A Group Carve Out Primer

An important first step in understanding group carve-out plans and their advantages is an appreciation of group term life insurance and its requirements. For that reason, we will begin this Chapter by considering group term life insurance.


Limitations of Group Term Life Insurance

There is little disagreement that, over the six plus decades that group term life insurance has been generally available, it has become a major force in the life insurance business; clearly, it occupies an important place in many individuals' plans.  However, group term life insurance has certain requirements and limitations that adversely affect its ability to meet many executives' long-term life insurance requirements.  These limitations include its:

Non-discrimination requirement
Reduction or termination at retirement
Loss upon termination, and
Imputed income costs for coverage over $50,000


 Non-Discrimination Requirement

Group term life insurance coverage must be provided on an even-handed, non-discriminatory basis.  If a plan of group term life insurance is deemed discriminatory, its tax advantages may be lost.  


Coverage Adversely Affected at Retirement

One of the concerns about group term life insurance is that it is normally reduced substantially or eliminated when the participant retires.  In the event that coverage is continued after the participant retires, its cost may become substantial.  An alternative, of course, is the conversion of coverage at retirement, but this also adds substantial cost at a time when the retirees' income has declined.


Coverage Lost Upon Termination

Group term life insurance coverage cannot be taken with a departing employee.  On termination of service, the group insurance ends.  


 Table I Rates over $50,000

Large amounts of life insurance delivered as group insurance has certain tax inefficiencies.  Employees must report the value of group term life insurance coverage in excess of $50,000 as imputed taxable income.  The amount of taxable income resulting from group coverage over $50,000 is based on government Table I rates that may be higher than the actual cost for the group insurance.

Group carve out plans are designed to overcome each of these normal group term life insurance limitations.


 Operation of the Group Carve-Out Plan

Group carve out plans simply replace existing group term life insurance amounts over $50,000 on the life of selected executives with individual universal life insurance coverage.  Declared rate, equity-indexed or variable universal life may be used, depending upon the individual executive's wishes and risk tolerance level.

The employer's premium payments generally remain constant.  It continues to make premium payments for the now-reduced group term life insurance coverage but also makes premium payments for the universal life insurance policy at least at the minimum premium level.  In many cases, the universal life insurance policy's minimum premium is fairly close to the premium for the replaced group term life insurance.

If minimum universal life insurance premiums are made by the employer, the combination of group term life and group carve out plan functions in a manner very similar to the group term insurance plan before the carve out.  A major difference, however, is that both the employer and the executive may make additional premium payments to the universal life insurance policy.  As a result of additional premiums:

Cash values may be increased
Post-retirement life insurance protection can be provided, and
Supplemental retirement income can be created

In addition to these benefits following on the heels of additional premiums, the simple fact of the carve-out adds an element of portability.  Although the group term life insurance would, of course, end if the executive terminated, the universal life insurance portion remains in force and moves with the executive.  


Group Carve-Out Plan Description

There are several benefits that follow the creation of a group carve-out plan, such as selectivity, portability, avoidance of imputed income and the ability to keep life insurance coverage beyond retirement.  Let's consider each of these benefits in somewhat greater depth.


Selective Coverage

One of the important characteristics of nonqualified plans is the employer's ability to decide who will be covered by them and who won't be.  Whether we consider it selectivity or discrimination is immaterial: it is a significant departure from qualified plans.  In the case of group carve-out plans, a class of executives is usually selected to participate.  For example, the class may be -- and often is -- comprised of "all vice presidents."  As is the case in other plans, this selectivity permits the employer to provide greater recognition to selected key executives.


Coverage Beyond Retirement

Life insurance needs don't generally change significantly when an individual retires.  In large measure, all of the things that needed to be done in the event of death before retirement need to be done after retirement.  Surviving family members need to continue to receive income, mortgages need to be paid, and so forth.  By personally owning the universal life insurance policy that replaced the group term coverage, the executive can continue it beyond retirement.  If he or she has added extra premiums while employed, that coverage may continue into retirement without the need to make additional premium payments.


 Coverage is Portable

Since the executive owns the universal life insurance policy, its coverage is portable.  In other words, the universal life insurance policy continues despite the executive's termination of his or her service with the employer.


Table I Costs Eliminated

The imputed income that arises because of the group term life insurance coverage that exceeds $50,000 is calculated using rates in government Table I.  Accordingly, the imputed income is known as the Table I cost.  Table I costs are eliminated in a group carve out plan.  The Table I rates are as shown in the chart below:


Table I Uniform Premiums for $1,000 of Group Term Life Insurance Protection
 5-Year Age Bracket
 Monthly Cost Per $1,000 of Protection
Under 25
$.05
25 - 29
.06
30 - 34
.08
35 - 39
.09
40 - 44
.10
45 - 49
.15
50 - 54
.23
55 - 59
.43
60 - 64
.66
65 - 69
1.27
70 and above
2.06