Many companies, from Wall Street to Main Street, USA, provide incentive compensation for their top producers. However, the vast majority of Group LTD plans are based only on Base Compensation or Salary. The primary reason for this disconnect is that the employer’s group LTD premiums are paid monthly on base earnings since neither bonuses nor commissions are guaranteed and can vary greatly year to year. Today we want to explore how this can affect group LTD benefits within the financial services industry; however, the same underinsurance situation exists for many, if not most, highly-compensated employees.
A review published by the Income Protection Journal examined group long-term disability filings from 2,912 financial services employers, along with 15 group disability insurance documents from public employers.
In 11 of the 15 documents reviewed, the benefit is calculated on base salary and excludes incentive compensation.
SHRM’s 2023 Employee Benefits Survey documents that group LTD plan caps commonly range from $6,000 to $15,000 per month across the employer market. An executive earning $300,000 in base salary has a calculated 60% benefit of $15,000 per month.
If the plan cap is $12,000, the benefit is $12,000. An executive earning $400,000 in base salary has a calculated benefit of $20,000. The same $12,000 cap reduces it by $8,000 before taxes are applied, and the tax treatment of employer-paid LTD benefits compresses what remains further still.
The table below illustrates how the cap interacts with the formula at several executive income levels, using a $12,000 monthly cap as the benchmark, a figure within the range Mercer documents as common among large employer plans.
| Annual Base Salary | Formula Benefit (60%) | Plan Cap ($12,000/mo) | Monthly Shortfall Before Tax |
|---|---|---|---|
| $200,000 | $10,000 | $10,000 | $0 |
| $300,000 | $15,000 | $12,000 | $3,000 |
| $400,000 | $20,000 | $12,000 | $8,000 |
| $500,000 | $25,000 | $12,000 | $13,000 |
Depending on their employer’s plan, employees may have opportunities to review or change their disability coverage during open enrollment, making it an important time to understand what their plan pays.
Federal Filings Show Few Individual Layers
Employers report an insured benefit plan each year on a Form 5500 filed with the Department of Labor. Schedule A lists the insurer, the type of coverage, and the number of employees covered, and the filings are public.
The review considered the most recent plan data and found 2,912 financial services employers reporting an insured long-term disability contract. Thirty-seven of them, or 1.3%, also reported a second layer of individual or multi-life coverage, meaning policies sold separately from the group plan. The filings show no such layer for the other 2,875.
The filings show what an employer reports. They lack individually owned policies and plan definitions.
For definitions, the review considered 15 group disability documents from 10 insurers that insure 85% of covered employees in the filings. The documents came from public employers because private financial firms do not publish theirs. Terms differ from one employer’s plan to the next, so the documents show the terms insurers write into group plans, not the terms in force at any one employer.
1. Benefits Equal a Percentage of Covered Earnings
Every group plan pays a percentage, such as 60%, of a defined term called covered monthly earnings, insured earnings, pre-disability earnings, or monthly earnings, depending on the insurer. No industry standard governs the term. In 11 of the 15 documents, the term means base salary and excludes incentive compensation: bonuses, commissions, overtime and, in some, equity compensation. In three, it is broader, one of them W-2 income, and one document does not carry the definition.
2. Bonus Pay Adjusts While Base Salary Plateaus
At many firms, base salary is set by job title and plateaus, while bonus income rises and falls with performance. Two people at the same firm with the same title and base earn very different totals when their bonuses differ, and a plan written on base salary covers them identically.
3. Monthly Maximums Cap the Benefit for Higher Earners
Every plan has a maximum monthly benefit. In the plans examined, it ranged from $3,000 to $20,000 a month, and those plans came from public employers, not financial services firms.
The benefit cap does not rise with income, so above a certain salary, the benefit equals the maximum rather than the calculated percentage. For example, a plan with a $12,000 monthly maximum would limit annual benefits to $144,000, even if 60% of an employee’s covered earnings would otherwise result in a higher benefit.
4. Own-Occupation Protection May Be Limited
Own-occupation coverage pays when you cannot do your own job, rather than any job. In six of the 15 documents, that period is 24 months, in one 36 months, and in one 60 months.
In policies where the own-occupation period ends, coverage may transition to a test of whether you can perform any occupation you are reasonably suited for. The test is measured against the same covered earnings figure, so the earnings threshold that ends the benefit is a share of base salary, not total compensation. A job paying more than that share of base salary ends the benefit, even if it pays a fraction of former total pay.
Four Things to Check Before You Re-Enroll
- Covered earnings wording. Is it base salary, gross income, W-2 income, or total cash compensation? Look in the policy’s definitions section, not the benefits summary.
- What the plan would pay. Take the benefit you would receive, the lower of the percentage of covered earnings and the maximum monthly benefit, multiply it by 12, and compare it with your annual take-home pay. The income replacement gap is what an individual policy would have to cover to maintain your household’s expenses.
- The own-occupation period. Find out how long it lasts and what replaces it.
- The policy itself. Ask your plan administrator in writing for the group policy, not the summary on the benefits portal.
This is not legal advice, and a licensed attorney in your jurisdiction can review your policy.
If part of your compensation comes from bonuses or commissions, an individual disability insurance policy may help address income gaps not covered by your employer’s group plan, subject to the insurer’s underwriting requirements and policy terms.
