The oldest and most common form of group life insurance is group term insurance. Coverage virtually always consists of yearly renewable term insurance that provides death benefits only, with no buildup of cash values. The group insurance marketplace with its widespread use of yearly renewable term contrasts with the individual marketplace, in which until recently such coverage has accounted for only a small percentage of the life insurance in force. This is primarily due to increasing annual premiums, which become prohibitive for many insureds at older ages. In group life insurance plans the overall premium, in addition to other factors, is a function of the age distribution of the group�s members. While the premium for any individual employee will increase with age, the flow of younger workers into the plan and the retirement of older workers tend to result in a relatively stable age distribution and thus an average group insurance rate that remains constant or rises only slightly.

The following discussion of group term insurance focuses largely on common contract provisions, other coverages that are often added to the basic contract, and relevant federal tax laws.

The provisions contained in group term insurance contracts are more uniform than those found in other types of group insurance. Much of this uniformity is a result of the adoption by most states of the NAIC Group Life Insurance Standard Provisions Model Bill. This bill, coupled with the insurance industry�s attempts at uniformity, has resulted in provisions that are virtually identical among insurance companies. While the following contract provisions represent the norm and are consistent with the practices of most insurance companies, some states may require slightly different provisions, and some companies may vary their contract provisions. In addition, negotiations between a policyowner and an insurance company may result in the modification of contract provisions.

The purpose of the benefit schedule is twofold. It classifies the employees who are eligible for coverage, and it specifies the amount of life insurance that will be provided to the members of each class, thus minimizing adverse selection because the amount of coverage for individual employees is predetermined. A benefit schedule can be as simple as providing a single amount of life insurance for all employees or as complex as providing different amounts of insurance for different classes of employees. For individual employer groups, the most common benefit schedules are those in which the amount of life insurance is based on either earnings or position.

Earnings Schedules. Most group term life insurance plans use an earnings schedule under which the amount of life insurance is determined as a multiple (or percentage) of each employee�s earnings. For example, the amount of life insurance for each employee may be twice (200 percent of) the employee�s annual earnings. Most plans use a multiple between one and two, but higher and lower multiples are occasionally used. The amount of insurance is often rounded to the next higher $1,000 and for underwriting purposes may be subject to a maximum benefit, such as $100,000. For purposes of the benefit schedule an employee�s earnings usually consist of base salary only and do not include additional compensation like overtime pay or bonuses.

An alternative to using a flat percentage of earnings is to use an actual schedule of earnings such as the following:

Combination Benefit Schedules. It is not unusual for employers to have benefit schedules that incorporate elements from several of the various types previously discussed. While there are numerous possible combinations, a common benefit schedule of this type provides salaried employees with an amount of insurance that is determined by a multiple of their annual earnings and provides hourly employees with a flat amount of life insurance.

Reduction in Benefits. It is common for a group life insurance plan to provide for a reduction in benefits for active employees who reach a certain age, commonly 65 to 70. Such a reduction, which is due to the high cost of providing benefits for older employees, will be specified in the benefit schedule of a plan. Any reduction in the amount of life insurance for active employees is subject to the provisions of the Age Discrimination in Employment Act.

Benefit reductions fall into three categories: (1) a reduction to a flat amount of insurance, (2) a percentage reduction, such as to 65 percent of the amount of insurance that was previously provided, or (3) a gradual reduction over a period of years (for example, a 10 percent reduction in coverage each year until a minimum benefit amount is reached).

Group insurance contracts are very precise in their definition of what constitutes an eligible person for coverage purposes. In general, an employee must be in a covered classification, work full-time, and be actively at work. In addition, any requirements concerning probationary periods, insurability, or premium contributions must be satisfied.

Covered Classification. All group insurance contracts specify that an employee must fall into one of the classifications contained in the benefit schedule. While these classifications may be broad enough to include all employees of the organization, they may also be so limited as to exclude many employees from coverage. In some cases these excluded employees may have coverage through a negotiated trusteeship or under other group insurance contracts provided by the employer; in other cases they may have no coverage because the employer wishes to limit benefits to certain groups of employees. No employee may be in more than one classification, and the responsibility for determining the appropriate classification for each employee falls on the policyowner.

Full-time Employment. Most group insurance contracts limit eligibility to full-time employees. A full-time employee is generally defined as one who works no fewer than the number of hours in the normal work week established by the employer, which must be at least 30 hours. Subject to insurance company underwriting practices, an employer can provide coverage for part-time employees. When this is done, part-time is generally defined as less than full-time but more than some minimum number of hours per week. Part-time employees may be subject to more stringent eligibility requirements. For example, full-time hourly paid employees may be provided with $20,000 of life insurance immediately upon employment, while part-time employees may be provided with only $10,000 of life insurance and may be subject to a probationary period.

Actively-at-Work Provision. Most group insurance contracts contain an actively-at-work provision, whereby an employee is not eligible for coverage if absent from work because of sickness, injury, or other reasons on the otherwise effective date of coverage under the contract. Coverage will commence when the employee returns to work. This provision is often waived for employers with a large number of employees when coverage is transferred from one insurance company to another and the employees involved have been insured under the previous insurance company�s contract.

Probationary Periods. Group insurance contracts may contain probationary periods that must be satisfied before an employee is eligible for coverage. When a probationary period exists, it rarely exceeds 6 months, and an employee will be eligible for coverage on either the first day after the probationary period or on the first day of the month following the end of the probationary period.

Insurability. While most group insurance contracts are issued without individual evidence of insurability, in some instances underwriting practices will require evidence of insurability. This commonly occurs when an employee fails to elect coverage under a contributory plan and later wants coverage or when an employee is eligible for a large amount of coverage. In these cases an employee will not be eligible for coverage until he or she has submitted the proper evidence of insurability and the insurance company has determined that the evidence is satisfactory.

Premium Contribution. If a group insurance plan is contributory, an employee will not be eligible for coverage until the policyowner has been given the proper authorization for payroll deductions. If this is done before the employee otherwise becomes eligible, coverage will commence on the eligibility date. During the next 31 days, coverage will begin when the policyowner receives the employee�s authorization. If the authorization is not received within 31 days, the employee must furnish evidence of insurability at his or her own expense to obtain coverage. Evidence of insurability will also be required if an employee drops coverage under a contributory plan and wishes to regain coverage at a future date.

With few exceptions an insured person has the right to name the beneficiary under his or her group life insurance coverage. These exceptions include credit life insurance, where the creditor is the beneficiary, and dependent life insurance, where the employee is the beneficiary. In addition, the laws and regulations of some states prohibit naming the employer as beneficiary. Unless a beneficiary designation has been made irrevocable, an employee has the right to change the designated beneficiary at any time. While all insurance contracts require that the insurance company be notified of any beneficiary change in writing, the effective date of the change may vary, depending on contract provisions. Some contracts specify that a change will be effective on the date it is received by the insurance company; others make it effective on the date the change was requested by the employee.

Under individual life insurance policies, death benefits are paid to an insured person�s estate if no beneficiary has been named or if all beneficiaries have died before the insured. Some group term insurance contracts contain an identical provision; others stipulate that the death benefits will be paid through a successive beneficiary provision. Under the successive beneficiary provision the proceeds will be paid, at the option of the insurance company, to any one or more of the following survivors of the insured person: spouse, children, parents, brothers and sisters, or executor of the employee�s estate. In most cases insurance companies will pay the proceeds to the person or persons in the first category that includes eligible survivors.

Two other provisions, each of which is often called a facility-of-payment provision, are sometimes found in group term insurance contracts. The first of these provides that a specified amount, generally $500 or less, may be paid to any person who appears to be entitled to such a sum by reason of having incurred funeral or other expenses relating to the last illness or death of the person insured. The other provision applies to any beneficiary who is a minor or who is physically, mentally, or otherwise incapable of giving a valid release for any payment received. Under this provision the insurance company has the option, until a claim is made by the beneficiary�s guardian, of paying the proceeds to any person or institution that appears to have assumed responsibility for the care, custody, or support of the beneficiary. These payments will be made in installments in the amount specified under any optional method of settlement that the insured selected or, in the absence of such a selection, in installments not to exceed some specified amount, such as $100 per month.

Group term insurance contracts covering employees provide that death benefits will be payable in a lump sum unless an optional mode of settlement has been selected. Each employee insured under the contract has the right to select and change any available mode of settlement during his or her lifetime. If no optional mode of settlement is in force at the employee�s death, the beneficiary generally has the right to elect any of the available options. The most common provision in group term insurance contracts is that the available modes of settlement are those customarily offered by the insurance company at the time the selection is made. The available options are not generally specified in the contract, but information about them is usually given to the group policyowner. In addition, many insurance companies have brochures available for employees that describe either all or the most common options available to employees. Any guarantees associated with these options will be those that are in effect when the option is selected.

In addition to a lump-sum option, most insurance companies offer all the following options: an interest option, an installment option for a fixed period, an installment option for a fixed amount, and a life income option.

Group insurance contracts stipulate that it is the responsibility of the policyowner to pay all premiums to the insurance company, even if the group insurance plan is contributory. Any required contributions from employees will be incorporated into the employer�s group insurance plan, but they are not part of the insurance contract and therefore do not constitute an obligation to the insurance company by the employees. Rather, these contributions represent an obligation to the employer by the employees and are commonly paid by payroll deduction. Subject to certain limitations, any employee contributions are determined by the employer or as a result of labor negotiations. Most states require the employer to pay at least a portion of the premium for group term insurance (but not for other group insurance coverage), and a few states impose limitations on the amounts that may be paid by any employee. The most common restriction limits the contribution of any employee to the greater of 60 cents per month per $1,000 of coverage or 75 percent of the premium rate for that employee. This limitation is adhered to by companies licensed to do business in the state of New York and is often incorporated into their contracts. However, for some hazardous industries a contribution higher than 60 cents per month is permitted.

Premiums are payable in advance to the insurance company or any authorized agent for the time period specified in the contract. In most cases premiums are payable monthly but may be paid less frequently. The rates used to determine the premium for any policyowner are guaranteed for a certain length of time, usually one year. The periodic premium is determined by applying these rates to the amount of life insurance in force. Consequently the premium actually payable will change each month as the total amount of life insurance in force under the group insurance plan varies.

Group insurance contracts state that any dividends or experience refunds are payable to the policyowner in cash or may be used at the policyowner�s option to reduce any premium due. To the extent that these exceed the policyowner�s share of the premium, they must be used for the employees� benefit. This is usually accomplished by reducing employee contributions or increasing benefits.

The provision concerning death claims under group life insurance policies is very simple. It states that the amount of insurance under the contract is payable when the insurance company receives written proof of death. No time period is specified in which a claim must be filed. However, most companies require that the policyowner and the beneficiary complete a brief form before a claim is processed.

For many years the owners of individual life insurance policies have been able to transfer any or all of their rights under the insurance contract to another party. Such assignments have been commonly used to avoid federal estate tax by removing the proceeds of an insurance contract from the insured�s estate at death. Historically assignments have not been permitted under group life insurance contracts, often because of state laws and regulations prohibiting assignments. In recent years most states have eliminated such prohibitions, and many insurance companies have modified their contracts to permit assignments, or they will waive the prohibition upon request. Essentially an assignment will be valid as long as it is permitted by and conforms with state law and the group insurance contract. Generally insurance companies require any assignment to be in writing and to be filed with the company.

Group life insurance contracts allow for a grace period (almost always 31 days) during which a policyowner may pay any overdue premium without interest. If the premium is not paid, the contract will lapse at the end of the grace period unless the policyowner has notified the insurance company that an earlier termination should take place. Even if the policy is allowed to lapse or is terminated during the grace period, the policyowner is legally liable for the payment of any premium due during the portion of the grace period when the contract was still in force.

The entire contract clause states that the insurance policy, the policyowner�s application that is attached to the policy, and any individual (unattached) applications of any insured persons constitute the entire insurance contract. All statements made in these applications are considered to be representations rather than warranties, and no other statements made by the policyowner or by any insureds can be used by the insurance company as the basis for contesting coverage. When compared with the application for individual life insurance, the policyowner�s application that is attached to a group insurance contract may be relatively short. Often most of the information the insurance company needs is contained in a preliminary application that is not part of the insurance contract. On the delivery of many group insurance contracts the policyowner signs a final "acceptance application," which in effect states that the coverage as applied for has been delivered. Consequently a greater burden is placed on the insurance company to verify the statements the policyowner made in the preliminary application.

The entire contract clause also stipulates that no agent has any authority to waive or amend any provisions of the insurance contract and that a waiver of, or amendment to, the contract will be valid only if it is signed by certain specified corporate officers of the insurance company have signed it.

Like individual life insurance contracts, group insurance contracts contain an incontestability provision. Except for the nonpayment of premiums, the validity of the contract cannot be contested after it has been in force for a specified period, generally either one or 2 years. During this time the insurance company can contest the contract on the basis of policyowner statements in the application attached to the contract that are considered to be material misrepresentations. Statements by any insured person can be used as the basis for denying claims during the first 2 years coverage is in force on that person but only if such statements relate to the individual�s insurability. In addition, the statements must have been made in a written application signed by the individual, and a copy of the application must have been furnished to either the individual or his or her beneficiary. It should be pointed out that the incontestability clause will not concern most covered persons, since evidence of insurability is not usually required and thus no statements concerning individual insurability will be made.

If the age of any person covered under a group term insurance policy is misstated, the benefit payable will be the amount that is specified under the benefit schedule. However, the premium will be adjusted to reflect the true age of the individual. This is in contrast to individual life insurance contracts, where benefits are adjusted to the amount that the premium paid would have purchased at the true age of the individual. Under a group insurance contract the responsibility for paying any additional premium or the right to receive a refund belongs to the policyowner and not to the individual employee whose age is misstated, even if the plan is contributory. If the misstated age would have affected the employee�s contribution, this is a matter to be resolved between the employer and the employee.

All group insurance contracts stipulate the conditions under which the insurance company or the policyholder may terminate the contract and under which the coverage for a particular insured person will terminate.

A group term insurance contract can be terminated for nonpayment of premium at the end of the grace period. Insurance companies may also terminate coverage for an individual employer group on any premium due date if certain conditions exist and notice of termination has been given to the policyowner at least 31 days in advance. These conditions include the failure to maintain a stated minimum number of participants in the plan and, in contributory plans, the failure to maintain a stated minimum percentage participation. The policyowner may also terminate the contract at any time by giving the insurance company 31 days� advance written notice. Moreover, the policyowner has the right to request the amendment of the contract at any time by notifying the insurance company.

The coverage for any insured person will terminate automatically (subject to any provisions for a continuation or conversion of coverage) when

It is estimated that only one or two percent of eligible employees actually take advantage of the conversion privilege. Several reasons account for this. Many employees will obtain coverage with new employers; others are discouraged by the high cost of the permanent insurance to which they must convert. Still others, if they are insurable at standard rates, may find coverage at a lower cost with other insurers and be able to purchase supplementary coverage (such as disability benefits) that are not available under conversion policies. In addition, insurance companies have not actively encouraged group conversions because those who convert tend to be the poorer risks. Finally, since some employers are faced with conversion charges as a result of experience rating, they are also unlikely to encourage conversion.

There is a more restrictive conversion privilege if an employee�s coverage is terminated because the master contract is terminated for all employees or is amended to eliminate eligible classifications. Under these circumstances the employee is given a conversion right only if he or she was insured under the contract for a period of time (generally 5 years) immediately preceding the date on which coverage was terminated. In addition, the amount of insurance that can be converted is limited to the lesser of (1) $2,000 or (2) the amount of the employee�s life insurance under the contract at the date of termination, reduced by any amount of life insurance for which the employee becomes eligible under any group life insurance that the same or another insurance company issues or reinstates within 31 days after such termination.

Over the last several years many insurers have introduced an accelerated benefits provision in their individual life insurance products. Under such a provision an insured is entitled to receive a portion of his or her death benefit while still living if one or more of the following events occur: (1) a terminal illness that is expected to result in death within 6 or 12 months, (2) a specified catastrophic illness, such as AIDS, a stroke, or Alzheimer�s disease, and (3) the incurring of nursing home and possibly other long-term-care expenses. The categories of triggering events and the specific definitions of each vary among insurers.

Often what becomes popular in the individual marketplace starts to show up in the group insurance marketplace. Such is the case with accelerated benefits, which are now offered by most group insurers. In fact, many group insurers make accelerated death benefits a part of their standard group term coverage unless an employer does not want the benefit provided.

Most group insurers allow accelerated benefits for terminal illnesses only. Some insurers use a life expectancy of 6 months or less; most use a life expectancy of 12 months or less. In either case a doctor must certify the life expectancy.

The amount of the accelerated benefit is expressed as a percentage of the basic life insurance coverage and may range from 25 percent to 100 percent. In addition, most insurers limit the maximum benefit to a specified dollar amount that may vary from $25,000 to $250,000. Any amount not accelerated is paid to the beneficiary upon the insured�s death.

There are no limitations on how the accelerated benefit can be used. It might be used to pay medical expenses and nursing home care not covered by other insurance, or it could even be used to prepay funeral expenses.

Although some insurers make no charge for the inclusion of an accelerated death benefit, most do levy some type of charge. In some cases, this may be a higher premium levied on the policyowner. In other cases, any accelerated death benefit paid will be reduced by an amount equal to the interest that could have been earned on the money over the next 6 to 12 months. Finally, a few insurers levy a modest transaction charge when an accelerated death benefit is taken.

Group term insurance contracts often provide additional insurance benefits through the use of riders. These benefits are also forms of group term insurance and consist of (1) supplemental life insurance, (2) accidental death and dismemberment insurance, and (3) dependent life insurance. These added benefits may be provided for all employees insured under the basic group term contract or may be limited to certain classes of employees. With the exception of dependent life insurance these coverages may also be written as separate contracts.

The majority of group life insurance plans enable all or certain classes of employees to purchase additional amounts of life insurance. Generally the employer will provide a basic amount of life insurance to all eligible employees on a noncontributory basis. This is commonly a flat amount of coverage or a multiple of annual earnings. The supplemental coverage is contributory and may be either incorporated into the basic group life insurance contract or contained in a separate contract. The latter method tends to be more common when the supplemental coverage is available to only a select group of employees. Although the employee may pay the entire cost of the supplemental coverage, either state laws that require employer contributions or insurance company underwriting practices will often result in the employer�s paying a portion of the cost. It is not unusual for there to be two sets of rates�one for smokers and another for nonsmokers.

The amount of supplemental coverage available will be specified in a benefit schedule. Under some plans an employee must purchase the full amount of coverage; under other plans an employee may purchase a portion of the coverage. The following are two examples of benefit schedules for a basic-plus-supplemental life insurance plan:

Giving employees the right to choose their benefit amounts leads to adverse selection. As a result, more stringent underwriting requirements are usually associated with supplemental coverage. These often include requiring individual evidence of insurability, except possibly when the additional amount of coverage is modest. Higher rates may also be charged for the supplemental insurance than for the basic coverage.

Many group life insurance contracts contain an accidental death and dismemberment provision that gives additional benefits if an employee dies accidentally or suffers certain types of injuries. Traditionally this group coverage was available only as a rider to a group life insurance contract. Now, however, it is common to find these benefits provided through separate group insurance contracts in which coverage is usually contributory on the part of employees. Such contracts are referred to as voluntary accidental death and dismemberment insurance.

Traditional Coverage. Under the usual form of accidental death and dismemberment insurance, an employee eligible for group life insurance coverage (and electing the life insurance coverage if it is contributory) will automatically have the accidental death and dismemberment coverage if the employer has added it. A few plans impose a probationary period, such as 6 months, before coverage begins. Under the typical accidental death and dismemberment rider, the insurance company will pay an additional amount of insurance that is equal to the amount of coverage under the basic group life insurance contract (referred to as the principal sum) if an employee dies as a result of accidental bodily injuries while he or she is covered under the policy. It is specified that death must occur within a certain time, often 90 days, following the date that injuries are sustained, but some courts have ruled this time period to be invalid and have required insurance companies to pay claims when longer periods have been involved. In addition to an accidental death benefit the following benefit schedule is provided for certain specific types of injuries:

Voluntary Coverage. The provisions of voluntary group accidental death and dismemberment insurance are practically identical to those in a group life insurance contract with an accidental death and dismemberment insurance rider. However, there are a few differences. Voluntary plans usually require the employee to pay the entire cost of coverage, and they virtually always provide both occupational and nonoccupational coverage. Subject to limitations, the employee may select the amount of coverage desired, and the maximum amount of coverage available tends to be larger than when coverage is provided through a rider. For example, one plan allows coverage to be purchased at the following levels: $25,000, $50,000, $75,000, $100,000, $200,000, or $300,000 as long as the amount selected does not exceed 10 times annual salary. The amount of coverage often decreases after age 65 or 70, just as the amount of traditional coverage decreases when it is a function of a life insurance benefit that is lowered at older ages.

Another difference is the frequent use in voluntary plans of a common accident provision, whereby the amount payable by the insurance company is limited to a stipulated maximum for all employees killed or injured in any single accident. If this exceeds the sum of the benefits otherwise payable for each employee, benefits are prorated. A final difference is that some plans allow an employee to purchase coverage on dependents. For example, under one plan the coverage on a spouse is equal to 40 percent of the coverage on the employee, and coverage on each child is 10 percent of the employee�s coverage.

Some group life insurance contracts provide insurance coverage on the lives of employees� dependents. Dependent life insurance has been viewed as a method of giving the employee resources to meet the funeral and burial expenses associated with the dependent�s death. Consequently the employee is automatically the beneficiary. The employee also elects and pays for this coverage if it is contributory. Coverage for dependents is almost always limited to employees who are themselves covered under the group contract. Thus if an employee�s coverage is contributory, the employee must elect coverage for himself or herself in order to be eligible to elect dependent coverage.

For purposes of dependent life insurance coverage, dependents are usually defined as an employee�s spouse who is not legally separated from the employee and an employee�s unmarried dependent children (including stepchildren and adopted children) who are over 14 days of age but under some specified age, commonly 19 or 21. To prevent adverse selection an employee usually cannot select coverage on individual dependents. A few policies do allow an employee to elect coverage for the spouse only or for children only. If dependent coverage is selected, all dependents fitting the definition are insured. When dependent coverage is in effect for an employee, any new eligible dependents are automatically insured.

The amount of coverage for each dependent is usually quite modest. Some states limit the maximum amount of life insurance that can be written, and a few states actually prohibit writing any coverage on dependents. Employer contributions used to purchase more than $2,000 of coverage on each dependent will result in income to the employee for purposes of federal taxation. However, amounts in excess of $2,000 may be purchased with employee contributions without adverse tax consequences. In some cases the same amount of coverage will be provided for all dependents; in other cases a larger amount will be provided for the spouse than for the children. It is also not unusual for the amount of coverage on children to be less until the children attain some specified age, such as 6 months. The following are examples of benefit schedules under dependent coverage:

A single premium applies to the dependent coverage for each employee and is unrelated to the number of dependents. In some cases the premium may vary, depending on the age of the employee (but not the dependents), but more commonly it is the same amount for all employees regardless of age. Dependent coverage usually contains a conversion privilege that applies only to the coverage on the spouse. However, some states require that the conversion privilege apply to the coverage on all dependents. Assignment is almost never permitted, and no waiver of premium is available if a dependent becomes disabled. However, if the basic life insurance contract contains a waiver-of-premium provision applicable to the employee, the employee�s disability will sometimes result in a waiver of premium for the dependent coverage. A provision similar to the actively-at-work provision pertaining to employees is often included for dependents. It specifies that dependents will not be covered when otherwise eligible if they are confined in a hospital (except for newborn children, who are covered after 14 days). Coverage will commence when the dependent is discharged from the hospital.

A discussion of group term insurance is incomplete without an explanation of the tax laws affecting its use. While discussions of these laws are often limited to federal income and estate taxation, federal gift taxation and taxation by the states should also be considered.

The growth of group term insurance has been greatly influenced by the favorable tax treatment afforded it under federal tax laws. This section is devoted to the effects of these tax laws on basic group term insurance and on coverages that may be added to a basic group term insurance contract. A complete explanation of the federal tax laws pertaining to group term insurance and their interpretation by the Internal Revenue Service would be lengthy and is beyond the scope of this chapter. Consequently this discussion of federal tax laws will only highlight these laws.

Deductibility of Premiums. In general, employer contributions for an employee�s group term insurance coverage are fully deductible to the employer as an ordinary and necessary business expense as long as the employee�s overall compensation is reasonable. The reasonableness of compensation (which includes wages, salary, and other fringe benefits) is usually only a potential issue for the owners of small businesses or the stockholder-employees of closely held corporations. For income tax purposes, a firm may not deduct any compensation that the Internal Revenue Service determines to be unreasonable. In addition, the Internal Revenue Code does not allow a firm to take an income tax deduction for contributions (1) that are made in behalf of sole proprietors or partners under any circumstances or (2) that are made in behalf of stockholders unless they are providing substantive services to the corporation. Finally, no deduction is allowed if the employer is named as beneficiary.

Contributions by any individual employee are considered payments for personal life insurance and are not deductible for income tax purposes by that employee. Thus the amount of any payroll deductions authorized by an employee for group term insurance purposes will be included in the employee�s taxable income.

Employees� Income Tax Liability. In the absence of tax laws to the contrary, the amount of any compensation for which an employer receives an income tax deduction (including the payment of group insurance premiums) represents taxable income to the employee. However, Sec. 79 of the Internal Revenue Code gives favorable tax treatment to employer contributions for life insurance that qualifies as group term insurance.

Sec. 79 Requirements. In order to qualify as group term insurance under Sec. 79, life insurance must meet the following conditions:

The following benefit schedule, however, would be acceptable:

If a group insurance plan that covers fewer than 10 employees does not qualify for favorable tax treatment under Sec. 79, any premiums paid by the employer for such coverage will represent taxable income to the employees. The employer, however, will still receive an income tax deduction for any premiums paid in behalf of the employees as long as overall compensation is reasonable.

Taxation of Proceeds. In most instances the death proceeds under a group term insurance contract do not result in any taxable income to the beneficiary if they are paid in a lump sum. If the proceeds are payable in installments over more than one taxable year, only the interest earnings attributable to the proceeds will be included in the beneficiary�s income for tax purposes.

Under certain circumstances the proceeds are not exempt from income taxation if the coverage was transferred (either in whole or in part) for a valuable consideration. Such a situation will arise when the stockholder-employees of a corporation name each other as beneficiaries under their group term insurance coverage as a method of funding a buy-sell agreement. The mutual agreement to name each other as beneficiaries is the valuable consideration. Under these circumstances any proceeds paid to a beneficiary constitute ordinary income to the extent that the proceeds exceed the beneficiary�s tax basis, as determined by the Internal Revenue Code.

In many cases benefits paid by an employer to employees or their beneficiaries from the firm�s assets receive the same tax treatment as benefits provided under an insurance contract. This is not true for death benefits. If they are provided other than through an insurance contract, the amount of the proceeds will represent taxable income to the beneficiary. (Until late 1996, up to $5,000 of benefits could be provided from the firm�s assets on a tax-free basis.) For this reason employers are less likely to use alternative funding arrangements for death benefits than for disability and medical expense benefits.

Proceeds of a group term insurance contract, even if paid to a named beneficiary, are included in an employee�s gross estate for federal estate tax purposes as long as the employee possessed incidents of ownership in the coverage at the time of death. However, no estate tax is levied on any amounts, including life insurance proceeds, left to a surviving spouse. In addition, taxable estates of $600,000 or less are generally free of estate taxation regardless of the beneficiary.

When an estate would otherwise be subject to estate taxation, an employee may remove the proceeds of group term insurance from his or her taxable estate by absolutely assigning all incidents of ownership to another person, usually the beneficiary of the coverage. Incidents of ownership include the right to change the beneficiary, to terminate coverage, to assign coverage, or to exercise the conversion privilege. For this favorable treatment, however, the Internal Revenue Code requires that such an assignment be permissible under both the group term insurance master contract and the laws of the state having jurisdiction. The absolute assignment is usually in the form of a gift, which is not without its own tax implications. The amount of insurance is considered a gift made each year by the employee to the person to whom the absolute assignment was granted. Consequently if the value of the gift is of sufficient size, federal gift taxes will be payable. Since the Internal Revenue Code and the Internal Revenue Service regulations are silent on the specific gift tax consequences of assigned group term insurance, there is disagreement about whether the gift should be valued at Table I costs or at the actual premium for the coverage.

The assignment of group term life insurance also results in the inclusion of some value in the employee�s estate. If the employee dies within 3 years of making the assignment, the full amount of the proceeds will be included in the employee�s estate. If death occurs more than 3 years after the assignment is made, only the premiums paid within the 3 years prior to death will be included in the employee�s taxable estate. In the past a problem arose if the employer changed group insurance carriers, thus requiring the employee to make a new assignment and again be subject to the 3-year time limit. However, the Internal Revenue Service now considers this type of situation to be a continuation of the original assignment as long as the amount and provisions of the new coverage are essentially the same as those of the old coverage.

As of 1997, the tax treatment of accelerated death benefits was added to the Internal Revenue Code. If certain requirements are satisfied, benefits paid to persons who are either terminally or chronically ill will receive favorable tax treatment. Benefits received because of a terminal illness are treated as income-tax-free death benefits as long as a physician has certified that the insured has an illness or physical condition that can reasonably be expected to result in death within 24 months or less after the date of certification. If a group contract provides accelerated death benefits to other categories of individuals, benefits can also be received with favorable tax treatment if a person is chronically ill and the coverage qualifies as a long-term care insurance contract. The definition of chronically ill and the conditions to qualify as a long-term care insurance contract are discussed in the chapter on long-term care insurance (see chapter 8).

Treatment of Added Coverages. Supplemental life insurance can be written as either a separate contract or as part of the contract providing basic group term life insurance coverage. If it is a separate contract and if the supplemental group life insurance meets the conditions of qualifying as group term insurance under Sec. 79, the amount of coverage provided is added to all other group term insurance for purposes of calculating the Uniform Premium Table I cost. Any premiums the employee pays for the supplemental coverage are included in the deduction used to determine the final taxable income. In all other ways supplemental life insurance is treated the same as group term insurance.

Many separate supplemental contracts are noncontributory, and the cost for each employee�s coverage does not exceed the Table I costs. In this case the supplemental contract does not qualify as group term life insurance under Sec. 79. As a result the value of the coverage is not included in an employee�s income.

When supplemental life insurance coverage is written in conjunction with a basic group life insurance plan, employers have the option of treating the supplemental coverage as a separate policy of insurance as long as the premiums are properly allocated among the two portions of the coverage. There is no advantage in treating the supplemental coverage as a separate policy if it would still qualify by itself as group term insurance under Sec. 79. However, this election will minimize taxable income to employees if the cost of the supplemental coverage is paid totally by the employees and all employees are charged rates at or below Table I rates.

Premiums paid for accidental death and dismemberment insurance are considered to be health insurance premiums rather than group term insurance premiums. However, these are also deductible to the employer as an ordinary and necessary business expense, the same as for group term insurance. Benefits paid to an employee under the dismemberment portion of the coverage are treated as benefits received under a health insurance contract and are income tax free. Death benefits received under the coverage are treated like death benefits received under group term life insurance.

Employer contributions for dependent life insurance coverage are fully deductible by the employer as an ordinary and necessary business expense if the employee�s overall compensation is reasonable. Employer contributions do not result in taxable income to an employee as long as the value of the benefit is de minimis. This means that the value is so small that it is administratively impractical for the employer to account for the cost on a per-person basis. Dependent coverage of $2,000 or less on any person falls into this category. The Internal Revenue Service considers amounts of coverage in excess of $2,000 on any dependent to be more than de minimis. If more than $2,000 of coverage is provided for any dependent from employer contributions, the cost of the entire amount of coverage for that dependent (as determined by Uniform Premium Table I rates) will be considered taxable income to the employee.

Death benefits will be free of income taxation and will not be included in the dependent�s taxable estate for estate tax purposes.

In most instances state tax laws affecting group term insurance are similar to the federal laws. However, two major differences do exist. In most states the payment of group term insurance premiums by the employer will not result in any taxable income to the employee, even if the amount of coverage exceeds $50,000. In addition, death proceeds receive favorable tax treatment under the estate and inheritance tax laws of most states. Generally the proceeds are at least partially, if not totally, exempt from such taxation.