5.3 Group Life Insurance and Conversion
Key Takeaways
- Group life uses one master policy held by the employer; each insured receives a certificate, and underwriting evaluates the whole group.
- Noncontributory plans require 100% participation; contributory plans typically require at least 75% to limit adverse selection.
- The conversion privilege lets a departing employee convert to an individual permanent policy within 31 days without evidence of insurability.
- Death during the 31-day conversion period is covered and the group insurer pays the benefit.
- The cost of the first $50,000 of employer-paid group term is tax-free; coverage above $50,000 creates imputed taxable income.
How Group Life Differs from Individual
Group life insurance covers many people under a single master contract issued to the group sponsor (usually an employer). Individuals do not receive their own policy; they receive a certificate of insurance describing their coverage. The vast majority of group life is annually renewable group term, providing pure death protection with no cash value.
Master Policy and Certificates
The policyowner is the group sponsor (the employer), not the insured employee. The employer holds the master policy; each covered employee holds a certificate. Underwriting evaluates the group as a whole rather than each individual, which is why most members can obtain coverage with little or no individual evidence of insurability.
Group Underwriting Principles
To prevent adverse selection (only sick people enrolling), group life requires that the group exist for a reason other than buying insurance, and it uses participation rules:
- Noncontributory plan: the employer pays 100% of the premium, so 100% participation of eligible employees is required.
- Contributory plan: employees share the cost, so typically at least 75% participation is required.
- Coverage amounts often follow a nondiscriminatory benefit schedule (e.g., a multiple of salary) so highly compensated employees cannot select against the plan.
| Term | Group Life | Individual Life |
|---|---|---|
| Document to insured | Certificate | Policy |
| Owner | Group sponsor/employer | The policyowner |
| Underwriting | Whole group | Each applicant |
| Evidence of insurability | Usually none | Usually required |
| Most common form | Annually renewable term | Various |
The Conversion Privilege
When an employee terminates employment or otherwise loses eligibility, the conversion privilege lets them convert group coverage to an individual whole life (permanent) policy WITHOUT proving insurability. This protects employees who became uninsurable while covered. Key exam facts about conversion:
- The employee generally has 31 days after termination to convert.
- Conversion is to an individual permanent policy, NOT to individual term, and NOT at the group term rate.
- The new premium is based on the insured's attained age and standard rates.
The 31-Day Conversion (Interim) Coverage
During the 31-day conversion period, the employee is still covered. If the terminated employee dies during those 31 days before converting, the group insurer pays the death benefit as if conversion had occurred. This interim protection is a frequent exam question.
Taxation of Group Term Life
Employer-paid group term premiums are a deductible business expense to the employer. For the employee, the cost of the first $50,000 of employer-paid coverage is a tax-free benefit. The cost of coverage above $50,000 (calculated using an IRS Table I rate) is imputed income added to the employee's taxable wages. The death benefit itself is generally income-tax-free to the beneficiary.
Worked Scenario
An employee leaves her job on June 1 with $100,000 of group term coverage. She intends to convert but is killed in an accident on June 20, before applying. Because death occurred within the 31-day conversion period, the group insurer pays the $100,000 death benefit to her beneficiary, even though no individual policy was issued.
An employee with employer-paid group term life dies during the 31-day conversion period after leaving employment, before converting. What happens?
How is employer-paid group term life taxed to the employee?
Conversion Rights When Coverage Ends
When an employee leaves the group or the group plan terminates, group term life usually includes a conversion privilege: the employee may convert to an individual permanent (whole life) policy without evidence of insurability.
Standard conversion rules tested on the exam:
- The conversion window is typically 31 days after group coverage ends; during that window the person remains insured even before applying.
- The new policy is permanent, not term, and is issued at the insured's attained age at standard rates (no medical exam, but a higher premium than the group rate).
- The face amount that may be converted is generally up to the amount lost under the group plan.
Contributory vs. Noncontributory and Taxation
| Plan Type | Who Pays | Participation Required |
|---|---|---|
| Noncontributory | Employer pays 100% | 100% of eligibles |
| Contributory | Employee shares cost | Usually 75% of eligibles |
For employer-paid group term life, the cost of the first $50,000 of coverage is a tax-free benefit to the employee. The premium cost of coverage above $50,000 is imputed income added to the employee's taxable wages (using an IRS Table I rate by age).
Exam Tip: $50,000 is the magic group-life number. Coverage at or below it is tax-free to the employee; the cost of the excess is taxable imputed income.
An employee with employer-paid group term life leaves the company. Under the typical conversion privilege, the employee may:
Continuation vs. Conversion
When group coverage ends, two distinct rights can apply, and the exam tests the difference:
| Right | What It Provides | Trigger |
|---|---|---|
| Continuation | Keep the same group coverage temporarily | Qualifying event (varies by plan/law) |
| Conversion | Switch to an individual permanent policy | Loss of group eligibility |
Conversion does not require evidence of insurability and must be exercised within about 31 days. The converted policy is permanent at attained-age rates, so the premium jumps from the group rate to an individual whole-life rate. A common scenario: an employee diagnosed with a serious illness leaves work the conversion right lets them lock in permanent coverage despite being otherwise uninsurable.
Exam Tip: Conversion is the safety net that protects an uninsurable departing employee; it always converts to permanent, never term.