lump-sum disability insurance "buyout," or "settlement," is a one-time lump-sum payment made to an individual policyholder in order to buy out the life of the individual's policy or claim. If you agree to a lump-sum buyout, you're agreeing to extinguish your rights under the policy and to release the insurance company from any obligations under the policy.
After a buyout is completed, you'll no longer have any rights against the insurance company and you'll no longer have a disability claim for which you'll receive benefits. While a buyout may be beneficial to you in the short term, it could ultimately be to your detriment if the payout undervalues your policy's future benefit.
Why Consider A Lump-Sum Buyout?
There are many reasons to consider a buyout, all of which may be unique to your financial situation. Careful consideration is required in making such an important decision.
The Ability to Invest Your Lump-Sum:
A lump-sum buyout is often tax-free and gives you the opportunity to invest the money in any way you see fit. Rather than waiting for monthly payments under your policy, buyout money could be used to enlarge your retirement savings or to make a financial investment that may provide substantial gains in the future. You may desire to enter into a new business and invest in new skills that don't conflict with your disability and medical issues. If you have children, you may wish to invest in their future by paying for college tuition.
Security and Peace of Mind:
Lump-sum buyouts can provide extra security for your family. As opposed to life insurance policies, disability insurance policies may not provide rights of survivorship. In addition, many insurance companies deny disability benefits after a period of time specified in the long-term disability policy. After an initial period of receiving benefits because you're unable to work at your "own occupation," some policies allow you to continue receiving benefits only if you're unable to work at "any occupation."
A lump-sum buyout can prevent you from being denied your benefits or having your claim terminated. If you negotiate a buyout you'll no longer be required to submit supporting documentation from medical professionals to prove your need to continue receiving long-term disability benefits.
Reasons to Reject a Lump-Sum Buyout
While there are many reasons to accept a buyout offer, there are also considerations that weigh against accepting a buyout. If you've worked in an occupation that has a "lifetime payout" and your family has a history of longevity, you may wish to continue under your disability policy. Though difficult to consider, you may waste the money by exercising poor judgment and making bad investments. Finally, you may be considering an offer that significantly undervalues your policy's future benefit.
Determining Your Policy's Actual Worth
In order 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 an overall reduced rate. Your insurance company's buyout offer will be based on this reduced rate, known as 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.
In addition, 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 an additional reduction based on when it believes you may die and if it believes you may go back to work. Your insurance company may also apply a final discount in order 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 attempt to negotiate a buyout.
Should You Accept the Offer? Ask an Attorney
Receiving a big check from your insurer may sound appealing at first. Sometimes it is the right option, but it's important to consult with an attorney before accepting a buyout offer. A buyout negotiation is a complicated process, so you'll want to obtain expert legal advice from an attorney specializing in disability law before making your decision.