Two partners agree that if either becomes totally disabled, the active partner will buy out the disabled partner's share of the business. Which disability product is designed to fund this arrangement?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
A disability buy-out, also called a disability buy-sell policy, funds a predetermined buy-sell agreement: when an owner becomes totally disabled, the policy pays a lump sum or installments that the active owner uses to buy the disabled owner's interest. This converts the disabled owner's equity into cash and keeps the business in the hands of the active owner. The arrangement requires an existing buy-sell agreement that establishes the value and terms of the transfer, and coverage is usually limited to a percentage of the business's value. It is a distinct disability product from overhead and key-person policies.
Why the other options are wrong
- B) A BOE policy pays the firm's continuing fixed operating costs while an owner is disabled, such as rent and staff salaries. It does not fund the transfer of the disabled owner's ownership interest.
- C) A key-person disability policy compensates the business for economic losses caused by a key employee's disability. It protects profits but does not buy out the disabled person's ownership stake.
- D) Group short-term disability replaces an employee's income during brief absences from work. It pays wages to the disabled person and has no role in transferring business ownership under a buy-sell agreement.
Memory hook
Buy-out policy turns a disabled partner's share into cash at the agreed price.