19.4 Group Life Insurance
In this section we elaborate on life insurance offered as group coverage by employers:
- Life insurance plans typically offered by employers
- Benefit determination in group life
- Supplementary types of group life insurance coverage
- When employer obligations are terminated
- Tax implications of group life insurance
Group life insurance is the oldest of the employer-sponsored group insurance benefits, dating from 1912. The most common type of group life insurance offered by employers is yearly renewable term coverage. It is the least expensive form of protection the employer can provide for employees during their working years. Due to a shorter average life expectancy, older employees and males have relatively higher premium rates. The premium for the entire group is the sum of the appropriate age- or sex-based premium for each member of the group. Obviously, a particular employee’s premium will increase yearly with age. However, if younger employees continue to be hired, the lower premium for new hires can offset increases due to aging employees hired some years earlier. Also, if young employees replace older ones, premiums will tend to stabilize or decrease. This flow of covered lives helps maintain a fairly stable average total premium for the employer group.
Most group term life insurance provides death benefit amounts equal to the employee’s annual salary, one and one-half times the salary, or twice the salary. Some provide three or four times the salary, but some states and many insurers set limits on maximum benefits. Some provide a flat amount, such as $10,000 or $50,000. Other employers base the amount on the position of the employee, but they have to be careful to adhere to nondiscrimination laws. An amount equal to some multiplier of the salary is most common and reduces the possibilities of discrimination. Insurers’ underwriting limitations are usually related to the total volume of insurance on the group.
Additional amounts of term life insurance may be available on a supplemental basis. Employers sponsor the supplemental plan, and employees usually pay the entire premium through payroll deductions. This allows employees to increase life insurance based on their individual needs. Supplemental coverages are usually subject to insurability evidence to avoid adverse selection. Accidental death and dismemberment insurance is also part of added benefits. This coverage provides an additional principal sum paid for accidental death. The death must occur within ninety days of the accident. The coverage also comes in multipliers of salary. The dismemberment part of the coverage is for loss of limb or eyesight. Dependent life insurance is available for low amounts for burial and funeral expenses. Benefits are minimal for children and spouses. Most employers also add waiver of premiums so that, in the event the employee becomes disabled, premiums are waived. Added benefits are also called voluntary coverage because the employee always pays for the coverage.
Beneficiary designation is determined by the insured persons; in some states, the employer may not be the beneficiary. The beneficiary can choose from the settlement options detailed previously. Any mistake in age made by the employer is corrected by a premium adjustment; this is different for individual coverage, which adjusts the death benefit. There is a grace period of thirty days for the premiums.
Life insurance policies have changed to meet the changing needs of policyholders. Many life insurance policies today allow benefits to be paid early in the event that the insured has a terminal illness or must pay catastrophic medical expenses, as noted previously. The insured must provide evidence that life expectancy is less than six months or one year or provide proof of catastrophic illness such as cancer or liver failure. The insured can then receive living benefits or accelerated death benefits rather than the traditional death benefit. Living benefits are limited in amount, typically from 25 to 50 percent of the face amount of the life insurance policy. The balance of the benefit (minus insurer expenses) is paid to beneficiaries after the death of the insured. Generally, adding the living benefits rider does not increase total group costs, and employers and employees do not pay more for the option.
Because living benefits may not provide enough funds to the terminally ill person, some may prefer to sell their policy to a viatical settlement company or to a life settlement program, which gives more funds up front, up to 80 percent of the face amount. Viatical settlements used to be very controversial; see the box “Do Viatical and Life Settlements Have a Place in Today’s Market?”
Many group plans terminate an employee’s group life insurance benefit when he or she retires. Those that allow employees to maintain coverage after retirement usually reduce substantially the amount of insurance available. If an employee is insurable at retirement, additional life insurance may be purchased on an individual basis. Alternatively, the employee can use the convertibility option in most group plans (regardless of the reason that employment terminates) to buy an equal or lower amount of permanent life insurance with level premiums based on the employee’s attained age. Conversion takes place without having to demonstrate evidence of insurability. Because of potential adverse selection and the rapid increase in mortality rates after middle age, the costs of conversion are high as well.
Taxation of the group life is subject to IRS section 79, which states that the employer’s premium contribution of up to $50,000 of death coverage is not considered income to the employee for income tax purposes. For any premiums for an amount of death benefits greater than $50,000, the employee has to pay taxes on the premiums as an income for income tax purposes. The premiums for the income calculations are based on the Uniform Premium Table I (revised in 1999 for lower rates), which is shown in Table 19.5 "Uniform Premium Table I".
Table 19.5 Uniform Premium Table I
|Age||Cost per Month per $1,000 of Coverage|
|24 and under||$.05|
|70 and over||$2.06|
Group universal life insuranceUsually offered as a supplement to a separate program of group term benefits. is available from many employers. This insurance is usually offered as a supplement to a separate program of group term benefits. Universal life premiums are paid by employees and are administered through payroll deduction. A substantial amount of coverage (e.g., twice the annual salary, up to a maximum of $100,000 in face amount) is available without evidence of insurability. Low administrative expenses and low agents’ commissions usually result in reasonably priced insurance. Group universal life insurance plans have become increasingly popular with both employers and employees. Employers are able to sponsor a life insurance plan that covers workers during their active years and into retirement at little or no cost to the employer. For example, the employer’s expense may be limited to the costs of providing explanatory material to new employees, making payroll deductions of premiums, and sending a monthly check for total premiums to the insurer. Group universal life insurance is also popular with employees, largely because of the flexibility of the product.
Do Viatical and Life Settlements Have a Place in Today’s Market?
Viatical settlements involve the sale of an existing life insurance policy by a terminally ill person to a third party. Viaticals saw their heyday during the late 1980s as AIDS patients with little time left sought funds to live out their final days or months with dignity. Numerous companies were formed in which individuals invested in the life insurance policies of AIDS patients, essentially betting on the short life expectancy of the policyholder. The investor would give the insured about 80 percent of the death benefits expecting to generate a large return in less than a year when the insured passed away and the proceeds would be collected by the investor/beneficiary.
With the advent of protease inhibitors in the mid-1990s, the life expectancy of people with AIDS increased dramatically. AIDS viaticals no longer looked like such a good investment. But the industry has not disappeared. Today, companies selling viaticals seek out individuals with other terminal illnesses, such as cancer or Amyotrophic Lateral Sclerosis (ALS, otherwise known as Lou Gehrig’s disease).
Viatical settlements are possible because ownership of life insurance may be transferred at its owner’s discretion. Viatical settlement firms typically buy insurance policies worth $10,000 and more from individuals with one to four years left to live. Both individual and employer-provided life insurance (group life) policies can be sold. Once sold, the new owner pays the premiums. The former owner uses the settlement money for anything from health expenses to taking that last dream vacation.
The option to receive a portion of the life proceeds before death is not new. The accelerated benefit option in life policies allows terminally ill policyholders access to the death benefits of their policies before they die. In such a case, a percentage of the face value (usually 50 percent or less) is paid in a lump sum to the policyholder. The rest of the insurance is paid to the beneficiary at the time of death. The low amount available under the accelerated benefit option is the impetus to the development of the viatical settlement companies. With transfer of ownership, the insured can get much more than 50 percent of the policy amount. According to Conning estimates, for a policy with a death benefit of $1.5 million, the typical payment would be $450,000 with a commission to the producer of close to $75,000.
While viatical settlements can provide greatly needed funds to terminally ill individuals, they are not without pitfalls. They pay less than the face value of the policy, but they usually provide higher amounts than the cash value of a policy. Settlement money may be subject to taxation, while life insurance benefits are not. Because beneficiaries may contest the sale of life insurance, which will reduce their inheritance, their advance approval is required. Senior citizens whose beneficiaries have died, however, often have no reason to continue paying premiums and may let their policies lapse anyway. In this case, selling their policy may provide them with funds they would otherwise never see.
Today, life settlements have supplanted viatical settlements in industry headlines. Life settlements are similar to viaticals, with the distinguishing feature that the insureds relinquishing their policies need not have a catastrophic illness (although in some jurisdictions, viaticals are defined broadly enough that there is no practical distinction between viatical and life settlements). Nonetheless, life settlements are marketed toward insureds with actuarially short conditional life expectancies, such as individuals over the age of sixty-five. This feature makes life settlements controversial, like their viatical cousins.
The regulatory climate of life and viatical settlements is tumultuous. Each state has a different view toward buyer practices, and regulatory standards range from nonexistent to draconian. Because sales are secondary-market transactions, some states impose no regulation over settlements. Agents and brokers may also be unlicensed. On the other hand, some states enforce onerous requirements on life settlement dealings. For example, the Ohio Department of Insurance (DoI) nearly drove life settlement dealings out of the state by calling for detailed information about brokers’ transactions. The “self-audit data call” asked for over ninety data elements about life settlement contracts, including sensitive health and personal information about insureds. Brokers doing business in the state claimed the scope of the data call was highly burdensome and that compliance meant a potential violation of Health Insurance Portability and Accountability Act (HIPAA) privacy laws (discussed in Chapter 20 "Employment-Based Risk Management (General)"). Nevertheless, noncompliant brokers were faced with the threat of losing their licenses to conduct business in Ohio. The DoI also wanted life settlement brokers to attest to the accuracy of their data call responses, a caveat that could expose them to litigation by insureds for misrepresentation. Ultimately, the Ohio DoI rescinded its data call request in March 2009 in light of significant criticism by the industry.
In the defense of states with strict regulatory protocols, the life settlement market is far from infallible. A variation known as stranger-originated life insurance (STOLI) has emerged as a new form of life settlement where senior citizens of high net worth become insureds for large death benefits. Premiums are paid by investors who become the owners and beneficiaries of these policies. The seniors usually receive a certain percentage of the death benefits. Because death benefits are not taxable, the life insurance industry is worried that the tax exemption may be lost if investors are the beneficiaries rather than family members. STOLI is a source of controversy because insureds may encounter tax liabilities, have their privacy compromised, and diminish their ability to buy more life insurance coverage in the future. The main problem is the insurable interest issue in some States.
The inconsistent regulatory environment is such that some life settlement transactions are completely illegitimate, as in the case of National Life Settlements (NLS), L.L.C. The company is alleged to have collected over $20 million from life settlement investors without purchasing any actual policies, according to bank records. NLS had compensated unlicensed brokers and agents in $3 million worth of commissions but returned only a fraction of the amount collected from investors over three years. The Texas State Securities Board seized the assets of NLS pending outcome of the legal investigation.
In an effort to improve industry transparency and ethical conduct, the National Association of Insurance Commissioners (NAIC) and National Conference of Insurance Legislators (NCOIL) proposed separate life settlements model acts in December 2007. The model acts put forth marketing standards, uniform purchase agreements, bans on STOLI, insureds’ limited rights of termination, and sanctions for offenders. As of this writing, twenty-eight states have enacted legislation based on the model acts or their own standards governing life settlements and licensing requirements.
The life settlement business is growing and offering increasingly sophisticated financing arrangements. About $15 billion in life insurance policies were sold via life settlements in 2006, per the Life Insurance Settlement Association. An Internet search for “life settlement” will turn up countless organizations specializing in the service. Maturation of the industry and more standardized regulatory oversight are likely to improve the public’s perception of life settlement and its reputation. Consumers are cautioned to be leery of STOLI dealings; conduct life settlements only through institutionally owned and funded entities; clarify all tax implications; and scrutinize contracts for features such as rescission periods, HIPAA compliance provisions, and next-of-kin notifications to protect their interests in life settlement transactions.
Questions for Discussion
- Is it ethical to profit from someone else’s misfortune by buying his or her life insurance at a discount?
- Are life settlements a good idea for the policyholder? What are their advantages and disadvantages?
- Do you think there is a need for viatical or life settlements when accelerated benefits are available?
Sources: Ron Panko, “Is There Still Room for Viaticals?” Best’s Review, April 2002, http://www3.ambest.com/Frames/FrameServer.asp?AltSrc=23&Tab=1&Site=bestreview&refnum=16722, accessed April 11, 2009; Lynn Asinof, “Is Selling Your Life Insurance Good Policy in the Long Term?” Wall Street Journal, May 15, 2002; Karen Stevenson Brown, “Life Insurance Accelerated Benefits,” http://www.elderweb.com/, accessed April 11, 2009; National Association of Insurance Commissioners, http://www.naic.org, accessed April 11, 2009; Life Partners, Inc., http://www.lifepartnersinc.com, accessed April 11, 2009; “Life Settlements—Top Ten Questions,” New York State Insurance Department, http://www.ins.state.ny.us/que_top10/que_life_set.htm, accessed March 15, 2009; Trevor Thomas, “Feature: Ohio Department Shelves Demand for Detailed Data on Settlements,” National Underwriter Life/Health Edition, March 9, 2009, http://www.lifeandhealthinsurancenews.com/Exclusives/2009/03/Pages/Feature-Ohio-shelves-demand-for-detailed-data-on-settlements.aspx, accessed March 15, 2009; Kevin M. McCarty, Commissioner, Florida Office of Insurance Regulation, “Stranger-Originated Life Insurance (STOLI) and the Use of Fraudulent Activity to Circumvent the Intent of Florida’s Insurable Interest Law,” January 2009, http://www.floir.com/pdf/stolirpt012009.pdf, accessed March 15, 2009; Trevor Thomas, “Life Settlement Firm Bought No Policies,” National Underwriter Life/Health Edition, February 19, 2009, http://www.lifeandhealthinsurancenews.com/News/2009/2/Pages/Texas-Life-Settlement-Firm-Bought-No-Policies.aspx, accessed March 15, 2009; “Regulatory and Compliance Update,” Life Settlement Solutions, Inc., February 2009, http://www.lifesettlementsmarketwatch.com/regulatory_compliance.html, accessed March 15, 2009; Alan Breus, “Virtues and Evils of Life Settlement,” Planned Giving Design Center, http://www.pgdc.com/pgdc/virtues-and-evils-life-settlement, accessed March 15, 2009; Rachel Emma Silverman, “Letting an Investor, Bet on When You’ll Die, New Insurance Deals Aimed at Wealthy Raise Concerns; Surviving a Two-Year Window,” Wall Street Journal, May 26, 2005, D1.
In this section you studied important aspects of group life insurance offered through employers:
- Yearly renewable term coverage is offered most often by employers to employees; group premium rates are based on the sum of the age- and sex-based premium for each member.
- Benefits are based on employee’s salary or position, up to state and insurer maximums allowed.
- Supplemental coverage, subject to individual evidence of insurability, may be offered; accidental death/dismemberment, waiver of premium in event of disability, and dependent life insurance are typical forms.
- Employees select beneficiaries; beneficiaries choose settlement options.
- Living benefits riders are allowed and do not generally increase group costs.
- Group life typically ends when the employee retires, but the policy is convertible.
- Group premiums are tax-free for up to $50,000 of the benefit.
- Group universal life insurance may be offered as a supplemental program and is popular because of its affordability and flexibility.
- How is yearly renewable term life insurance made more affordable under a group arrangement?
- Build a group life insurance program for Spookies Grocery Store using what you learned in this section, the section immediately preceding it, and Case 2 of Chapter 23 "Cases in Holistic Risk Management". You can also ask a family member to give you their employer’s employee benefits handbook if you are not currently employed.
- On which factors is the underwriting and pricing of group life based?
- How are age mistakes made by employers in group life coverage corrected? How does this differ from policies offered on an individual basis?
- What options for continuing coverage does a retiree covered under a group life policy have?