5.3 Group Life Insurance and Conversion
Key Takeaways
- Group life uses a single master contract issued to the sponsor while members receive certificates of coverage and group/experience underwriting, often guaranteed issue up to a limit.
- Participation rules control adverse selection: noncontributory (employer-paid) plans require 100% participation, while contributory plans require about 75%.
- Under IRC Section 79, employer-paid group term is tax-free up to $50,000; the IRS Table I imputed cost of coverage above $50,000 is taxable income to the employee, while the death benefit stays income-tax-free.
- The conversion privilege allows conversion to an individual whole life policy within about 31 days with no evidence of insurability, and the group benefit still pays if the member dies during that window.
How Group Life Works
Group life insurance covers many people under a single master contract issued to an employer, union, or association — the policyowner. Individual members do not receive policies; they receive certificates of coverage that summarize their benefits. The most common form is group term life, providing temporary, no-cash-value protection for the period of employment or membership.
Individual vs. Group: Core Contrasts
| Feature | Individual Life | Group Life |
|---|---|---|
| Contract | Issued to the individual | Master contract to the sponsor; certificates to members |
| Underwriting | Individual; full evidence of insurability | Group/experience underwriting; often guaranteed issue up to a limit |
| Cost | Higher per unit | Lower (spread risk, group rates) |
| Portability | Owner-controlled | Tied to employment/membership; conversion on loss |
| Most common type | Whole or term | Annual renewable group term |
Group underwriting looks at the group as a whole, not each member, which lets healthy and impaired employees obtain coverage without exams up to a guaranteed-issue limit. Amounts above that limit may require evidence of insurability.
Eligibility and Anti-Selection Controls
To prevent adverse selection (only the unhealthy enrolling), group plans use design rules:
- Eligible group must be formed for a purpose other than buying insurance.
- Noncontributory plans (employer pays 100%) require 100% participation — everyone is covered, eliminating selection.
- Contributory plans (employees share cost) typically require at least 75% participation.
- Benefits are usually set by a nondiscriminatory formula (e.g., flat amount, or a multiple of salary) so coverage is not hand-picked.
Trap: noncontributory = 100% participation; contributory = usually 75%. Confusing those thresholds is a common miss.
Federal Tax Rule — Section 79 ($50,000)
Under IRC Section 79, employer-paid group term life premiums are a tax-free benefit to employees only up to $50,000 of coverage. For coverage above $50,000, the imputed cost of the excess (per an IRS Table I rate based on age) is added to the employee's taxable income.
Worked example: An employer provides $150,000 of group term life at no cost to a 45-year-old employee.
- Excess over $50,000 = $100,000.
- Table I rate for age 45 (illustrative): $0.15 per $1,000 per month.
- Monthly imputed cost = 100 units × $0.15 = $15; annual = $180.
- The employee reports $180 as additional taxable income (less any after-tax employee contributions).
The death benefit itself remains income-tax-free to the beneficiary regardless of amount — only the premium on excess coverage is taxed to the living employee.
The Conversion Privilege
When group coverage ends — termination of employment, ineligibility, or the group plan terminating — the member usually has a conversion privilege: the right to convert to an individual whole life policy without evidence of insurability.
| Conversion Rule | Standard Provision |
|---|---|
| Time to apply | Typically 31 days after coverage ends (the conversion/grace window) |
| Evidence of insurability | Not required |
| New policy type | Individual permanent (whole) life, not term |
| Premium | Based on attained age and standard rates (higher than group) |
| Death during the 31 days | Group benefit is payable even if no conversion application filed |
Scenario: An employee leaves a job on June 1; group life ends. She has 31 days (until about July 1) to convert to an individual whole life policy with no medical exam, at attained-age premiums. If she dies on June 20 without applying, the group death benefit still pays because she died within the conversion period.
An employer provides $150,000 of noncontributory group term life to a 45-year-old employee. What is the federal income tax treatment?
An employee's group life coverage ends when she leaves her job. Under the typical conversion privilege, what may she do?
Key Takeaways
- Group life uses one master contract to the sponsor; members get certificates and group/experience underwriting (often guaranteed issue up to a limit).
- Participation rules prevent adverse selection: noncontributory = 100%, contributory = ~75%.
- IRC Section 79: employer-paid group term is tax-free up to $50,000; the Table I imputed cost of excess coverage is taxable to the employee; the death benefit stays income-tax-free.
- The conversion privilege allows conversion to individual whole life within about 31 days with no evidence of insurability, and the group benefit still pays if the member dies in that window.
Summary: Group life spreads risk across a sponsored group under a master contract, lowering cost and easing underwriting. Section 79 makes the first $50,000 of employer-paid coverage tax-free while taxing the imputed cost of the excess. When members leave, the 31-day conversion privilege lets them move to individual whole life without proving insurability, and a death during that window is still covered by the group plan.