LIFE INSURANCE FOR EXECUTIVES

Life insurance can be an important executive benefit. Life insurance is important to high income employees as a means of providing income security to their families during the early part of their careers. In later years, it can provide or augment the executive's estate to be left to family and other heirs, or it can help provide liquidity to the estate to meet estate taxes and other expenses. A number of methods with favorable tax consequences have been devised to provide life insurance to executives. Generally, the aim is to provide insurance in a way that minimizes the current year-to-year income tax cost of the plan to the employee, and also keeps the life insurance out of the employee's estate for federal estate tax purposes. Some of the methods used include the following:

• Split-Dollar Plans. In a split-dollar plan, cash-value life insurance is used, with the death benefit divided or split between the employer and the employee's designated beneficiary. The premium can be paid entirely by the employer or premium costs can be shared between employer and employee. The employer does not receive a tax deduction for its share of the premium payments. However, the plan is designed so that the employer is reimbursed for its premium payments by its share of the death benefit, which is received by the employer tax-free. Thus, the employer's cost for a split-dollar plan is the loss of the use of its share of the premium payments during the time in which the plan is in effect.

• Many variations on the basic split-dollar approach are possible. For example, to avoid federal estate taxes, the plan is often designed so that the employee has no incidents of ownership in the policy. This can be done, for example, by having the policy applied for by a beneficiary such as a spouse or a family trust, with a split-dollar arrangement between the employer company and the policyholder. Although this arrangement may eliminate the federal estate tax in the employee's estate, it is still considered by the IRS to result in compensation income to the employee.

• Death Benefit Only (DBO) Plans. A DBO plan is a form of deferred-compensation plan in which the benefits are paid only to a designated beneficiary upon the death of the employee. The purpose of this arrangement is to avoid federal estate taxes on the death benefit.

  Under the federal estate tax law, a death benefit from a deferred-compensation plan is included in the employee's estate if the employee had a nonforfeitable right to receive benefits while living, even if the employee never actually received such benefits while alive. Thus, the DBO benefit is designed to be paid only at death. If there is a DBO plan, the employer's fringe benefit arrangements for the employee must also be designed carefully to make sure the DBO plan will accomplish its intended purpose. The IRS will lump other deferred-compensation plans-not including qualified plans-together with the DBO plan to determine if the company provides a lifetime benefit to the employee.

  To provide a substantial death benefit even during the early years of the plan, DBO plans are usually funded informally with life insurance. That is, the employer owns insurance on the life of the employee, with the employer itself as beneficiary. At the death of the employee, the policy provides funds enabling the employer to pay the death benefit to the employee's beneficiary.

  For income tax purposes, a DBO plan is treated the same as any other deferred-compensation plan-death benefits are taxable in full to the beneficiary as ordinary income when received.

• Group Term Life Insurance Plan. Under Section 79, a group term life insurance plan can have a special class for executives and provide them with amounts of group term insurance relatively greater than the amounts provided for other employees. However, if the plan provides amounts of insurance that are higher multiples of compensation for key employees, it probably will be deemed discriminatory and, therefore, the tax exclusion for the value of the first $50,000 of insurance will be lost by key employees.

GROUP UNIVERSAL LIFE INSURANCE : Types of Group Universal Products & Underwriting

Types of Group Universal Products
Two approaches have been used in designing group universal life insurance products. Under the first approach, there is a single group insurance plan. An employee who wants only term insurance can pay a premium equal to the mortality and expense charges so that there is no accumulation of cash values. Naturally, an employee who wants to accumulate cash values must pay a larger premium.

Under the second approach, there are actually two group insurance plans—a term insurance plan and a universal life insurance plan. An employee who wants only term insurance contributes to the term insurance plan, and an employee who wants only universal life insurance contributes to the universal life insurance plan. With this approach, an employee purchasing universal life insurance must make premium payments that are sufficient to generate a cash-value accumulation. Initially, the employee may be required to make minimum premium payments, such as two or three times the cost of the term insurance. If an employee who has only the term insurance coverage later wants to switch to universal life insurance coverage, his or her group term insurance certificate is canceled, and the employee is issued a new certificate under the universal life insurance plan. An employee can also withdraw his or her cash accumulation under the universal life insurance plan and switch to the term insurance plan or can even have coverage under both plans. Typically, an employee is eligible to purchase a maximum aggregate amount of coverage under the two plans. For example, if this amount is three times annual salary, the employee can purchase term insurance equal to two times salary and universal life insurance that has a term insurance amount equal to one times salary.

Underwriting
Insurance companies that write group universal life insurance have underwriting standards concerning group size, the amounts of coverage available, and insurability.

Currently, most group universal life insurance products are limited primarily to employers who have at least 100 or 200 employees. However, a few insurers write coverage for even smaller groups. Some insurance companies also have an employee percentage-participation requirement, such as 20 percent or 25 percent, that must be satisfied before a group can be installed. Other insurance companies feel their marketing approach is designed so that adequate participation will result and, therefore, have no participation requirements.

Employees can generally elect amounts of pure insurance equal to varying multiples of their salaries, which typically start at one-half or one and range as high as three or five. There may be a minimum amount of coverage that must be purchased, such as $10,000. The maximum multiple an insurance company will offer is influenced by factors such as the size of the group, the amount of insurance provided under the employer's basic employer-pay-all group term insurance plan, and the percentage participation in the plan. In general, the rules regarding the amounts of coverage are the same as those that have been traditionally applied to supplemental group term life insurance plans. The initial premium, which is a function of an employee's age and death benefit, is frequently designed to accumulate a cash value at age 65 equal to approximately 20 percent of the total death benefit.

Other approaches for determining the death benefit may be used, depending on insurance company practices and employer desires. Under some plans, employees may elect specific amounts of insurance, such as $25,000, $50,000, or $100,000. Again, an employee's age and the death benefit selected determine the premium. Some plans allow an employee to select the premium he or she wants to pay. The amount of the premium and the employee's age then automatically determine the amount of the death benefit.

The extent to which evidence of insurability is required of individual employees is also similar to that found under most supplemental group term life insurance plans. When an employee is initially eligible, coverage is usually issued on a guaranteed basis up to specified limits, which again are influenced by the size of the group, the amount of coverage provided under the employer's basic group term insurance plan and the degree of participation in the plan. If an employee chooses a larger death benefit, simplified underwriting is used up to a second amount, after which regular underwriting is used. Guaranteed issue is often unavailable for small groups; underwriting on the basis of a simplified questionnaire is used up to a specific amount of death benefit, after which regular underwriting is used.

With some exceptions, future increases in the amount of pure insurance are subject to evidence of insurability. These exceptions include additional amounts resulting from salary increases, as long as the total amount of coverage remains within the guaranteed issue limit. A few insurance companies also allow additional purchases without evidence of insurability when certain events occur, such as marriage or the birth of a child.

GROUP UNIVERSAL LIFE INSURANCE : General Nature

GROUP UNIVERSAL LIFE INSURANCE
Beginning in the mid-1980s, many large writers of group insurance started to sell group universal life insurance, a trend that was greeted with much interest by insurers, employers, and even employees. This interest seems to stem primarily from the following five factors:

1. The success of universal life insurance in the individual marketplace.

2. Tax legislation that made employer-provided term life insurance in excess of $50,000 taxable after retirement.

3. The clarification of the tax treatment of universal life insurance. For the first few years after the introduction of universal life insurance, there was concern that the Internal Revenue Service (IRS) would not grant it the same favorable tax treatment that was granted to traditional cash-value life insurance policies. There was speculation that the interest paid on the cash value might become subject to taxation and also that the death benefit would be considered taxable income for the beneficiary. For the most part these fears were laid to rest by tax legislation, as long as a universal life insurance policy meets certain prescribed guidelines. Therefore, the cash value of a universal life insurance policy accumulates tax free, and death benefits are free of income taxation.

4. The desire of employers to contain employee benefit costs. Little needs to be said about the attempts of employers to minimize the costs of their employee benefit plans. Group universal life insurance plans can make life insurance available to employees with little cost to the employer.

5. Less favorable tax treatment for formerly popular products for prefunding postretirement life insurance, such as retired-lives reserves.

Group universal life insurance products are being marketed primarily as supplemental life insurance plans, either to replace existing supplemental group term life insurance plans or as additional supplemental plans. Some insurers are promoting them as a way of providing the basic life insurance plan of an employee. Marketing efforts tout group universal life insurance as having the following advantages to the employer:

- No direct costs other than those associated with payroll deductions and possibly enrollment, because the entire premium cost is borne by the employee. In this sense, group universal life insurance plans are much like the payroll-deduction-funded plans

- No Employee Retirement Income Security Act (ERISA) filing and reporting requirement as long as the master contract is issued to a trust and as long as there are no employer contributions for the cost of coverage. The current products are marketed through multiple-employer trusts, with the trust being the policyholder.

- The ability of employees to continue coverage into retirement, alleviating pressure for the employer to provide postretirement life insurance benefits.

The following advantages are being claimed for employees:

- The availability of a popular life insurance product at group rates

- The opportunity to continue insurance coverage after retirement, possibly without any postretirement contributions

- Flexibility in designing coverage to best meet the needs of the individual employee

The current plans being marketed are still evolving, and differences do exist among the plans being offered by competing insurance companies. Because of the flexibility given to policyholders, the administrative aspects of a group universal plan are formidable, and most insurers originally designed their plans only for employers with a large number of employees, usually at least 1,000. However, some insurers that write the product now make it available for as few as 50 employees or less.

Skeptics, including employees of some insurance companies offering group universal life coverage, wonder if the administrative problems can be handled so that coverage can be offered at a cost significantly lower than what is found in the individual marketplace. In raising this question, skeptics point out the administrative problems and costs that have arisen when universal life insurance has been included in payroll-deduction individual insurance plans. In addition, the highly competitive market for individual universal life insurance has resulted in rates with extremely low margins for contributions to surplus. These drawbacks, coupled with the lack of employer contributions, make savings to employees through the group insurance approach less likely than for many other types of insurance. Other critics point out that the popularity of universal life insurance in the individual marketplace decreased as interest rates have dropped over the last few years. Nevertheless, plans that are installed are usually well received by employees, and participation generally meets or exceeds expectations.

In 1998, universal life insurance accounted for about 6.5 percent of group life insurance certificates in force, up from 2 percent in 1995.[1]

General Nature
Group universal life insurance is a flexible-premium policy that, unlike traditional cash-value life insurance, divides the term insurance protection and the cash-value accumulation into separate and distinct components. The employee is required to pay a specified initial premium, from which a charge is subtracted for one month's mortality. This mortality charge in effect is used to purchase the required amount of term insurance (often referred to as pure insurance or the amount at risk) at a cost based on the insured's current age. Under some policies, an additional deduction is made for expenses. The balance of the initial premium becomes the initial cash value of the policy, which, when credited with interest, becomes the cash value at the end of the period. The process continues in succeeding periods. New premiums are added to the cash value, charges are made for expenses and mortality, and interest is credited to the remaining cash value. Employees receive periodic disclosure statements showing all charges made for the period, as well as any interest earnings.

Group universal life insurance offers an employee considerable flexibility to meet several life-cycle financial needs with a single type of insurance coverage. The death benefit can be increased because of marriage, the birth of a child or an increase in income. The death benefit can be reduced later when the need for life insurance decreases. Cash withdrawals can be made for the down payment on a home or to pay college tuition. Premium payments can be reduced during those periods when a young family has pressing financial needs. As financial circumstances improve, premiums can be increased so that an adequate retirement fund can be accumulated. The usual settlement options found in traditional cash-value life insurance are available, so an employee can periodically elect to liquidate the cash accumulation as a source of retirement income.

Dependent Life Insurance

Dependent Life Insurance
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 a 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; even 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 older than 14 days of age and younger than some specified age, commonly 19 or 21. To prevent adverse selection, an employee usually cannot select coverage for 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 for each dependent are recognized as 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 is provided for all dependents; in other cases, a larger amount is provided for the spouse than for the children. It is also not unusual for the amount of coverage for children to be less until the children attain some specified age, such as six months. Tables 1 and 2 are examples of benefit schedules under dependent coverage.


Table 1: Benefit Schedule (Same Amounts for All Dependents)


Table 2: Benefit Schedule for Dependents (Varied Amounts)

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 sometimes will 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 are not covered when otherwise eligible if they are confined in a hospital (except for newborn children, who are covered after 14 days). Coverage commences when the dependent is discharged from the hospital.

ADDED COVERAGES : Supplemental Life Insurance

ADDED COVERAGES
Group term life insurance contracts often provide additional insurance benefits. Historically, these have been added through the use of riders, but many insurers now incorporate some or all of these benefits into their basic term insurance contracts. The most common types of these benefits, which are also forms of group term insurance, are
(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.

Supplemental Life Insurance
The majority of group life insurance plans enable all or certain classes of employees to purchase additional amounts of life insurance. Generally, the employer provides 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 only to a select group of employees. The employee may pay the entire cost of the supplemental coverage; however, state laws that require employer contributions or insurance company underwriting practices 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 is 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. Tables 1 and 2 are two examples of benefit schedules for a basic-plus-supplemental life insurance plan.


Table 1: Benefit Schedule (Flat Amount)


Table 2: Benefit Schedule (Multiple of Annual Earnings)

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. In addition, higher rates may be charged for supplemental insurance than for basic coverage.