Group insurance is characterized by a group contract, experience rating of larger groups, and group underwriting. Perhaps the best way to define group insurance is to compare its characteristics with those of individual insurance, which is underwritten on an individual basis.

In contrast to most individual insurance contracts the group insurance contract provides coverage to a number of persons under a single contract issued to someone other than the persons insured. The contract, referred to as a master contract, provides benefits to a group of individuals who have a specific relationship to the policyowner. Group contracts usually cover individuals who are full-time employees, and the policyowner is either their employer or a trust established to provide benefits for the employees. Although the employees are not actual parties to the master contract, they can legally enforce their rights. Consequently employees are often referred to as third-party beneficiaries of the insurance contract.

Employees covered under the contract receive certificates of insurance as evidence of their coverage. A certificate is merely a description of the coverage provided and is not part of the master contract. In general, a certificate of insurance is not even considered to be a contract and usually contains a disclaimer to that effect. However, some courts have held the contrary to be true when the provisions of the certificate or even the explanatory booklet of a group insurance plan varies materially from the master contract.

In individual insurance the coverage of the insured normally begins with the inception of the insurance contract and ceases with its termination. However, in group insurance individual members of the group may become eligible for coverage long after the inception of the group contract, or they may lose their eligibility status long before the contract terminates.

A second distinguishing characteristic of group insurance is the use of experience rating. If a group is sufficiently large, the actual experience of that particular group will be a factor in determining the premium the policyowner will be charged. The experience of an insurance company will also be reflected in the dividends and future premiums associated with individual insurance. However, such experience will be determined on a class basis and will apply to all insureds in that class. This is also true for group insurance contracts when the group�s membership is small.

The applicant for individual insurance must generally show evidence of insurability. For group insurance, on the other hand, individual members of the group are usually not required to show any evidence of insurability when initially eligible for coverage. This is not to say that there is no underwriting, but rather that underwriting is focused on the characteristics of the group instead of on the insurability of individual members of the group. As with individual insurance, the underwriter must appraise the risk, decide on the conditions of the group�s acceptability, and establish a rating basis.

The purpose of group insurance underwriting is twofold: (1) to minimize the problem of adverse selection (meaning that those who are likely to have claims are also those who are most likely to seek insurance) and (2) to minimize the administrative costs associated with group insurance. Because of group underwriting, coverage can be provided through group insurance at a lower cost than through individual insurance.

There are certain general underwriting considerations applicable to all or most types of group insurance that affect the contractual provisions in group insurance contracts as well as insurance company practices pertaining to group insurance. These general underwriting considerations include

Probably the most fundamental group underwriting principle is that a group must have been formed for some purpose other than to obtain insurance for its members. Such a rule protects the group insurance company against the adverse selection that would likely exist if poor risks were to form a group just to obtain insurance. Groups based on an employer-employee relationship present little difficulty with respect to this rule.

Ideally an underwriter would like to see a reasonable but steady flow of persons through a group. A higher-than-average turnover rate will result in increased administrative costs for the insurance company as well as for the employer. If turnover exists among recently hired employees, the resulting costs can be minimized by requiring employees to wait a certain period of time before becoming eligible for coverage. However, such a probationary period does leave newly hired employees without protection if their previous group insurance coverage has terminated.

A lower-than-average turnover rate often results in an increasing average age for the members of a group. To the extent that a plan�s premium is a function of the mortality (death rates) of the group, such an increase in average age will result in an increasing premium rate for that group insurance plan. This high premium rate may cause the better risks to drop out of a plan, if they are required to contribute to its cost, and may ultimately force the employer to terminate the plan because of its increasing cost.

An underwriter is concerned with the length of time a group insurance contract will remain on the insurance company�s books. Initial acquisition expenses, often including higher first-year commissions, frequently cause an insurance company to lose money during the first year the group insurance contract is in force. Only through the renewal of the contract for a period of time, often 3 or 4 years, can these acquisition expenses be recovered. For this reason firms with a history of frequently changing insurance companies or those with financial difficulty are often avoided.

In most types of group insurance the underwriter will require that benefit levels for individual members of the group be determined in some manner that precludes individual selection by either the employees or the employer. If employees could choose their own benefit levels, there would be a tendency for the poorer risks to select greater amounts of coverage than the better risks would select. Adverse selection could also exist if the employer could choose a separate benefit level for each individual member of the group. As a result this underwriting rule has led to benefit levels that are either identical for all employees or determined by a benefit formula that bases benefit levels on some specific criterion, such as salary or position.

Benefits based on salary or position may still lead to adverse selection because disproportionately larger benefits will be provided to the owner or top executives, who may have been involved in determining the benefit formula. Consequently most insurance companies have rules for determining the maximum benefit that may be provided for any individual employee without evidence of insurability. Additional amounts of coverage either will not be provided or will be subject to individual evidence of insurability.

The underwriter is also concerned with the eligibility provisions in a group insurance plan. As previously mentioned, many group insurance plans contain probationary periods that must be satisfied before an employee is eligible for coverage. In addition to minimizing administrative costs, a probationary period will discourage persons in poor health from seeking employment primarily because of a firm�s group insurance benefits.

Most group insurance plans normally limit eligibility to full-time employees since the coverage of part-time employees may not be desirable from an underwriting standpoint. In addition to having a high turnover rate, part-time employees are more likely to seek employment primarily to obtain the group insurance benefits that are available. Similar problems exist with seasonal and temporary employees, and consequently eligibility is often restricted to permanent employees.

Group insurance plans may be contributory or noncontributory. Members of contributory plans pay a portion, or possibly all, of the cost of their own coverage. When employees pay the entire portion, these plans are often referred to as fully contributory or employee-pay-all plans. Under noncontributory plans the policyowner pays the entire cost. Since all eligible employees are usually covered, this type of plan is desirable from an underwriting standpoint because adverse selection is minimized. In fact, most insurance companies and the laws of many states require 100 percent participation of eligible employees under noncontributory plans. In addition, the absence of employee solicitation, payroll deductions, and underwriting of late entrants into the plan results in administrative savings to both the policyowner and the insurance company.

Most state laws prohibit an employer from requiring an employee to participate in a contributory plan. The insurance company is therefore faced with the possibility of adverse selection since those who elect coverage will tend to be the poorer risks. From a practical standpoint 100 percent participation in a contributory plan would be unrealistic since for many reasons some employees neither desire nor need the coverage provided under the plan. However, insurance companies will require that a minimum percentage of the eligible members of a group elect to participate before the contract will be issued. The common requirement is 75 percent, although a lower percentage is often acceptable for large groups and a higher percentage may be required for small groups. A 75 percent minimum requirement is also often a statutory requirement for group life insurance.

A key issue in contributory plans is how to treat employees who did not elect to participate when first eligible but who later desire coverage, or who dropped coverage and want it reinstated. Unfortunately this desire for coverage may arise when these employees or their dependents have medical conditions that will lead to a disproportionate number of claims once coverage is provided. To control this adverse selection, insurance companies commonly require individual evidence of insurability by these employees or their dependents before coverage will be made available. However, there is one exception. Some plans have short periodic open enrollment periods during which the evidence-of-insurability requirement is lessened or waived.

Insurance companies frequently require that the employer pay a portion of the premium under a group insurance plan. This is also a statutory requirement for group life insurance in most states. Many group insurance plans set an average contribution rate for all employees, which in turn leads to the subsidizing of some employees by other employees, particularly in those types of insurance where the frequency of claims increases with age. Without a requirement for employer contributions younger employees might actually find coverage at a lower cost in the individual market, thereby leaving the group with only the older risks. Even when group insurance already has a cost advantage over individual insurance, its attractiveness to employees is enhanced by employer contributions. In addition, underwriters feel that the absence of employer contributions may lead to a lack of employer interest in the plan and consequently poor cooperation with the insurance company and poor plan administration.

To minimize the expenses associated with group insurance, the underwriter will often require that the employer carry out certain administrative functions. These commonly include communicating the plan to the employees, handling enrollment procedures, collecting employee contributions on a payroll-deduction basis, and keeping certain types of records. Underwriters are concerned not only with the employer�s ability to carry out these functions but also with the employer�s willingness to cooperate with the insurance company.

For most insurance companies a large portion of newly written group insurance consists of business that was previously written by other insurance companies. Therefore it is important for the underwriter to ascertain the reason for the transfer. If the transferred business is a result of dissatisfaction with the service provided by the prior insurance company, the underwriter must determine whether his or her insurance company can provide the type and level of service desired. Since an employer is most likely to shop for new coverage when faced with a rate increase, the underwriter must evaluate whether the rate increase was due to excessive claims experience. Often, particularly with larger groups, poor claims experience in the past is an indication that there might be poor experience in the future. Occasionally, however, the prior experience may be due to circumstances that will not continue in the future, such as a catastrophe.

Excessive past claims experience may not result in coverage denial for a new applicant, but it will probably result in a higher rate. As an alternative, changes in the benefit or eligibility provisions of the plan might eliminate a previous source of adverse claims experience.

The underwriter must also be reasonably certain that the employer will not present a persistency problem by changing insurance companies again in the near future.

The size of a group is a significant factor in the underwriting process. With large groups there is usually prior group insurance experience that can be used as a factor in determining the premium. In addition, adjustments for adverse claims experience can be made at future renewal dates under the experience-rating process.

The situation is different for small groups. In many cases coverage is being written for the first time. Administrative expenses tend to be high in relation to the premium. There is also an increased possibility that the owner or major stockholder might be interested in coverage primarily because he or she or a family member has a medical problem that makes individual life insurance coverage difficult or impossible to obtain. As a result contractual provisions and the benefits available tend to be quite standardized in order to control administrative costs. Furthermore, because past experience for small groups is not necessarily a realistic indicator of future experience, most insurance companies use pooled rates under which a uniform rate is applied to all groups that have a specific coverage. Since poor claims experience for a particular group is not charged to that group at renewal, more restrictive underwriting practices relating to adverse selection are used. These include less liberal contractual provisions and in some cases individual underwriting for group members.

The age and sex of employees in a group will affect the experience of the group. As employees age, the mortality rate increases. At all ages the death rate is lower for females than for males. Adjustments can be made for these factors when determining the proper rate to charge the policyowner. The major problem arises in contributory insurance plans. To the extent that higher costs for a group with a less-than-average mix of employees are passed on to these employees, a lower participation rate may result.

The nature of the industry represented by a group is also a significant factor in the underwriting process. In addition to different occupational hazards among industries, employees in some industries have higher-than-average death claims that cannot be directly attributed to their jobs. Therefore insurance companies commonly make adjustments in their life insurance rates based on the occupations of the employees covered as well as on the industries in which they work.

The underwriter must weigh factors other than occupational hazards as well. Certain industries are characterized by a lack of stability and persistency and thus may be considered undesirable risks.