Chapter 8 Exam: Group Life Insurance

KEYWORDS: GROUP LIFE INSURANCE

Prior to reading this chapter, please review the following keywords. An understanding of their basic definitions will improve your comprehension of the chapter content.

Blanket Health Policies:  These policies are issued to cover a group that may be exposed to the same risks, but the composition of the group (i.e., the individuals within the group) are continually changing. A blanket health plan may be issued to an airline or a bus company to cover its passengers or to a school to cover its students. As compared to group insurance, no certificates of coverage are issued in a blanket health plan.

Certificate of Insurance:  This is a document that’s issued by an insurance company/broker and used to verify the existence of insurance coverage granted to individuals under specific conditions. With group insurance, the group (typically the employer) is the policy owner and maintains a master policy. The insureds (typically the employees) receive a certificate of insurance rather than a policy.

Contributory Plan:  This is a group insurance plan that’s issued to an employer under which both the employer and employees contribute to the cost of the plan. Generally, 75% of the eligible employees must be insured in most states. The employees must contribute to the cost of the plan.

Conversion Privilege:  Before an original insurance policy expires, this privilege allows a policy owner to elect to have a new policy issued which will continue the insurance coverage. Conversion may be effected at attained age (premiums based on the age attained at the time of conversion) or at original age (premiums based on the age of the insured at the time of original issue). Conversion is a common privilege for term life insurance and all group insurance. The insured is not required to prove insurability (good health) when converting a policy.

Credit Policies:  These policies are designed to help the insured pay off a loan in the event she’s disabled due to an accident or sickness, or she dies. If the insured becomes disabled, the policy provides for monthly benefit payments that are equal to the monthly loan payments due. If the insured dies, the policy will pay a lump-sum to the creditor to pay off the loan. Credit policies typically cannot exceed the amount of the loan since that’s the limit of the creditor’s insurable interest in the insured(s).

Franchise Insurance:  This is a life or health insurance plan for covering groups of persons with individual policies that are uniform in provisions, but perhaps different in benefits. Solicitation typically takes place in an employer’s business with the employer’s consent. Franchise insurance is generally written for groups that are too small to qualify for regular group coverage. This policy may be referred to as wholesale insurance when the policy is life insurance.

Master Policy:  This policy is issued to the employer under a group plan and contains all of the insuring clauses which define employee benefits. Individual employees who participate in the group plan receive individual certificates that outline the highlights of the coverage.

Non-Contributory Plan:  This is an employee benefit plan under which the employer bears the full cost of the employees’ benefits. In most states, the plan must cover 100% of eligible employees. The employees do NOT contribute to the cost of the plan.

Persistency:  As it pertains to insurance, persistency is the percentage of policies that an insurer has in force after a specified period. Persistency is negatively impacted by policies that are replaced by other insurers, that are canceled by the policy owner, or that lapse due to non-payment. Companies with higher persistency are more stable and profitable than those with lower persistency. In general, companies aim for 80% persistency after three-years, and 60% persistency after five years. This means that 60% of the policies that were written five years ago should still be active.

INTRODUCTION

Group life insurance covers a group of people under a single policy contract. Group life insurance is most often comprised of annual renewable term life insurance and is typically offered by a large association or entity for its workers. Depending on the type of policy, the workers may contribute to the cost of the policy through weekly or monthly paycheck deductions (premium payments). Group life insurance policies contain many features and conditions that are different from those that are covered in an individual life insurance policy.

This chapter will introduce the basic concept of group life insurance, terms, and conditions of group life insurance, eligibility, types, and features. We’ll also examine the process of underwriting group insurance and the many advantages of group life insurance.

The chapter is broken into the following sections:

• Principles and Characteristics of Group Life Insurance

• Underwriting Requirements for Group Life Insurance

• Other Forms of Group Life Insurance

• Taxation of Group Life Insurance Plans

The state-specific portion of this course (located at the end) will detail the specific insurance definitions, rules, regulations, and statutes for your state. If a conflict exists, state law will supersede the general content.

Review of this chapter will enable a person to:

• Differentiate between individual and group life insurance contracts

• Understand the underwriting process of group life insurance contracts

• Determine who’s eligible under a group life insurance contract

• List the features of group insurance contracts

• Understand the difference between contributory and non-contributory group plans

• Determine the eligibility of employee group members

• Understand the concepts of adverse selection and the law of large numbers

• Understand the conversion privilege under group life policies

• Understand the rating classification system that’s used in life insurance contracts

• Provide examples of different types of risks

• Determine which risks are insurable or declined

• Understand taxation of group life insurance plans

PRINCIPLES AND CHARACTERISTICS OF GROUP LIFE INSURANCE

Group insurance is a way to provide life insurance, health insurance, or both kinds of coverage for a number of people under one contract. Typically, group insurance is provided by an employer for its employees; however, it’s also available to other kinds of groups. As opposed to individual life insurance (which is written on a single life), group life insurance is written on more than one life. Group life insurance is typically written for employee-employer groups and is most often written as an annually renewable term policy.

Group life insurance differs from individual life insurance contracts in several ways. One of the differences between the two is that group insurance is most often comprised of annual renewable term life insurance. In contrast, individual insurance contracts may be either term life or whole life insurance. Underwriting is handled differently, and varying types of policy provisions appear in a group life policy. Group term life insurance, as with all insurance contracts that were previously mentioned, is a two-party contract between the policy holder and the insurer (identical to an individual contract). However, unlike an individual insurance policy, the insured is almost never the policy owner of group life insurance. Instead, the employer is generally the policy owner.

The employer or group that provides the group life coverage pays all or a portion of the premium and is the policy owner. The employer or plan sponsor receives the master policy/contract. In contrast, the covered employees or plan participants receive a certificate of coverage or a booklet which describes the benefits, the coverage provided, and how long the insurance coverage will last. The covered employee or plan participant is also referred to as the certificate holder. Types of groups that are eligible include employees of a single employer, credit groups, labor unions, and multiple employer groups.

EMPLOYER RESPONSIBILITIES

The employer is responsible for the selection of group coverages, recordkeeping, and employee enrollment. The employer is not permitted to discriminate, especially when the plan is non-contributory.

GROUP INSURANCE VERSUS INDIVIDUAL INSURANCE

Features that separate group insurance from individual insurance include:

1. Underwriting

   • In an individual policy, the insured must prove that he’s insurable.

   • In group insurance, the group must meet various criteria, but the insureds are not individually underwritten.

2. Policy Ownership

   • With individual insurance, the insured is traditionally also the policy owner. In instances of third party ownership, the policy owner and the insured are different parties (e.g., husband covering wife, wife covering husband, parent covering child, etc.)

   • With group insurance, the insured is rarely the policy owner. There’s one master policy that’s owned by the employer or plan sponsor.

‒         The employer or plan sponsor receives the master policy and, as such, is the policy owner or contract holder.

‒         Employees or plan participants receive the certificates of insurance (not individual policies), and as such, are certificate holders.

1. Policy Type

   • Group life insurance is always considered temporary insurance. Annually, renewable term is typically used, which provides a fixed amount of coverage throughout the contract.

   • Individual insurance can be any of the previously discussed temporary or permanent insurance products.

   • Whenever a person converts his group insurance to individual insurance, he’s always converting temporary protection to permanent protection.

2. Cost

   • Individual insurance policies are considerably more expensive for the insurer to issue (underwrite, commission, billing, maintenance, etc.). As described previously, these administrative costs are passed on to the customer, thereby making individual policies more expensive to purchase.

   • Group insurance policies are substantially less expensive for the insurer to underwrite, issue, and maintain. As such, group insurance is much cheaper for the customer to purchase.

   • In some cases, the employer or sponsor may pay a substantial portion or all of the premium cost for the group insurance policy. With individual insurance, the customer (policy owner) is always responsible for all of the premium cost.

[EXAM TIP:  Since the individual doesn’t own or control the policy, he’s issued a certificate of insurance (often referred to as the certificate of coverage and benefits) to serve as evidence of an employee’s coverage. The actual policy, which is referred to as the master policy, is issued to the employer and the employer becomes the policy owner.]

CONTRIBUTORY AND NON-CONTRIBUTORY PLANS

Non-Contributory Plan   

With this plan, the employer pays the entire cost of the plan. The insurance company requires that 100% of all eligible employees participate. The most significant benefit of a non-contributory insurance plan is that it helps the insurer avoid adverse selection.

With a non-contributory group insurance plan, the employees or plan participants do NOT contribute to the premium payments.

Contributory Plan    

With this form of employee group insurance plan, the employees share the cost. The insurance company requires that at least 75% of all eligible employees chose to be covered/participate. For example, if a company has 1,000 eligible employees, at least 750 of them must choose to be covered. If not, the insurer will not write the policy.

With a contributory group insurance plan, the employees or plan participants contribute to the premium payments.

ELIGIBLE GROUPS

People cannot form a group for the sole purpose of securing group insurance coverage. The securing of such coverage must be incidental to the group’s formation. In other words, a group of people cannot form an organization whose primary purpose is to secure insurance coverage for the group.

Businesses are operated in order to produce a product or provide a service and earn a profit; therefore, they’re eligible to purchase group insurance. A group of persons who are engaged in occupations of a common industry may form an association (e.g., all hat manufacturers) and then later purchase group coverage.

Remember, for groups to offer group insurance, the primary requirement is that the group is formed for a purpose other than acquiring insurance. Offering group insurance products should be a benefit of the group, not the purpose of the group. States may impose additional requirements. For example, states may require the group to have existed for more than two years or have a minimum of two members.

Although there’s generally an employment or professional relationship present in order for group coverage to be secured, this is not always the case. Examples of some of the groups that are eligible to participate in group insurance include:

• Single employee groups (employer)

• Multiple employee groups (employment-related)

• Labor unions

• Trade associations

• Credit/debit groups

• Fraternal organizations

• Customer groups (e.g., credit union members)

• Trustee groups (established by two or more employers or labor unions)

ELIGIBILITY OF GROUP MEMBERS (EMPLOYEES)

• An employee must be full time and actively working.

• If the plan is contributory, employees must approve of automatic payroll deduction.

• The new employee probationary period is typically one to six months.

• During the enrollment period, an employee has 31 days to sign up. Otherwise, she may need to provide evidence of insurability.

UNDERWRITING REQUIREMENTS FOR GROUP LIFE INSURANCE

Sound group underwriting can be profitable to an insurer, since it primarily reduces adverse selection. Adverse selection or anti-selection is the tendency or danger of an insurer to write (i.e., approve) more bad risks than acceptable risks. People with more significant risk tend to seek insurance coverage more often than those with little risk. Since more individuals are covered under group policies, there’s a higher probability that a “bad” risk will be included. However, the insurer may continue to earn a profit if the acceptable risks far outweigh the bad. This offset of high versus low risk is what an insurer is depending on when it writes group life coverage. Writing large groups of individuals also helps to reduce adverse selection based on the law of large numbers.

Proof of insurability may not be required of larger groups, but insurers may require some type of insurability for smaller groups. As explained previously, the smaller the group, the greater the potential for adverse selection.

For example, if an insurer writes a group life insurance policy for 500 employees, the law of large numbers indicates that some of those employees will be of high risk, some will be low risk, but the majority should be of standard risk. Throughout the year, the insurance company will hardly notice if it needs to pay out one or two death claims out of the group of 500 insureds. However, if the insurer writes a group life insurance policy for 10 insureds, the law of large numbers no longer applies and the risk is far less predictable. Paying out one or two death claims out of the group of 10 insureds could have a significant impact.

Group life plans will not exclude employees who have a physical impairment (e.g., paralysis) from the group life plan.

Underwriters take policy persistency into account. As it pertains to insurance, persistency is the percentage of active policies in force, without them lapsing or being replaced by policies of other insurers. Insurers may measure policy persistency in various periods, such as one year, three years, or five years from policy issue. Due to the expenses involved in acquiring and issuing a new policy, persistency can be a vital factor in the stability and success of an insurer. The insurer may avoid groups that change insurers regularly because it may believe that writing such groups doesn’t represent an acceptable risk.

CLASSIFICATION OF RISK

In order to minimize adverse selection, insurers require a minimum number of group members/employees to participate in a group insurance plan. After all of the necessary information is collected on an applicant, the underwriter will classify the applicant based on the degree of risk assumed.

The following rating classification system is used to categorize the favorability of a given risk:

• Preferred:  Low risk and lower premiums

• Standard:  Average risk, with no extra ratings or restrictions

• Substandard:  High risk (rated up) with higher premiums

  • Declined:  Not insurable since the potential of loss to the insurance company is too high

[EXAM TIP:  Lower risks tend to have lower premiums. If an applicant is too risky, the insurer will decline coverage.]

ADDITIONAL FEATURES OF GROUP TERM LIFE INSURANCE

Conversion to Individual Policy   

All group policies contain a conversion privilege which gives a covered employee the option of converting his group term life coverage to his own individual plan upon termination from the company. Termination of employment includes an employee who’s laid-off or who leaves a job voluntarily. In most cases, when an employee leaves an employer, he may take advantage of the conversion privilege. However, most insurers only allow the terminated employee to convert the group coverage to an individual whole life policy.

Conversion Period

The period during which the terminated employee may convert to an individual plan of insurance without proof of insurability is within 31 days after termination. If death occurs during the conversion period (31 days after termination), even if the employee doesn’t intend on converting to an individual policy, the death claim will be paid by the group policy. An individual is covered under the group policy during the conversion period.

No medical exam or other proof of insurability is required to convert coverage to an individual policy. In other words, an insured employee may exercise the conversion privilege regardless of his insurability.

If a member’s coverage is terminated, the member and his dependents may convert their group coverage to individual permanent (whole life) coverage without being required to show proof of insurability. If conversion occurs, the premium is based on the insured’s (employee’s/dependent’s) current or attained age.

Group Policy Termination

If the master policy is terminated, each individual member who has been insured for at least five years is permitted to convert to an individual policy which will provide coverage up to the face value of the group policy.

Incident of Ownership – Beneficiary Selection

Although the employer is the contract owner in a group life policy, it retains all of the rights of ownership with the exception of the right to name or change the beneficiary. Therefore, the covered employee or “certificate holder” possesses an “incident of ownership” in the group plan. In other words, it’s the “certificate holder” (insured employee) who names the beneficiary, not the policy owner (employer). The employee may name the employer as a beneficiary of the group life policy, but only if the employer has an insurable interest in the employee.

For example, an employer may have an insurable interest in a key executive who has 20 years of experience. However, the employer is not likely to have an insurable interest in a part-time clerk.

In recent years, based on modifications of state laws, many insurers have been permitted to include an assignment provision in group life policies. Of course, any assignment must be in writing and must be filed with the insurer.

OTHER FORMS OF GROUP LIFE INSURANCE

The following are different types of life insurance that are issued as group plans.

GROUP CREDIT LIFE INSURANCE

Group credit life policies are established by organizations (e.g., banks and finance companies) and stipulate that, if the insured dies before a loan is repaid, the policy benefits will be used to settle the loan balance. Premiums for group credit life insurance are based on claims experience and expense factors, not necessarily the borrower’s age. The premiums are typically paid by the insured. A decreasing term policy is commonly used.

BLANKET LIFE INSURANCE

Blanket life insurance covers groups of individuals who are exposed to the same hazard. For example, passengers on an airplane or students and faculty of schools. No one person is named on the policy, and certificates of coverage are not given out. Individuals are only covered for the specified common hazard.

LIFE INSURANCE FOR MEMBERS OF THE ARMED FORCES AND FEDERAL EMPLOYEES

The federal government provides life insurance coverage for those in the armed services and other federal employees.

Servicemembers’ Group Life Insurance (SGLI)

SGLI is provided up to $400,000 (in $50,000 increments) for full-time members of the armed services. The coverage provided is group term life insurance and all active servicemembers are covered unless they choose otherwise.

Family Servicemembers’ Group Life Insurance Coverage (FSGLI)

FSGLI is a component of the Servicemembers’ Group Life Insurance program. FSGLI provides coverage for spouses and children of servicemembers who are insured under SGLI. Non-military spouses are covered automatically for $100,000 or the amount of the member’s coverage, whichever is less. Premiums for spousal coverage are based on the spouse’s age and the amount of coverage. Dependent children are covered for $10,000 each at no cost to the member.

Veterans’ Group Life Insurance (VGLI)

VGLI provides for the conversion of Servicemembers’ Group Life Insurance coverage to a renewable term policy of insurance protection after a servicemember’s separation from service.

Servicemembers and their spouse may be able to convert their SGLI or VGLI to permanent insurance through a commercial insurer without proving insurability.

Federal Employees Group Life Insurance (FEGLI)

FEGLI provides group term life insurance for all other federal employees or civil service workers.

TAXATION OF GROUP LIFE INSURANCE PLANS

For a group life insurance plan to receive favorable tax treatment, there are specific requirements. These requirements ensure that the average employee is not discriminated against in favor of higher-level employees.

Premiums For Group Life Insurance

Premiums that are paid by employees for their group life insurance are not tax-deductible. On the other hand, premiums that are paid by employers for group life insurance are tax-deductible as a legitimate business expense as long as specific requirements are satisfied. However, a sole proprietor or partner cannot deduct premiums for group life covering his own life since he’s not considered to be an employee.

The premium on the first $50,000 of group term life coverage that an employer provides is not included in an employee’s taxable income (i.e., it’s tax-exempt to an employee). The cost of coverage amounts above $50,000 may be taxable as ordinary income to the employee and reported on an employee’s W-2 despite the fact that the employee has not actually received any money.

Most employers will establish benefit schedules according to the following:

• Earnings

• Employment position

• Flat benefit.

Proceeds For Group Life Insurance

Proceeds from a group life policy are tax-free if they’re taken in a lump-sum. Proceeds taken in installments will be subject to taxes on the interest portion of the installments.

Retired Lives Reserve and Qualified Plans

Retired Lives Reserve (RLR) is a group life insurance product with the objective of providing continuing life insurance protection beyond retirement. RLR provides annual renewable term insurance and a reserve account that accumulates funds before retirement, which will be used to pay premiums on the term insurance after a person’s retirement. Under this plan, an employer can make a tax-deductible contribution to the fund (i.e., reserve account) on behalf of employees, and the contributions are not tax-deductible to employees. A life insurance company or trust can administer this fund or reserve account.

A qualified retirement plan may purchase life insurance to provide death benefits under very limited circumstances. The plan document must authorize such a purchase, but the decision to buy a policy may be made by either the plan administrator (employer) or the participant. In a defined contribution plan, the policy is part of the participant’s account; however, in a defined benefit plan, the death benefit is part of the definite determinable benefit provided to the participant by the plan. Most importantly, the purchase of life insurance must be incidental to the primary purpose of providing retirement benefits under the plan.

CHAPTER SUMMARY: GROUP LIFE INSURANCE

Key points to remember from this chapter include:

• Group insurance provides both life and health insurance policies.

• Group insurance is comprised of annual renewable term life insurance.

• Group insurance is a two-party contract and is usually between an employer and an employee.

• Employees are referred to as certificate holders.

• Employers are referred to as contract holders.

• In group life insurance, individuals are NOT required to provide evidence of insurability.

• In a non-contributory plan, the employer pays the entire cost.

• In a contributory plan, the employees share the cost with the employer.

• People cannot form a group for the sole purpose of securing group insurance coverage.

• For new employees, the probationary period is one to six months.

• For group life insurance, the enrollment period is 31 days.

• Under a group life policy, individuals are offered a conversion privilege upon their employment termination.

• The conversion period is valid for 31 days after the group coverage termination date.

• A group life insurance uses the following rating classification system to categorize risks:

‒      Preferred risk is a low risk that offers lower premiums.

‒      Standard risk is an average risk with no extra ratings or restrictions.

‒      Substandard risk is high risk (rated up) that has higher premiums.

‒      Declined means not insurable because the potential of loss to the insurance company is too high.

• Group Credit Life Insurance is set-up by banks and finance companies to pay off a creditor’s outstanding debts.

Group versus Individual Insurance

The essentials of group versus individual forms of insurance apply to life and health insurance.