For purposes of this text, “Group Disability Income Insurance” is a means through which a group of persons who have a business or professional relationship with the owner of the insurance contract are provided the Disability Income insurance coverage under a single contract. The benefit is highly job related as the members of the group (usually employees of the employer who is the owner of the insurance contract) receive a monthly disability income benefit, subject to a maximum amount, if illness or accident prevents a member from performing the normal functions of his or her job.
A thorough study of all of the aspects of group insurance is beyond the scope of this text, but knowledge of the fundamentals of group insurance is necessary in order to understand how Group Disability Income insurance is marketed and functions. These fundamentals will generally apply for most all areas of health and life insurance
There are several differences between individual and group insurance, such as:
Group underwriting is considerably different than individual underwriting, regardless of the product. In group insurance, individual evidence of insurability is not typically required and there are usually much broader benefits available to group insureds.
The philosophy of the benefits of group insurance is most prevalent during the underwriting function. Group underwriting is usually not concerned with the health or other such aspects of any particular individual, but the purpose is to obtain a group of individuals that will yield a predictable rate of mortality/morbidity. Further, the aggregate of all such groups in essence, creates a much larger group so that the mortality/morbidity can be more accurately experienced. Therefore, the group itself is the subject of underwriting, and not the individual members of the group. The group can be underwritten with the central purpose of eliminating as much as possible, or at least controlling, adverse selection by the individuals within the group.
Group underwriting requires that there be certain elements of any group in order for the mortality/morbidity of the group to attain the objectives of the insurer. There are six basic elements of proper group insurance underwriting. These apply to all group products, including Disability Income insurance.
The primary requirement that eliminates adverse selection as much as possible is that the members of the group must have come together for some reason other than obtaining insurance. This is so important as otherwise many groups would be formed for the sole purpose of getting insurance.
F A group must have been formed for reasons other than obtaining insurance.
CONSUMER APPLICATION
Jerome was diagnosed with Multiple Sclerosis and realized that unfortunately he did not have disability income insurance of any type. Being aware that with this disease, it was highly probable that eventually he would need medical help and could be confined to a wheelchair. After joining a support group, he discovered that those who had disability income insurance usually worked for large companies and was able to purchase it on a group basis.
Jerome and 3 others from his support group contacted various MS patients that did not have Disability Income insurance and were uninsurable, and through the internet, they soon found over 100 other MS patients in the same predicament. They were successful in forming a national MS patients organization, became incorporated and Jerome was elected President. One of his first acts was to try to get Disability Income insurance for the members.
Jerome was unable to obtain the insurance for the organization as the organization had been formed for the purpose of obtaining insurance.
In order to obtain the necessary morbidity/mortality for the group, it is necessary that there be new entrants to the group and an exodus of older and impaired persons. Employer-employee groups because of the flow of persons can be expected in most cases to be in average health.
F There must be individuals joining and leaving the group.
In order to avoid anti-selection – selection against the insurer – groups normally must provide benefits that are beyond the control of the employer or employees. However, because of competitive pressure principally and pressure from large employers for more benefits and greater flexibility in choosing benefits, insurers have become more liberal and more flexible, particularly in the area of adding excess coverage to basic health plans provided by an employer and in more health care financing choices.
F Group benefits must be independent of the employer or employees.
Cafeteria plans (discussed later) allow participating employees to select benefits from a wide array of benefit, using employer-provided funds. This allows employees to select the combination of benefits that best serves the employee and his family.
CONSUMER APPLICATION
Apex Machinery Co. received a lot of pressure from its employees to liberalize its benefits when union organizers attempted to unionize the employees. The company yielded to the requests of its employees for more choice in their benefits, particularly in their medical plans. Among the choices was Disability Income insurance, with elimination periods of 30 days to 6 months, and with benefits equal to 50%, 60, or 70% of income, and benefit periods of 3 or 5 years, or to age 65.
It did not take long for the insurer to determine that the younger and healthier employees took the minimum benefits, while those that were not healthy and those that were older (or both) took the maximum benefits. This completely obliterated the actuarial “average” experience of the group, and it did not take long before the insurer had to raise the premiums.
Step two in anti-selection. When the insurer raised the premiums, the younger and healthier individuals felt that it was not worth the added premium and dropped out, leaving the older and least healthy participants. The morbidity (claims) experience worsened and eventually the insurer had to cancel the entire group. This left the employer with the choice of finding a new carrier – whose premiums would be based upon the claims experience of the group – with high premiums, or not offer Disability Income insurance to its employees.
Hand-in-glove with the above underwriting requirements is that of minimum participation. The rule is basically that all eligible employees in the group must be covered by insurance. If the plan is contributory (employee pays part of the premium) the rule-of-thumb is usually 75% of the eligible employees must join. If the plan is noncontributory (employer pays all premiums), the requirements are usually 100% participation.
The purpose of this requirement is that in order for the experience of the group to approach the average for experience purposes, there must be enough lives to justify the group insurance and to safeguard against an undue or unexpected portion of the members being substandard.
Questions of “eligibility” arise in any group situation, but particularly in relation to medical insurance in today’s society of dual-breadwinners in families. While both family members may be eligible for insurance, the practice is for one to obtain family insurance, which would cover the other family member(s). In actual practice, usually the one who has the best benefits or the lowest cost is the one that will insure the family. Also, some persons may belong to a religious order that does not believe in insurance, or there could be some other such reason as to why an employee does not wish to become insured, and in those situations, the rules are usually relaxed.
Insurers much prefer that the employer (or the union, etc.) participate in the premiums for the plans. For the noncontributory plans, the employer controls the benefits and makes things much more simple. Since it requires 100% participation, the minimum participation is not a factor.
Contributory plans, on the other hand, are less costly to the employer as the employee bears part of the cost so the employer can arrange for more and better benefits. It is a fact of life that if an individual has to pay for all or part of something, it will be more appreciated by the individual, and this applies in group insurance. Studies have shown that there is much more utilization of a benefit program when the employer pays for the entire premium, and conversely, lower utilization in contributory plans. Particularly with health insurance and the ever-increasing premiums, employees are aware that if everyone runs to the doctor for a cold, they are going to have to pay more for their share of the premiums in the future.
With contributory plans, employees usually have a waiting period before they can become eligible for group benefits - usually one month. If they do not elect to participate in the program at the end of their eligibility period, they may be required to provide proof of insurability if they wish to join later. Some noncontributory plans also have these probationary periods.
Instead of a single insurance policy issued to the insured, a “master contract,” or policy, is issued to the employer or contract owner, and certificates of insurance are provided each participant insured under the group plan. One administration organization must act on behalf of the group – usually the Human Resources Department of the employer serves in this capacity. If the plan is contributory, a payroll deduction plan must be set up so that the employer/contract owner can collect premiums, account for them, and submit them to the insurer. These systems can be set up quite easily in today’s computerized business climate.
These group underwriting requirements are typical of those used for larger groups. However, most groups are not large and the size of the group is also an important underwriting factor. Obviously, for smaller groups there are more underwriting requirements needed to offset adverse selection, and can include less liberal policy provisions, short-form health questionnaires, and in some cases, underwriting nearly as detailed as in individual insurance.
Traditionally, Group insurance is less expensive than individual insurance, and one of the principal reasons is that there is only one insurance policy to issue and maintain – the master group policy. Participating members are issued “certificates” which is a description of the benefits offered under the group policy and steps necessary to file claims. Therefore, employees are not technically parties to the contract, but they may enforce their rights as third-party beneficiaries.
Group insurance has historically be considered as being less expensive than individual insurance because of several factors:
“Cheaper by the dozen” applies to group marketing. Individual commissions do not have to be paid, automatically lowering the cost of the insurance. To put it another way, group commissions have a lesser effect on the gross premium of the insurance, than does individual commissions.
In some larger groups, the insured company deals directly with the home office of the insurance company, cutting out the “middle man.” Generally, there are no commissions paid in these cases, but a fee would be paid to a “consultant.”
There is no need for individual premium notices, individual underwriting and individual files. There is also savings because individual policies are not issued, only certificates with one master policy. Premium collection procedures are much less involved, and since there is only one person to deal with on experience refund matters, there is much less cost.
However, some groups are expensive (relatively) to administer because of various benefits offered, especially smaller groups.
Even though standard provisions are used among the insurers and must be approved by the Department of Insurance, many intrinsic details, options and riders make the end product very flexible. The amount of flexibility is principally determined by the size of the group. Group disability insurance is generally part of an overall employee benefit program. Since it is part of a much larger insurance program, group Disability Income insurers will mold a program to fit with the other benefits as long as there is no invitation for adverse selection and there are no excessive administrative costs – and there is no legal problems.
Experience rating is used principally in group insurance and technically, it is a statistical procedure used to calculate a premium rate, based on the loss experience of an insured group. The premiums that are paid for group insurance are related to actual claims and expense experience that is expected for that specific group. “Rate book rates,” as used in other types of insurance, are called “manual rates” in group insurance are used only for small groups.
There are two types of experience rating:
If the group’s loss record is better than the amount used for the premium calculation, in other words the amount loaded into the basic premium, a percentage of the premium is then returned.
The types of groups that would be eligible for group insurance has changed over the years, but the National Association of Insurance Commissioners (NAIC) Model Group Insurance Bill now permit group coverage on four types of groups, many of which would never have been considered as a group a few years ago. Some states have allowed group insurance to be written on additional types of groups.
The employees of a single employer, who can be a sole proprietorship, partnership or corporation, are the most recognizable of the groups. The definition of “employees” for group insurance purposes may include several other categories besides those directly employed. The majority of group insurance is written on employer/employee groups.
This is principally used for group credit life and disability income insurance. The insured contract owner is the creditor such as a loan company, bank, credit union or any business that relies heavily upon their accounts receivable, such as a credit card company. If the debtor dies or becomes disabled, the proceeds are usually paid to the creditor to liquidate the account. This means that a primary requirement of this type of insurance is that the debtor must agree under an irrevocable and binding contract to repay the creditor for his obligation.
Under the Employee Retirement Income Security Act (ERISA) any multiple-employer arrangement, whether trusteed or not, is considered a “multiple-employer welfare arrangement,” or MEWA. The Multiple Employer Trusts (METs) fall under the same regulations, but market group benefits to employers that have a small number of employees. They may be sponsored by life insurance companies, independent administrators (Third-party administrators), or two or more employers in the same industry. The METs sponsor designs the group, determines who will be eligible for the benefits and under what basis, and provides administration.
The member employers pay premiums to the sponsoring organization, which in turn purchases group insurance. The entire group of employer is experience rated which gives them greater credibility and therefore more benefits can be obtained and for lesser premium than if each employer used a group based on their own business.
Claims are paid by the METs unless there is a third-party administrator, who does the administration of claims. The METs should maintain adequate reserve and be able to assess adequate premiums (which are called “contributions”).
As a note of interest, METs have a checkered past. During the period of 1988 to 1991, the General Accounting Office reported that METs left 398,000 customers with unpaid claims of over $129 million. Because they were not required to be regulated by state Insurance regulatory bodies, more than 600 METs did not comply with state insurance laws, principally because states could not identify METs that operated in their jurisdictions and when complaints were registered, the METs claimed that they were exempt from state regulation because of ERISA. In 1992, the U.S. Congress passed legislation that requires self-insured METs to meet state insurance regulations with the result that the number of self-funded METs has decreased significantly.
Other group underwriting and group state laws include professional associations, college alumni associations, religious groups, trade associations, customers of large retail store or of savings and loan associations, etc.
Disability Income insurance is one of the two medical plans available to employees or members of an organization that qualify for group insurance, the other being Medical insurance which is beyond the scope of this text. Group Disability Income insurance consists of two types: Short-term and Long-term.
As a general rule, Short-term Disability Income insurance is simpler in many respects than the Long-term plans. Typically, the Short-term Disability Income plans places a maximum dollar amount on the benefits that will be paid in case of disability, regardless of the earnings of the insured. Some Short-term plans and the majority of Long-term plans apply benefits as a percentage of the total earnings of the insured excluding bonuses and overtime.
A Short-term plan may provide a maximum dollar amount of benefits, regardless of how much the insured draws in income. For instance the Short-term plan offered might provide a benefit equal to 75% of earnings, with a maximum of $250 per week. It is common to provide Short-term benefits on a weekly basis. If the group is large enough, or if the earnings vary greatly among the various levels of employees, the group policy may have a schedule of benefits that would so indicate the variances, and the maximum benefit would often be graded by occupational classes, rather than by strictly income.
In the discussion of elimination periods, it was noted that in most Long-term plans, the waiting period for sickness and injury was the same. With the typical Short-term plan, however, there is no elimination period of disabilities that results directly from an accident, but there would be a waiting period for sicknesses (usually one to seven days). The reasoning is that most sicknesses are of short duration and this would eliminate many “nuisance” claims – otherwise premiums would be higher because of the short waiting period for injuries caused by accident. There is actually several other combination of elimination periods available.
The benefit period for both accident and sickness caused disabilities, are usually payable for up to a range of 13 to 52 weeks. Twenty-six (6 months) weeks is the most common benefit period.
NOTE: Federal law requires that pregnancy be treated the same as sickness under all fringe benefit plans (which include disability income insurance) for employers with 15 or more employees. Various states have even stricter laws in this respect, and the impact of these laws on the cost has been substantial.
One of the most successful methods of marketing Group Short-term Disability Income insurance is by what is termed “Workplace Marketing.” As the name connotes, the plans are sold at the employers place of business and usually also include other types of insurance, such as Cancer policies, life insurance, accident policies, etc., with the premiums being paid by the employer and/or by the employee through payroll deduction (which is usually the case).
This type of marketing is not true “group” marketing, but would more precisely be called “Endorsement Group” or “Franchise Group.” The employer endorses the programs offered by the agent and/or company, who then makes individual presentations of the products at the workplace to each employee, and it is usually done during, before or after working hours. Many times the enrollment of the employees in these Short-term Disability Income insurance and other plans coincides with the enrollment of the employees in an employer-sponsored group health plan, which provides minimum disruption of the employee’s time.
With Group Long-term Disability Income Insurance, the benefits are provided to fulfill the need for income during a Long-term disability from either sickness or accident, and regardless if it is job connected. Normally, in Group plans, the definition of disability is that of total disability, but a few companies will include a residual disability benefit clause in their policies, and some also offer a presumptive disability clause (as discussed earlier).
If the group policy has a residual benefit provision, the insured does not have to be totally disabled to qualify for benefits, e.g., if the insured suffers a disability that that reduces his income by (normally) at least 20% in the first two years of disability, then the policy will pay a proportionate benefit. The purpose of this is to be consistent with insurers continuing to place emphasis on rehabilitation services as part of the overall plan benefits. If the presumptive benefit provision is provided in the policy, the elimination period is waived, and the total loss of sight, speech, hearing, or two more of limbs (arms &/or legs) will qualify the insured for long term benefits de facto.
Typically, an elimination period of 7 days to 12 months is used. The Long-term policy is actually designed to provide long-term disability income protection upon the expiration of the Short-term disability coverage. If the disability continues, coverage will usually be provided to age 65, however other coverage periods – such as 2 years, 5 years, lifetime accident, etc., - are often used.
The size of the group is the most important factor in underwriting Long-term disability income policies, as a large group will allow much more flexibility in underwriting. Another important factor in group underwriting for this coverage is the nature of the work that the group performs. Some insurers refuse to write blue-collar groups, or underwrite them much more cautiously.
Taxation of health insurance benefits are consistent among various types of health insurance whereas the premiums contributed by the employer for disability income insurance for employees, are tax-deductible (usually) for the employer and are not taxable income to the employee.
Employee contributions are not tax deductible by the employee. Therefore, the payment of benefits under an insured plan (or a noninsured salary continuation plan) are treated as taxable income by the employee, but only to the extent that the benefits that are received are directly attributable to the employer’s contributions.
CONSUMER APPLICATION
Manuel works for Acme Steel and is covered by the employer’s disability income plan. He contributes $1,000 a year (25% of the total premium) for the disability policy under a cafeteria plan and the employer contributes $3,000 (75%). When Manuel becomes disabled, he receives disability benefits of $2,000 a month. 75% of the benefit ($1500) is taxable to Manuel.
Flexible Benefit Premium Plans are a result of Title 26. IRS Code Section 125, “Cafeteria Plans,” and are also frequently called “Cafeteria Plans.” The entire program is beyond the scope of this text but it is used so frequently in the marketing of Short-term Disability Income insurance products that a description of the program is in order.
Flexible Benefit plans may offer group and/or individual policies, but usually the benefits offered in the Disability Income insurance area, are supplemental benefits – supplemental to group health (usually major medical plans), pension plans and life insurance, and not necessarily supplement to group Disability Income insurance, although they certain can be and are frequently offered. Supplemental Disability Income insurance is usually written on an individual basis with payroll deduction, so even if the policies are individual policies, the payment of premiums to the insurer by the employer (payroll deduction to the employee) and the fact that marketing is performed at the work site and during, before or after work, puts a “group face” on the product.
Section 125 was created by Congress in the Revenue Act of 1978 and added to the Internal Revenue Code because of the changes in the work force and the increasing cost of health benefits. Basically, it allows employers to establish flexible benefit plans, or cafeteria plans, under which employees can choose between tax-free benefits and taxable benefits.
In May 1984, the IRS issued proposed regulations on Section 125 that serves still as guidelines for implementing flexible benefits plans. The Deficit Reduction Act of 1984 (DEFRA) and the Tax Reform Act of 1986 served to clarify the plans but did very little changing. There continues to be changes, generally liberalization, with the latest change being Revenue Ruling 2002-41 regarding contributions by employers to accident and health plans. It addresses Section 106, which provides that “gross income of an employee does not include employer-provided coverage under an accident or health plan.” At this time, there are questions as to whether “accident and health plan” includes disability income, but in any event this later ruling affects the taxation of benefits only (discussed later in more detail).
For general reference, Section 125 offers an employer the opportunity to provide their employees with the option to pay premiums for various qualified benefits with pretax dollars. Qualified benefits can include:
Accident and Health Insurance (Medical and Disability Income)
Group Term Life Insurance
Dependent Care Reimbursement Account
Medical Reimbursement Account
401(k) plans
Vacation Days
Health Reimbursement Arrangements (HRAs)
The following Consumer Application illustrates the difference in pretax (flexible benefits) deductions and without the Section 125 application.
CONSUMER APPLICATION
Bert has gross pay of $30,000 and is offered a ‘Cafeteria Plan’ with various benefits, including Short-term disability as he has no other disability coverage except what he might collect from Workers’ Compensation if he were injured on the job. He would pay premiums of $2,400 annually for the health insurance plan.
Without Section 125 – Flexible Benefits Plan
Gross Pay $30,000
Taxes (25%) (7,500)
Deduction from pay for insurance premiums (2,400)
Net Take-home Pay $20,100
With Section 125 – Flexible Benefits Plan
Gross Pay $30,000
Deductions for Insurance, pre tax (2,400)
Taxable pay $27,600
Taxes (25%) (6,900)
Net Take-home Pay $20,700
Bert would have $50 a month more in his pocket if he enrolled in the Flexible Benefits Plan!
STUDY QUESTIONS
1. The primary requirement that eliminates adverse selection as much as possible is that the group
A. must be formed for reasons other than obtaining insurance.
B. must all have common impairments or illnesses.
C. must consist of persons residing in the same geographical area.
D. must have been formed in order to purchase insurance.
2. A plan that allows employees to choose health benefits from a wide variety of sources, is
A. an HMO.
B. a participating physicians organization.
C. a smorgasbord plan.
D. a cafeteria plan.
3. In group insurance, if a plan is non-contributory, the participation rules are
A. only executives may participate.
B. 25% of all eligible employees must participate.
C. all (100%) of all eligible employees must participate.
D. non-existent – any number may join.
4. Contributory plans are
A. less costly to the employer.
B. less costly to the employee.
C. more costly to the employer.
D. illegal in most states.
5. Traditionally, group insurance
A. is more expensive than individual insurance.
B. is less expensive than individual insurance.
C. may be written only when union groups are involved.
D. does not pay commissions.
6. With a group Disability Income insurance plan, premiums from a rate book are called “manual” rates, and are
A. illegal in most states.
B. used only for small groups.
C. only used for property and casualty insurance plans.
D. adjusted according to the claims experience of the group.
7. One of the differences between short term and long term disability, is
A. short term plans pays a maximum benefit regardless of earnings.
B. short term benefits are always a function of the earnings.
C. short term benefits are the same for all classes of employees.
D. there is no elimination period for long term plans.
8. The most common benefit period for group short term Disability Income insurance, is
A. 3 weeks.
B. 3 years.
C. twenty-six weeks (6 months)
D. 30 days.
9. Under federal law, with all health insurance products, pregnancy
A. is not covered,
B. is treated as any other sickness.
C. is treated as an injury.
D. has a waiting period of 10 months.
10. On group Disability Income insurance plans, employees contributions
A. are tax deductible by the employee.
B. are not tax deductible by the employee.
C. are not tax deductible by either the employer or the employee.
D. are not tax deductible by the employer.
ANSWERS TO STUDY QUESTIONS
1A 2D 3C 4A 5B 6B 7A 8C 9B 10B