GROUP TERM LIFE INSURANCE
Group life insurance is a major component of many employee benefit plans. In fact, to encourage employers to provide employee benefits such as a group life insurance plan, the federal government has granted these plans favorable tax treatment. In this review, we explore the features of group life insurance, explain how benefits are determined and examine the advantages of group insurance for both employers and employees.
Features of Group Life Insurance
The function that group life insurance serves is identical to the function of an individual plan in which a beneficiary receives the proceeds of a policy. In the case of group life insurance, if the covered member dies, his or her beneficiary will receive a stated amount of death proceeds.
Group life insurance, like individual plans, may be either of the term or permanent variety. Unlike individual coverage, however, group life insurance has a number of distinct features:
Master policy for entire group
Lower overall costs
No individual selection of benefits
Minimum participation standards
Low rates based on stability of the group
Master Policy for Entire Group
A significant characteristic of group insurance is that a single master contract or master policy is used and is the only contract required, regardless of the number of persons included in the coverage. The master policy outlines the contractual relationship between the policyholder (the employer) and the insurance company. No individual underwriting or risk evaluation is involved; the insurer looks at the group as a whole and applies its selection standards to the group.
Group life insurance is available at lower rates than individual insurance. In general, the administrative, operational and selling costs associated with group life insurance are less than those of individual plans. These savings are passed on to group policyholders in the form of lower premiums.
No Individual Selection of Benefits
Another characteristic of group life insurance is that benefits are predetermined according to certain schedules the insurer establishes. This prevents individuals from electing their own benefit levels-unhealthy persons would tend to elect high coverage amounts whereas healthy individuals might insure themselves only minimally-a situation that would lead to adverse selection against the insurer and undermine the principles of group underwriting. Predetermined benefit schedules also prevent the employer from selecting against the insurer in favor of certain employees. This does not mean that the employer has no choice in determining benefit levels; rather, the selection must be in line with the insurer's group benefit schedules. Most often, these schedules are based on earnings, employment position or flat benefit.
Just as established benefit schedules help prevent adverse selection, so do participation standards. Typically, insurers require that a minimum number of individuals eligible to participate in the group plan must do so to maintain the group coverage. If only older employees or those who were in poor health participated in the plan, the risk to the insurer would be greatly increased. Consequently, most insurers require that at least 75 percent of eligible employees participate when a plan is contributory and, for plans that are noncontributory, all eligible employees must be covered.
Low Rates Based on Group Stability
Unlike individual life policies that are rated on the insured's age, health and other characteristics, group life insurance rates are based, in part, on the stability of the group. As people enter and leave the group, this flow of insureds allows the group to operate effectively. However, groups with high employee turnover or no departures are not especially attractive to an insurer. If turnover is high, administrative expenses increase. If turnover is low, the group will age, mortality will increase and insurance company costs will increase.
Standard Group Life Provisions
To a large extent, the design of a group life insurance plan and the provisions it contains are a result of IRS requirements and the group insurance laws of the state in which the contract is written. Though these laws vary from state to state, there is enough uniformity among most group contracts to identify standard provisions. Here are some of the major provisions:
The actual death benefit in force on any one insured employee is established by a schedule of benefits included in the group policy the employer elects. Typically, these schedules provide for both minimum and maximum amounts for individual insureds and must conform with any limits state law establishes.
Effective Date of Coverage
After a group policy is in effect, new employees must satisfy a probationary period-usually 30 to 90 days-before they can enroll in the plan. After the probationary period has been satisfied, employees are given 31 days to enroll in the plan. Those who do not sign up during the enrollment period but apply at a later date, generally must submit proof of their insurability.
Who Pays Premiums
As with other group plans, a group life plan may be either contributory or noncontributory. A contributory plan calls for employees to share the premium cost with the employer; a noncontributory plan is one that is paid entirely by the employer. A contributory group life plan usually specifies that the employee's share of premium payments will be collected on a payroll deduction basis.
Beneficiaries and Settlement Options
An individual insured under a group life plan may name anyone as beneficiary of the death proceeds and is allowed to change that designation as desired. If the named beneficiary does not survive the insured and no other beneficiary has been named, most group plans allow the insurer to pay the proceeds to a surviving member of the insured's family or, as a last resort, to the insured's estate. In these cases, the proceeds are not paid to the employer.
As is the case with individual life insurance policies, the insured under a group life plan (or his or her beneficiary) can elect to have the proceeds paid in a lump sum or under an installment certain basis, according to the schedule or table in the group policy.
The vast majority of group life plans are term plans. When an employee retires, leaves the job, ceases to be an eligible member of the group or the plan itself is canceled, his or her coverage ceases, and there are no cash values available to purchase paid-up insurance. However, almost all group term life policies contain a conversion privilege, which allows an individual insured to convert the group coverage to an individual permanent policy with the same face amount.
There is a growing trend among employers to offer more than just a conversion privilege. Instead, many employers are now offering portable group term life insurance. This means that employees can take their insurance with them. The insurance coverage remains a term life benefit with no cash value.
31-Day Continuation of Coverage
Most group life contracts stipulate that an insured's death benefit is still payable if, within 31 days of terminating employment or plan cancelation, the insured dies. This provision gives an individual an extra 31 days of coverage before he or she must elect the conversion option or while waiting for coverage to become effective under another employer's plan.
Some employers offer insurance to employees' dependents as part of a group life plan. In these cases, the cost of the additional coverage usually is paid for by the employee and the amount of coverage available for any one dependent is fixed (and usually much less than the employee's coverage). Covered dependents of a deceased employee may or may not have the same rights to continue coverage. For example, a surviving spouse may be able to elect continued coverage but surviving children may not.
Waiver of Premium
Typically, group life plans provide a waiver of premium provision, which continues coverage but waives the cost of premium payments for employees whose active employment has come to a halt because of a total disability. Certain restrictions usually apply in these cases.
Benefits for Older/Retired Employees
Another provision contained in some group policies is a reduction formula that affects the amount of life insurance benefits available to insured employees once they reach a certain age (such as age 70), reflecting the increase in the cost of insurance at advanced ages. The provision reduces the amount of coverage available while the older employee is still working and may cancel the coverage entirely once he or she retires.
Accelerated Death Benefits Rider
Many insurers offer an accelerated death benefits rider to group life insurance policies. This rider allows the early payment of some portion of the policy face amount if the insured is terminally or chronically ill.
For example, a $100,000 policy that provides for a 75 percent accelerated benefit would pay up to $75,000 to the terminally ill insured, with the remaining $25,000 payable as a death benefit to the beneficiary when the insured dies.
How Group Life Insurance is Written
Theoretically, the same kinds of life insurance plans that are available for individuals also are available for group insurance. However, in practice, group life insurance is written as either term or paid-up permanent. Some plans also are based on universal life. Let's briefly review each.
Group Term Life
By far, the majority of group life plans are written as annually renewable term insurance. As the name implies, coverage and premium are established for one year, after which the employer, as policyholder, can renew the protection without evidence of insurability and the insurer, after reviewing the group's experience rating, may adjust the premium. Group term policies provide death protection only; there is no cash value accumulation under these plans.
Group Paid-up Life
Despite its advantages, group term does have a drawback: the absence of cash values and the subsequent loss of insurance protection when an employee leaves the group or retires. Retiring employees may find that the cost of converting their group term coverage to an individual policy is unaffordable; and, because the term insurance has no cash value that can be used to purchase paid-up coverage, they may lose all life insurance protection. For some, the answer may be group paid-up insurance.
With group paid-up, a certain amount of insurance is specified and is written with a combination of accumulating units of whole life and decreasing units of term. Each year, a portion of the premium purchases a unit of paid-up insurance. As the paid-up coverage increases, the term portion of the coverage decreases. Usually, the employer pays the term cost and the employee pays for the paid-up units. The result, over time, is a declining cost to the employer while the employee has paid-up permanent insurance available when he or she retires or otherwise terminates employment. In addition, the cash value belongs to the employee and may be borrowed or used as collateral for a loan, just as they can with individual cash-value life insurance policies.
Group Universal Life
A group life insurance product that has gained rapid popularity since its introduction is group universal life (GUL). The coverage usually is paid for by the employee (with after-tax dollars), but at group premium rates that are lower than similar insurance purchased on an individual basis. (These premium payments are usually collected on a payroll deduction basis.) In addition, coverage usually is issued without the employee having to provide evidence of insurability, at least up to certain limits. It is permanent insurance protection with cash value accumulation, and is flexible to conform to the employee's changing needs.
Income Tax Treatment of Group Life
One of the reasons an employer installs a group life insurance plan is to provide a benefit to its employees on a tax-advantaged basis. However, it is important to keep in mind that this favorable tax treatment is only given to group term insurance. To encourage employers to offer group life plans, current tax laws treat such plans favorably, as long as they conform to certain requirements.
General Tax Rules
The tax treatment of group insurance plans is spelled out in Section 79 of the Internal Revenue Code. The general tax rules regarding group life insurance are as follows:
The cost of the first $50,000 in group term life insurance benefits that an employer provides to an employee is not taxable to the employee. The cost of employer-provided benefits in excess of $50,000 is taxable income to the employee, in accordance with the table shown here.
The premium the employer pays for the cost of group life coverage is deductible by the employer, within the bounds of reasonable business deductions. Any premium an employee pays is not tax-deductible by the employee. However, if the employee has more than $50,000 in coverage, any premiums he or she pays can be allocated to the excess coverage, thereby reducing the amount he or she would otherwise be taxed.
The death benefit proceeds payable under a group life plan are received income tax free by the beneficiary. If the proceeds are paid in installments, the interest portion of each installment payment is taxable to the beneficiary. (This is consistent with the treatment of death proceeds payable under an individual life insurance policy and applies whether the group plan is term or permanent.)
Retired employees whose past employers continue to provide them with group term insurance coverage are taxed in the same way as active employees.
During the last decade, accelerated death benefits have become an important source of income for chronically ill individuals and for people suffering from AIDS and other terminal illnesses. If certain requirements are met, accelerated death benefits received from a life insurance contract on the life of a terminally or chronically ill individual before the individual's death can be excluded from income. However, for a chronically ill individual the exclusion applies as long as the proceeds are used to pay the cost of qualified long-term care services and the treatment is not covered by insurance or other program.
Group term proceeds will be includable in the deceased employee's gross estate if the employee possessed any incidents of ownership or if the proceeds are payable to his or her estate. The employee can avoid all direct incidents of ownership by absolutely assigning rights under the policy to a third party, provided the insurer and state law permit the assignment.
There may still be estate problems after the assignment if the employee dies within three years of the assignment. The proceeds are includable for estate tax purposes unless the employee's incidents of ownership were assigned at least three years prior to death, or if it can be proven that assignments within three years were not made in contemplation of death.