How Are Lump-Sum Buyouts Calculated?
Every disability company has their own methodology and formulas for determining the value of an insured’s disability income policy. As a result of handling buy-outs with almost every disability insurance company, we are well aware of each company’s valuation methods. There are multiple factors involved in determining the value of an insured’s disability income policy. Some of the factors that insurance companies will consider are:
- the life expectancy and mortality of the insured;
- the current corporate bond rate;
- the likelihood that the insured will remain totally or residually disabled;
- the amount of insurance company reserves for the specific policy;
- the present value of future monthly disability benefits;
- the age of the claimant and years remaining on the policy
In every lump-sum policy buyout, the insurance companies will make an offer that is discounted to present value dollars. This means that if the future value of an insured’s disability payments in 10 years would be $960,000 ($8,000 a month multiplied by 120 months), then the present value is the amount of money an insured needs today at a stated interest rate in order to equal $960,000. Assuming an $8,000 monthly benefit, 120 months of remaining payments, and an interest rate of 4%, then the present value of $960,000 would be approximately $790,000. This means that if you deposited $790,000 in the bank today and received an interest rate of 4%, then you would have $960,000 ten years from today if you never touched the money.
The present value amount is always less than future value. Insurance companies only offer settlements based upon the present value and they will never pay 100% of the present value as there is no financial benefit for them to do so. They will however, use the previously stated factors in arriving at a buy back amount.