Disability Benefits

[JBones]

I am reviewing a frozen DB plan that I may be taking over and noticed code 4H (Long-Term Disability) on the 5500 under the welfare benefit code section. I reviewed the plan documents (prototype) and the plan's disability benefit was changed during the EGTRRA restatement from AE of retirement benefit to 1) if Class A Disability, AE of 110% of benefits earned to date, 2) if Class B, AE of 107.5% of benefits earned to date and 3) if Class C, AE of 105% of benefit earned to date.

I haven't gone back to the client yet with any follow up questions, but first, is it correct to use code 4H solely based on this definition of the plan's disability benefit?

Also, are there any other issues that I should be aware of? The plan is a small plan - only 4 participants, so I would think it would be okay to assume no preretirement disability in my valuation?

[SoCalActuary]

Interesting design issue.

You have a small risk issue here, but if the benefit is only payable as an annuity benefit, you are probably OK.

If a Class A disability is defined to be a high level of disability, you probably have impaired life expectancy as well. So the 110% benefit is offset against the reduced annuity rate.

Another option is for the plan to purchase a disability policy on the insured, so you only have the cost of the policy without any additional risk to measure.

[JBones]

Interesting design issue.

You have a small risk issue here, but if the benefit is only payable as an annuity benefit, you are probably OK.

If a Class A disability is defined to be a high level of disability, you probably have impaired life expectancy as well. So the 110% benefit is offset against the reduced annuity rate.

Another option is for the plan to purchase a disability policy on the insured, so you only have the cost of the policy without any additional risk to measure.

The benefit is defined as the Actuarial Equivalent of the retirement benefit, and it looks like lump sum is an available payment option for disability benefits. I've heard that the IRS has stated that it is sometimes reasonable to assume no preretirement mortality in a plan with an insured death benefit. I would think that reasoning could apply to this situation as well. With only 4 participants and a maximum increased liability of 10%, the cost difference would be negligible and the prior actuary did not assume any disability decrement.

Has anyone had experience with this type of design? I'm trying to figure out what the plan sponsor and actuary were trying to accomplish by amending the plan to provide this benefit (especially since it's not reflected in the valuation).