Your Earnings Definition Can Cause Claim Problems

The definition of covered earnings in a group life and disability contract matters.  It dictates how much premium should be paid and how much will be paid in claims.  Here’s an example.

West Overshoe Manufacturing Company had a great year in 2017.  They decided to increase everybody’s pay by 10% starting on January 2 of this year.  Bill Leathersole earned $60,000 in 2017, and he will make $66,000 in 2018.  Unfortunately he got sick in the middle of January, and he’ll be out for at least a year.

The definition of earnings in West Overshoe’s long term disability contract is last year’s W2.  Here’s how his claim is going to play out:

  • Current salary:  $5500/month
  • Covered earnings based on the contract:  $5000/month ($60,000 / 12)
  • Group LTD plan covers:  60% of pay
  • Monthly benefit:  $3000 (60% of $5000), or 54.5% of pay instead of the 60% that he was expecting.  Bill, who is already tense with his recent diagnosis, is not going to be happy.

The advantage of using last year’s W2 as an earnings definition is it makes administration easier.  There is no need to recalculate salary every month because the earnings definition is fixed for the year.

However, this definition doesn’t keep pace with salary increases as they happen.  The way to resolve this is to use current salary.  This would keep the coverage levels current, but it does require the plan administrator to update the salaries as they happen.

We were just involved in a real life example of how important the earnings definition can be.  A client wanted to use current salary as their earnings definition.  However their partners have a compensation plan that provides a base salary and an additional amount of “cafeteria” money to be used to offset business and personal expenses.  We didn’t know this when the plan was first set up.

We found out when a partner submitted an LTD claim.  His “cafeteria” money was about 20% of his overall compensation, and it was definitely lost when he became disabled.  Unfortunately, the traditional “salary only” definition of earnings specifically excluded other types of compensation.

The claim was approved, but the monthly benefit was much lower than expected.  To solve the problem, we were able to negotiate a retroactive contract change, correcting the definition of earnings so the claim could be paid correctly.  Retroactive amendments that impact known claims are hard to do, but we were pleased with our partners at the insurance company who worked with us to solve the problem.

The definition of earnings is important.  It’s a small part of a contract, but getting it wrong can make a big difference with a claim.

If you’d like to discuss this topic or others related to employee benefits, call us at (866) 724-0008 or click the link below.

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