CHARACTERISTICS OF TRADITIONAL GROUP INSURANCE

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

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

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

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

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

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

The purpose of group insurance underwriting is twofold:

- To minimize the problem of adverse selection (those who are most likely to have claims are also those who are most likely to seek insurance)

- To minimize the administrative costs associated with group insurance

- Because of group underwriting, coverage can be provided through group insurance at a lower cost than through individual insurance.

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

- The reason for the existence of the group

- The stability of the group

- The persistency of the group

- The method of determining benefits

- The provisions for determining eligibility

- The source and method of premium payments

- The administrative aspects of the group insurance plan

- The prior experience of the plan

- The size of the group

- The composition of the group

- The industry represented by the group

- The geographic location of the group

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

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

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

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

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

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

The general level of benefits for all employees is also of interest to the underwriter. For example, benefit levels that are too high may encourage overutilization and malingering, while benefit levels that are unusually low may lead to low participation if a plan is voluntary.

Determination of Eligibility
The underwriter is also concerned with the eligibility provisions that are contained in the group insurance plan. Many group insurance plans contain probationary periods that must be satisfied before an employee is eligible for coverage. In addition to minimizing administrative costs, a probationary period also discourages persons with known medical conditions from seeking employment primarily because of a firm's group insurance benefits. This latter problem is also addressed by the requirement that an employee be actively at work before coverage commences or, particularly with major medical coverage, by limiting coverage for preexisting conditions to the extent allowed by federal and state laws.

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

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

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

A key issue in contributory plans is how to treat employees who did not elect to participate when first eligible but who later desire coverage or who dropped coverage and want it reinstated. Unfortunately, this desire for coverage may arise when these employees or their dependents have medical conditions that will lead to claims once coverage is provided. To control this adverse selection, insurance companies commonly require individual evidence of insurability by these employees or their dependents before coverage will be made available. However, there are two exceptions: First, some plans have short, periodic open enrollment periods during which the evidence-of-insurability requirement is lessened or waived. Second, the Health Insurance Portability and Accountability Act effectively eliminates the use of evidence of insurability for medical expense plans, but not for other types of group insurance.

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

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

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

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

The underwriter must determine the new insurance company's responsibility for existing claims. Some states prohibit a new insurance company from denying (by using a preexisting-conditions clause) the continuing claims of persons who were covered under a prior group insurance plan if these claims would otherwise be covered under the new contract. The rationale for this "no-loss, no-gain" legislation is that claims should be paid neither more liberally nor less liberally than if no transfer had taken place. Even in states that have no such regulation, an employer may still wish to provide employees with continuing protection. In either case, the underwriter must evaluate these continuing claims as well as any liability of the previous insurance company for their payment.

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

Size
The size of a group is a significant factor in the underwriting process. With large groups, prior group insurance experience can usually be used as a factor in determining the premium, and considerable flexibility also exists with both rating and plan design. In addition, adjustments for adverse claims experience can be made at future renewal dates under the experience-rating process.

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

Composition
The age, sex, and income of employees in a group will affect the experience of the group. As employees age, the mortality rate increases. Excluding maternity claims, both the frequency and duration of medical and disability claims also increase with age.

At all ages, the death rate is lower for females than for males. However, the opposite is true for medical expenses and disability claims. Even if maternity claims are disregarded, women as a group tend to be hospitalized and disabled more frequently and require medical and surgical treatment more often than men.

Employees with high income levels tend to incur higher-than-average medical and dental expenses. This is partly because practitioners sometimes base charges on a patient's ability to pay. In addition, persons with higher incomes are more likely to seek specialized care or care in more affluent areas, where the charges of practitioners are generally higher. On the other hand, low-income employees can also pose difficulties. Turnover rates tend to be higher, and there is often difficulty in getting and retaining proper levels of participation in contributory plans.

Adjustments often can be made for all of these factors when determining the proper rate to charge the policyholder. Some states, however, require the use of unisex rates, in which case the mix of employees by sex becomes an underwriting consideration. Also, major problems can arise in contributory plans: to the extent that higher costs for a group with a less-than-average mix of employees are passed on to these employees, a lower participation rate may result.

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

In addition to occupational hazards, the underwriter must weigh other factors as well. Certain industries are characterized by a lack of stability and persistency and thus may be considered undesirable risks. The underwriter must also be concerned with what impact changes in the economy will have on a particular industry.

Geographic Location
The size and frequency of health insurance claims varies considerably among geographic regions and must be considered in determining a group insurance rate. For example, medical expenses tend to be higher in the Northeast than in the South, and higher in large urban areas than in rural areas. Certain geographic regions also tend to have a higher frequency of disability claims.

A group with geographically scattered employees also poses more administrative problems and probably results in greater administrative expense than a group in a single location. In addition, the underwriter must determine whether the insurance company has the proper facilities to service policyholders at their various locations.