Disability insurance is a vital financial tool designed to protect individuals in the event of an illness or injury that prevents them from working. Typically, disability insurance benefits are calculated based on the insured’s gross income, providing a percentage of pre-disability earnings to replace lost income. However, for high-earning professionals and executives who receive compensation in the form of stock awards, bonuses, and other non-traditional income sources, determining gross income can be far more complex than for someone who is compensated solely by salary or hourly wages. Failing to include stock awards can result in the insured receiving significantly lower benefits than they should.
Stock-based compensation has become a popular method of remunerating employees, particularly in industries like technology, finance, and startups. The most common types of stock-based compensation include:
Restricted Stock Units (RSUs) are one of the most common forms of stock-based compensation. An employer grants employees a certain number of company shares, which are typically subject to a vesting schedule. Employees do not own the shares until they vest, meaning they cannot sell or transfer them before this time.
RSUs are considered taxable income once they vest, and the value of the vested shares is based on the company’s stock price at that time. Many high-earning executives receive some compensation in RSUs, which can represent a substantial part of their overall income.
Stock options give employees the right to purchase company stock at a predetermined price (the strike price) after a certain period of time (vesting). There are two main types of stock options:
Stock options do not have immediate value when granted; they only become valuable when the company’s stock price rises above the strike price. Employees can then exercise their options, purchasing shares at the lower strike price and potentially selling them for a profit.
Performance shares are another form of stock compensation that is awarded based on the company achieving certain financial or operational goals. Like RSUs, performance shares are often subject to a vesting period and may be tied to the company’s stock price or other performance metrics.
ESPPs allow employees to purchase company stock at a discounted rate, usually through payroll deductions. While this type of compensation is generally smaller compared to RSUs or stock options, it can still play a role in an employee’s total compensation package, especially in industries where company stock consistently performs well.
When it comes to determining disability benefits, disability insurance companies typically base their calculations on an insured’s gross income prior to the onset of the disability. For individuals who receive stock-based compensation, the process of calculating gross income is more nuanced. How stock awards are treated depends on several factors, including the type of policy, how the stock awards are structured, and whether they are vested or unvested.
Many employer-sponsored group disability insurance policies only cover base salary and exclude other forms of compensation, including stock awards, bonuses, and commissions. Most group policies do not even mention stock. However, courts in the Ninth Circuit have held that unless stock awards are specifically included, they should be considered as a type of “bonus.” Depending on the policy, some group policies do include “bonuses” as part of an insured’s earnings. Courts in the Ninth Circuit have held that unless the policy specifically excludes stock, stock awards provided under an incentive or compensation plan should be considered as a form of “bonus.”
Group policies are typically less comprehensive than individual policies and may not account for significant portions of an executive’s total compensation. As a result, if the insured relies heavily on stock-based compensation and the policy excludes that income, the benefits provided under a group policy may be insufficient to replace their actual lost income.
Individual disability insurance policies tend to offer more customization and flexibility compared to group policies. When purchasing an individual policy, an insured has the option to negotiate how different types of compensation, including stock awards, are treated. However, even in individual policies, stock-based compensation is not always automatically included in the definition of gross income.
For individual policies, the inclusion of stock awards may depend on the following factors:
The vesting schedule of stock awards plays a critical role in how they are treated for disability insurance purposes. RSUs, stock options, and performance shares often vest over several years, meaning that the employee does not have full ownership or control over the stock until it vests. If a disability occurs before the stock vests, the stock awards are generally excluded from gross income because the employee has not yet earned them.
However, if a disability occurs after the stock has vested, the vested shares are considered part of the insured’s total compensation and may be included in the gross income calculation. This can create a significant disparity in benefits depending on when the disability occurs relative to the vesting schedule.
One of the challenges for insurers in evaluating stock-based compensation is determining the value of stock awards, particularly for RSUs and stock options. The value of RSUs is relatively straightforward to calculate, as it is based on the stock price on the vesting date. However, for stock options, the value can be more difficult to assess because it depends on the difference between the strike price and the market price at the time the options are exercised.
Insurers may use a variety of methods to determine the value of stock-based compensation, including:
For individuals whose compensation includes a significant amount of stock awards, it is essential to take proactive steps to ensure that their disability insurance policy adequately reflects their total income. Here are some strategies to consider:
Given the complexity of stock-based compensation, it is advisable to work with a financial advisor or an insurance specialist who understands how different types of compensation are treated in disability insurance policies. They can help assess your current coverage and recommend additional riders or supplemental policies if necessary.
If purchasing an individual disability insurance policy, negotiate with the insurer to include stock-based compensation in the definition of gross income. Be prepared to provide documentation of your stock awards, including vesting schedules, stock option agreements, and historical stock transactions.
If you have group disability insurance through your employer, review the policy carefully to determine whether stock-based compensation is included. If it is not, consider purchasing supplemental long-term disability insurance to cover the gap. Many insurers offer executive disability plans specifically designed for high earners with complex compensation packages.
Maintain detailed records of your stock awards, including vesting schedules, exercised options, and any performance shares. If you become disabled, you will need to provide this documentation to the insurer to substantiate your claim for benefits based on stock-based compensation.
If you are already on disability, and part of your pre-disability income included stock awards, check your policy. If your policy included “bonus” income as part of your pre-disability earnings, ask your insurer if they included your stock income in their calculation of your benefit. They likely did not. The insurer will probably tell you that stock is not included as income under the policy, only bonuses. Courts disagree. If your policy is governed by ERISA, you will then have six months to find counsel and appeal that denial. The insurer may well deny the appeal as well, after which your counsel can file suit on your behalf and get the correct back benefits paid and the amount of monthly future benefits agreed upon by the court.
Stock-based compensation can represent a significant portion of an individual’s total income, especially for executives and professionals in high-growth industries. However, the treatment of stock awards in disability insurance policies is not always straightforward. In most cases, insurers will insist that stock awards are not included under the policy, and depending on the policy the insurer could be correct. Courts can order them to include it, but courts might only consider vested stock awards when calculating gross income, and exclude unexercised stock options or unvested RSUs.
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