5.3 Group Life Insurance and Conversion
Key Takeaways
- Group life covers many people under one master contract held by the employer/sponsor; individuals receive certificates of coverage, not individual policies.
- Most group life is annually renewable term issued with little or no individual underwriting; the group, not the individual, is underwritten.
- Employer-paid group term life up to $50,000 is income-tax-free to employees; the cost of coverage above $50,000 is imputed income taxed via the IRS Table I rates.
- On termination of employment or eligibility, an insured generally has a 31-day conversion right to an individual permanent policy with NO evidence of insurability.
- If the insurer fails to notify of conversion rights, the conversion period and a death-claim grace can extend; ERISA, COBRA-style continuation, and nondiscrimination rules also apply.
How Group Life Works
Group life insurance covers many lives under a single master contract (also called the master policy) issued to a sponsor, usually an employer, union, or association. The sponsor is the policy owner; individual members are insureds who receive a certificate of insurance summarizing their coverage. They do not hold individual policies.
Most group life is annually renewable term (ART) with a one-year rate that adjusts as the group ages. Because the term is renewed, it builds no cash value. Permanent group coverage exists but is far less common.
Group Underwriting and Eligibility
The insurer underwrites the group, not each person, which is why group life often requires little or no individual evidence of insurability up to a guaranteed issue limit. To prevent adverse selection, insurers require a legitimate group formed for a purpose other than buying insurance and demand a minimum participation level (commonly 75% of eligible employees for contributory plans, 100% for noncontributory plans).
| Plan type | Who pays | Typical participation |
|---|---|---|
| Noncontributory | Employer pays 100% | 100% of eligible employees |
| Contributory | Employee shares cost | Usually 75% minimum |
New hires enroll during an initial eligibility window; missing it can require evidence of insurability later.
The group itself must be a natural group - formed for a purpose other than obtaining insurance, such as an employer-employee relationship, a labor union, a trade association, or a creditor-debtor arrangement. This natural-group requirement, combined with minimum participation, is the core safeguard that lets the insurer underwrite the pool rather than each member.
The $50,000 Tax Rule (Section 79)
Under Internal Revenue Code Section 79, employer-paid group term life is income-tax-free to the employee on the first $50,000 of coverage. The cost of any coverage above $50,000 is imputed income added to the employee's taxable wages, valued using the IRS Uniform Premium Table I rates (cost per $1,000 of excess coverage per month, by age band), reduced by any after-tax amount the employee pays.
Exam anchor: $50,000 is the magic number. Below it, the employer-paid benefit is tax-free; above it, the employee reports imputed income on the excess.
Worked Example: Imputed Income
An employee, age 45, receives $150,000 of employer-paid group term life and pays nothing toward it.
- Excess coverage = $150,000 − $50,000 exclusion = $100,000.
- Convert to units of $1,000 = 100 units.
- IRS Table I rate at age 45 = $0.15 per $1,000 per month (illustrative).
- Monthly imputed cost = 100 × $0.15 = $15.00.
- Annual imputed income = $15.00 × 12 = $180.00 added to taxable wages.
If the employee had contributed $5/month after-tax ($60/year), the imputed income would drop to $180 − $60 = $120. Only the excess over $50,000 is ever counted.
Conversion Privilege
When an employee terminates employment or otherwise loses group eligibility, the conversion privilege lets that person convert group term coverage to an individual permanent (whole life) policy without evidence of insurability. This protects people who became uninsurable while covered.
Key rules tested on the exam:
- The conversion window is typically 31 days from loss of group coverage.
- The converted policy is permanent (not term) at the insured's attained-age rate.
- Coverage continues during the 31-day window; if the person dies in that window, the death benefit is payable even if no conversion application was filed.
- If the insurer fails to give required notice of the conversion right, many states extend the conversion period (e.g., an extra 15 days after notice).
Continuation, ERISA, and Nondiscrimination
Group life plans frequently fall under federal ERISA (Employee Retirement Income Security Act) reporting and fiduciary rules. While COBRA itself centers on health coverage, many group life plans offer comparable continuation or portability so departing employees can keep group-rate term for a period before converting.
Section 79's favorable tax treatment also requires the plan to be nondiscriminatory: if a plan favors key employees, those key employees lose the $50,000 exclusion and are taxed on the cost of their entire benefit.
| Right at termination | What it provides |
|---|---|
| Conversion | Individual permanent policy, no proof of insurability, ~31 days |
| Portability/continuation | Keep group term temporarily, often with evidence required |
Certificates, Probationary Periods, and the Actively-at-Work Rule
Because individuals hold certificates rather than policies, the master contract controls all terms. New employees typically serve a probationary period (e.g., 30-90 days) before becoming eligible, then have an eligibility/enrollment period to sign up. An actively-at-work provision requires the employee to be on the job, not home sick, on the day coverage takes effect; this is the group analog to individual underwriting and screens obvious adverse selection without medical exams.
Conversion Mechanics and a Quick Trap
On conversion, the new individual policy is permanent whole life at the attained-age premium - never a continuation of the cheap group term rate. Applicants sometimes expect to convert into more group term; that is wrong. The convertible amount usually cannot exceed the group coverage lost.
During the 31-day window the group coverage continues, so a death in that period pays the group death benefit even with no conversion filed. If the employer or insurer failed to give written notice of the conversion right, states commonly extend the deadline and may keep coverage in force until proper notice is delivered - protecting employees from clerical lapses.
An employee, age 50, receives $200,000 of employer-paid group term life. For income tax purposes, how is the benefit treated?
A terminated employee wants to keep life coverage. Which statement about the group conversion privilege is correct?