Group Chap 11: Group Life Insurance Benefits

Question 1

Basic Group Term Life Insurance

1. Types of Plans
2. Plan Provisions
3. Federal Income Tax Implications
4. Regulatory Considerations

Answer 1

1. Provides common level of basic insurance for covered group of employees when insured dies

2. Types of Plans
4 Types
a. Flat dollar plans (e.g. $10,000 for all EEs)

b. Multiple earnings plans (e.g. 1x or 2x salary)

c. Salary bracket plans (e.g. specified insured amounts based on what salary bracket EE falls into)

d. Position plans (e.g. insured amount based on EE category/ job level)

Such plans preclude individual selection and minimize anti-selection

Many plans include age related and/or retirement related reductions in face amount of insurance
(1) Reduced need for life insurance after age 65/retirement
(2) Reductions must be actuarially cost justified under the Age Discrimination in Employment Act (ADEA)

3. Plan Provisions
Eligibility Provisions
a. Usually full time EEs working mroe than a minimum number of hours (e.g. >30hr)

b. Actively-at-work requirements - requires EE be actively at work before the insurance becomes effective

c. Non-contributory or Contributory
(1) Non-contributory - no EE contributions toward the cost of coverage; typically require 100% participation of eligible employees
(2) Contributory - typically 75% minimum participation (varies by size of group, etc)

d. Medical evidence of insurability - typically a medical questionnaire for amounts in excess of a defined threshold, when benefits are based on a multiple of salary

e. Specified plan maximum amount of insurance - to avoid disporportionate amounts of coverage on a single life

Continuity of Coverage Provisions and Conversion Rights
a. Insured’s right to convert group term policy to individual policy upon termination of employment - also may apply if insurance ends due to termination of the entire group policy (provision may be more limited)

b. Almost all states/provinces require a conversion provision

c. Individual policy may have a face amount less than or equal to the lost group coverage

d. Premium rates for a standard individual based on the insured’s age at time of conversion

Disability Provisions
a. Waiver of Premium (WOP) - group life insurance is continued without premium payment when EE becomes totally disabled (i.e. can’t work and can’t pay premium)

b. Total and Permanent Disability - provides a benefit on a monthly installment basis - On death of insured, the original death benefit would be reduced by any disability installments made

c. Extended Death Benefit - death benefit payable if insured’s insurance terminates and dies within a year of the termination date, while being continuously and totally disabled from the termination date to the date of death

Benefit Payment Provisions
a. Benefits are payable to the beneficiary designated by the insured - Employer may not be named beneficiary

b. Settlement options - lump sum, monthly installment, or a money market-like account

c. Accelerated Benefits Provisions - allows a limited payout of the death benefit prior to the death if the insured becomes terminally ill - usually 50% to 75% of face amount

4. Federal Income Tax Implications
- Deductibility of Premiums
a. Premiums paid by employer deductible on employer’s income tax in US and Canada - applies to most life, supplemental life, survivor’s benefits, dependent life, accidental deaht and group universal life plans

Taxability of Proceeds
a. Benefits under group term life are excludable from beneficiary’s gross income in US and Canada - Applies to most life, supplemental life, survivor’s benefits, dependent life, accidental death and group unicersal life

b. Payments to terminally ill under accelerated benefit option are excludable from gross income, provided certified by physician that death expected within 24 months

Taxable Income to Employees
a. In US, employees are taxed on the value of employer provided group term that exceeds $50,000

b. The first $50,000 is received tax-free

c. Value of group term life uses a schedule of premium rates known as Table I - Promulgated by IRS and updated to reflect changes in mortality in the US

d. Imputed income determined as follows:
Table I rate for attained age on last day of tax year multiplied by amount of insurance in excess of $50,000 divided by $1,000.
Employee contributions substracted from the calculated amount.

e. Example: EE age 50, covered for $125,000 contributes $0.10 for each $1,000 of coverage
Table I monthly rate for attained age 50: 0.23
Table 1 cost (($125,000-$50,000)/$1,000) * 0.23 * 12 =$207
Employee contributions (125,000/1,000) * 0.10 * 12 = $150
Imputed Income: $207 - $150 = $57

f. All of employee’s contribution can offset (even contributions on the first $50,000)

g. Only applies group term life insurance plans that do not discriminate in favor of “key employees” - If plan is discriminatory, $50,000 exclusion does not apply, and imputed income for key empoyees is greater of Table I rates and actual cost of the insurance

h. In Canada, all employer payments for group life are taxable to employee (including sales taxes) - Applies to all types except accidental death and disemberment coverage (AD&D taxed only in Quebec)

5. Regulatory Considerations
Federal Regulation
a. Group term life is subject to many provisions of ERISA

b. Age discrimination in Employment Act (ADEA) requires that any age-related reductions in group life insurance coverage be actuarially cost justified

State and Provincial Regulation
a. In addition to federal regulations

b. Common Requirements:
(1) Do not permit individual selection of the face amount
(2) Maximum EE contribution requirements
(3) Minimum participation requirements
c. Other regulations based on NAIC model laws may apply

Question 2

Group Supplemental Life Plans

Answer 2

1. Types of Plans
a. Provide additional insurance beyond basic group term, and are employee-pay-all

b. Generally a unisex, step-rated premium structure where rates vary by 5-year age brackets

c. Amounts of insurance - choice of flat amounts or a choice of multiple of earnings

2. Plan Provisions
a. Generally the same as basic group term life

b. Disability provisions limited to WOP

c. Minimum participation requirements lower than for basic group term (e.g. 25% instead of 75%)

d. Evidence of insurability requirements more stringent than for the basic coverage

e. Full evidence required for amounts above Guarantee Issue (GI) limit
- Most insurers pay the additional costs of tests to encouragge participation and improve spread of risks in the plan
- GI limits for supplemental plans have increased in past 5-10 years, result of competition in the market

f. Suicide exclusion is common (for first 2 years of policy)

g. Portability Provisions
- Allow participants who terminate employment to continue group coverage by paying premiums directly to insurer
- Commonly rates applicable to portable lives are based on a seaprate schedulee of rates and include a monthly admin charge
- Experience of portable lives usually not included with experience of the active group for experience rating purposes
- Mortality experience on portable lives significantly worse than on similar active lives, reflecting anti-selection

3. Federal Income Tax Implications
Taxable Income to Employees
a. Generally on a fully contributory (employee-pay-all) basis

b. Employee-pay-all supplemental life insurance considered outside IRC Section 79 (avoiding imputed income consequences) provided two conditions are met
(1) No direct or indirect employer subsidiess
(2) Premium step-rates all at or below Table I, or all at or above Table I premium step-rates - Referred to as the “Straddle Test”, Financial treatment of optional life plan must be independent of employer provided plan

c. Advantageous for basic and supplemental group life programs to be trated as separate plans
- Supplemental plan would otherwise be imputed at the Table I level

d. Most recent update to Table I (1999) decreased rates by 50% for some age bands
- Plan sponsors may want to consider this in determing whetther to treat basic and supplemental plans as separate plans

e. Alternative approach may provide optional life plan through Voluntary Employees’ Beneficiary Association (VEBA)
- Employer’s involvement becomes more restricted

4. Regulatory Considerations
How state and provincial laws have been interpreted
a. Precluding individual selection of amount - you may offer an EE a limited number of selections of specific dollar or multiple of earnings

b. Minimum participation requirements - if the basic group term plan meets a statutory 75% requirement, then all the group term life through that ER meets the minimum requirements (even if <75% participate in the supplemental plan)

Question 3

Group Accidental Death and Dismemberment (AD&D)

Answer 3

1. Typically a companion coverage to group term life
2. Benefit payable if EE dies as a result of a covered accident
   a. Percentage of the benefit (commonly 50%) if the EE loses a member (e.g. hand, foot, or sight of an eye)
   b. If more than 1 member/body part is lost, then full AD&D benefit is payable
3. Many ERs provide basic AD&D where amount is 100% of the basic group life amount
   a. Supplemental AD&D plans on an employee-pay-all basis
4. Coverage may either be non-occupational (only covering accidents not related to employment) or 24-hour (covering both on-job and off-job accidents)
5. Voluntary AD&D may cover other family members
6. Business travel accident (BTA) - specific form of AD&D - provides benefits if an EE dies while traveling on company business
7. Recent years - feature more extensive benefits (e.g. comas, burns)
8. Typically more exclusions than group term life policies
   a. E.g. AD&D won’t pay for benefits incurred during active military duty, while committing a felony or riot, while intoxicated or self-inflicted injury

Question 4

Dependent Group Life Insurance

Answer 4

1. Types of Plans
a. Lump sum benefit to the EE in the event of death of a covered dependent (i.e. not on EE’s own life)

b. Only available when EE group life insurance is in force

c. Definition of a dependent - legally married spourse, natural and adopted children, same-sex married spouses, civil union partners, same-sex domestic partners, and children of domestic partners
- Coverage on domestic partners required to demostrate that insurable interest exists (e.g. via domestic partnership registrations)

d. Originally designed as non-contributory providing very modest benefits
- Premiums based on a composite rate developed from age and gender distribution of the EE group

e. Evolved into predominantly employee-pay-all with more liberal benefit amounts
- To avoid antiselection, amounts on the spouse may be limited to some percentage of the EE amount
- Where higher amounts of spousal coverage permitted, premium rates often based on age step rates

f. Coverage on children normally ends at age 19, or 23 if attending college
- As a result of the Affordable Care Act, many plans extended coverage to age 26 to be consistent with medical plans

2. Plan Provisions
Eligibility Provisions
a. Usually the same as for health coverage, except newborns not eligible until they reach age 14 days

b. Deferred effective data provision - defers effective date for dependent currently confined for medical treatment until he/she is medically released

c. Where higher amounts of spousal coverage are offered, may require a medical questionnaire

Contunity of Coverage Provisions
a. Coverage continues only when EE’s group term life coverage continues

b. Conversion rights consistent with EE coverage

Benefit Payment Provisions
Beneficiary is usally the EE, and benefits are typically a lump sum

3. Federal Income Tax Implications
Taxable Income to Employees
a. In US, if amounts available on spouses, domestic partners, and children are less than $2,000, benefits are excludable and result in no imputed income to employees

b. Where amounts exceed $2,000, income imputed employees based on Table I, less employee contributions

c. In Canada, premiums paid by the employer, including sales taxes, are ta xable income

4. Regulatory Considerations
Some jurisdictions establish a maximum amount of insurance on the lives of dependent spouses and children

Question 5

Survivor Income Benefits

Answer 5

1. Types of Plans
a. Provide a monthly payment to the EE’s spouse and children on the EE’s death (instead of lump sum)

b. Benefit is a percentage of the EE’s monthly earnings

c. Typical spouse benefit is payable to the earliest of remarraige, attainment of a limiting age (e.g. 62), or death
- Children’s benefit is payable to 19, or 23 if a full-time student

d. Somewhat common for blue collar or union employers

2. Plan Provisions
a. Provisions for eligibility and continuity of coverage are similar to group basic term life with 2 potential differences
- Conversion privilege applies to present value of the monthly survivor benefit
- Disability provision is limited to WOP

b. Benefit payment provisions may include:
- Guaranteed benefit period
- Maximum benefit period
- Remarriage provision - benefits may or may not cease on remarriage
- Dowry provision - lump sum benefit payable on remarriage, to reduce incentive not to remarry
- Social security offset
- Last survivor provision - benefits may be defined by the composition of the remaining eligible survivor

c. Benefits are paid to EE’s spouse if eligible, otherwise in equal shares to the children

3. Federal Income Tax Implications
Taxability of Proceeds
- Benefit received in form of annuity
- Each monthly payment composed of non-taxable portion and taxable interest portion
- In US, portion excluded from taxable income is ratio of commuted value of survivor annuity to commuted value of suvivor annuity using 0% interest (i.e. only counts value above what a 0% interest policy would earn)
- IRC 72 uses a mortality basis for discounting

Taxable Income to Employees
- Survivor Income benefits in US and Canada considered group term life
- May be imputed on excess of $50,000 exclusion
- Imputed income based on commuted value of expected payments
- Present value uses mortality specified in IRC 72 and interest rate used by insurer to calculate the amount of insurance

Question 6

Group Permanent Life Insurance

Answer 6

1. Types of Plans
a. Note - this is rarely provided today because of tax limitations

b. Single-Premium Group Paid-up Life
- Level death benefit is provided for a single fixed premium, based on attained age
- Includes a level face amount and growing cash value

c. Group Ordinary Life Insurance
- The group counterpart to individual whole life
- A fixed life insurance amount, level premiums, and a growing cash value

d. Group Term and Paid-up Plan
- Splits coverage into a combination of group paid-up life insurance paid by EE and decreasing group term insurance paid by ER

2. Plan Provisions
a. Similar to group term life with the following potential differences
- No continuity of coverage necessary for group paid-up insurance
- Disability provision limited to WOP on the term portion of group term and paid-up
- Conversion privilege is limited to face amount less cash value for group ordinary life insurance

3. Tax Considerations
a. In US, employer-provided group permanent life subject to Section 79
- Imputes income based on conservative interest and mortality assumptions
- Imputed taxable income can be greater than value to employee using the cash values in policy
- Employee-pay-all may be excluded and not generate imputed income under following conditions
(1) Insurer sells directly to employee, who pays full cost
(2) Employer’s participation is limited to selection of insurer and type of insurance, providing insurer with lists of employees and use of premises, and collecting premiums
(3) Insurer or employer does not condition the sale on the purchase of other obligations

Question 7

Group Universal Life Insurance (GUL)

Answer 7

1. Types of Plans
a. Allows certificate holders to share in assumption risk (mortality, interest rate, expense, persistency), so premiums can be lower than group whole life

b. May also provide coverage on dependent spouses and children

c. Consist of term life insurance an a side fund that accumulates with interest

d. Each certificate holder has own accumulated fund
- Charges taken out for mortality and expenses - charges subject to guaranteed maximum (similar to individual universal life)
- Interest is earned
- Death benefits can be level or increasing - Death Benefit = Face Amount + Accumulated Fund

e. Premiums typically flexible, but may be fixed in some cases

f. GUL premium
- Premium credited to the fund net of premium tax, expense charges, and term cost with balance accumulating with interest
- Premium may be determined flexibly with the minimum amount allowable being enough to satisfy the cost of the mortality and expenses and maximum specified by IRS Section 7702
- “Cost of term insurance” based on either one-year or five-year step rates

g. Credited interest rate is set by the insurer annually
- There may be a guaranteed minimum credited interest rate, hisotrically in the 3-4% range, though lower in recent years with low interest rate environment

2. Plan Provisions
a. Eligiility provisions are similar to group supplemental

b. GUL continuity of coverage approaches:
- WOP may apply to the target premium or charges
- Portability provision similar to supplemental life plans may apply
- Accumulation fund may be used by the certificate holder to purchase paid-up insurance on retirement or termination
- Coverage may continue on a non-premium paying basis, with monthly term costs withdrawn from the accumulation fund until exhausted
- Coversion privilege may be provided, less any paid-up insurance purchased by the fund

c. Death benefit payment provisions
-Similar to group term life
- Fund may be paid out as a surrender or a policy loan
- On death, any outstanding loans and interest charges are deducted from the death benefit otherwise payable

3. Regulatory Considerations
a. Most provincial and state insurance laws that apply to group term are also applicable to GUL
b. NAIC model illustration regulation - to ensure taht illustrations do not mislead purchasers and to make illustrations more understandable

4. Federal Income Tax Implications
Taxable Income of Employees
a. Tax implications favorable, if plan outside of Section 79 (in US)
b. Features
- Interest accumulates on tax-deferred basis
- Cash surrender taxable on the gain on surrender - Gain on surrender = excess of cash surrender over certificate holder’s basis in the contract
- Death benefit (term plus fund) payable tax free to beneficiary

c. GUL outside of Sectoin 79 does not generate imputed income
- Under Section 79 (If employer contributions are involved) subject to group permanent life tax provisions

d. IRC requirements assume protection elements such that savings elements do not inappropriately dominate
- GUL certificate satisfy either
(1) Cash value accumulations test
(2) Both the guideline level premium test and cash value corridor test
- If contract fails requirements, it is not considered life insurance
(1) All income immediately taxable
(2) Loses advantage of tax-free buildup of cash value
(3) Only death benefits in excess of net surrender value excludable from beneficiary’s gross income
- If GUL certifacte exceeds defined limit in relation to face amount may become Modified Endowment Contract (MEC)
(1) Policy distributions such as withdrawals and policy loans treated as taxable interest and subject to IRS penalty of 10%

Question 8

Group Variable Universal Life (GVUL)

Answer 8

1. Types of Plans
a. Similar to GUL plans, however, under GVUL, there are several investment options available to invest the accumulation fund
- E.g. Equity investment fund, money market, or fixed interest rate options

2. Plan Provisions
a. All provisions in GUL are found in GVUL

b. In addition, there are limitations on withdrawls and movement of funds among investment options

3. Regulatory Considerations
a. Most states and provincial insurance laws that apply to group term are also applicable to GVUL

b. GVUL illustrations are not required to meet NAIC model illustration regulation

c. GVUL is considered an investment product as well as insurance as is therefore subject to SEC and Financial Industry Regulatory Authority (FINRA) regulation