5.3 Group Life Insurance and Conversion
Key Takeaways
- Group life uses one master policy with certificates; the group is underwritten as a whole, usually as annually renewable term with no cash value.
- Actively-at-work, probationary periods, and participation minimums (75% contributory, 100% noncontributory) control adverse selection.
- Employer-paid group term premiums are tax-free to the employee on the first $50,000; coverage above creates Table I imputed income.
- On loss of group coverage the conversion privilege allows converting to individual permanent insurance within 31 days with no evidence of insurability.
- Converted coverage is whole life at attained-age rates, so it is typically more expensive than the group term it replaces.
Group Life Insurance
Group life insurance covers many people under a single master policy issued to a sponsor (usually an employer). Individuals receive a certificate of insurance, not their own policy. The sponsor is the policyowner; covered individuals are certificate holders.
Defining characteristics
- Group underwriting: the group as a whole is underwritten, not each individual, so most members enroll with little or no evidence of insurability up to a guaranteed-issue limit.
- Coverage type: group life is almost always annually renewable term, so it builds no cash value.
- Experience rating: premiums reflect the group's overall claims experience and demographics, not one person's health.
- Cost: typically cheaper than individual coverage due to administrative efficiency and employer subsidy.
Eligibility and anti-selection controls
To prevent adverse selection (only the unhealthy enrolling), insurers require:
| Control | Purpose |
|---|---|
| Eligible class definition | Coverage tied to employment, not health |
| Actively-at-work provision | Coverage starts only when the employee is working |
| Probationary period | New hires wait (e.g., 30-90 days) before eligibility |
| Enrollment period | Limited window; late entrants need evidence of insurability |
| Minimum participation | For noncontributory, 100% must enroll; contributory usually 75% |
Contributory plans require employees to pay part of the premium (typical minimum participation 75%). Noncontributory plans are fully employer-paid and require 100% participation, which eliminates anti-selection because no one can opt out.
Group term taxation: the $50,000 rule
Employer-paid group term life premiums are a deductible business expense for the employer and are generally not taxable to the employee on the first $50,000 of coverage. Premiums for coverage above $50,000 create imputed income to the employee, valued using the IRS Table I cost per $1,000.
Worked example. An employee age 45 has $150,000 of employer-paid group term life. Only the amount over $50,000 is taxable: $150,000 - $50,000 = $100,000. If Table I shows $0.15 per $1,000 per month, monthly imputed income = 100 x $0.15 = $15.00, or $180 per year added to the employee's W-2.
The conversion privilege
When group coverage ends - because the employee terminates, retires, or the group plan is canceled - the certificate holder has a conversion privilege:
- Convert to an individual permanent (whole life) policy, not term.
- No evidence of insurability is required.
- The conversion must usually be exercised within 31 days of losing group coverage; coverage continues during this conversion period even if the person dies before converting.
- The individual premium is based on the insured's attained age and the insurer's standard rates.
Trap: the converted policy is whole life at attained-age rates, so it is usually more expensive than the group term it replaced. Also, if the entire group plan terminates, conversion rights may be limited (often only for those insured a minimum period, with caps on the convertible amount).
Group versus individual
| Feature | Group life | Individual life |
|---|---|---|
| Policy issued to | Sponsor (master policy) | Insured |
| Underwriting | Group basis | Individual basis |
| Cost | Lower | Higher |
| Portability | Via conversion only | Fully portable |
Contributory vs noncontributory recap
| Plan type | Who pays | Minimum participation | Anti-selection risk |
|---|---|---|---|
| Noncontributory | Employer pays 100% | 100% of eligibles | Lowest (no one opts out) |
| Contributory | Employee shares cost | Usually 75% | Higher (healthy may decline) |
The participation rules exist to keep enough healthy lives in the pool. If too few enroll, the group skews toward those who expect to claim, driving up cost - the textbook definition of adverse selection.
Other group concepts tested
- Group conversion period continuation: during the 31-day window, the person is still covered; a death in that window pays the group benefit even if no conversion application was filed.
- Assignment of the master policy: the certificate is not individually owned, so members cannot assign coverage the way an individual policyowner can; the sponsor controls the master contract.
- Dependent coverage: many group plans offer small flat amounts on a spouse and children; this coverage is also term and ends with the employee's eligibility, subject to its own conversion rights.
Group scenario
A 60-employee firm offers noncontributory group term equal to two times salary. A new hire must complete a 90-day probationary period and be actively at work on the effective date. If the new hire is hospitalized on day 91, coverage does not begin until they return to active work, because the actively-at-work provision is a condition of the effective date - a frequently tested trap.
An employee terminates employment and loses $100,000 of group term life. Under the conversion privilege, the employee may:
An employee receives $200,000 of employer-paid group term life. How much of the coverage creates taxable imputed income under the $50,000 rule?