Group insurance is insurance coverage of a group under one master contract. The most common types of group insurance are life and health insurance, both of which can be given as a tax-free benefit to employees. The primary requirement is that the group being insured was not formed for the sole purpose or primary purpose of buying the insurance. Group insurance costs less than comparable insurance purchased individually, because acquisition costs and administrative expenses are lower. Unlike for individual insurance coverage, individual evidence of insurability is usually not required.
Group insurance saves money for the insurer because acquisition costs are much lower, especially per individual, since no sales commission has to be paid to a sales agent, as is usually the case with individual policies.
In setting group insurance premiums, underwriting uses experience rating, where the group is sufficiently large that actual losses are more determinative of the premiums. A medical examination is generally not required for group insurance, unless there are only a few members, typically less than 10.
Because premiums are based on experience ratings, the employer must have a sufficient number of employees or data over sufficient amount of time so that it has credibility as a proxy for future losses. In many cases, the premiums will be higher in the initial years, but will be reduced in subsequent years if actual losses are within the expected range or lower.
Underwriting guidelines for a group differs from those of individuals and, thus, have different requirements:
- insurance must be incidental to the group, meaning that the group was not formed simply to buy the insurance
- there is a continual replacement of individuals within the group, where older members who leave the group are replaced by younger members who enter the group
- formulaic determination of benefits, where the determination of benefits is determined by a formula based on earnings, employment position, length-of-service, or some combination of those factors, which reduces adverse selection against the insurer, because riskier individuals cannot choose a higher-level level of coverage, although some employers do allow a selection of benefits within certain maximum limits. Any employee wanting greater coverage will have to prove insurability.
Minimum participation is generally required so that expenses per member can be reduced and because the group is unlikely to have a large proportion of higher risk individuals. With noncontributory plans, the employer pays 100% of the cost, so the insurance coverage can be extended to every eligible employee. However, with contributory plans, where the employee must contribute at least some of the cost, 100% participation is unlikely.
Third-party sharing of cost is also usually required for group insurance, where the 3rd party is usually the employer. Otherwise, older members of the group will have to pay much higher premiums or younger members of the group would be paying much higher premiums than they could purchase individually, which could cause a drop in participation. Third-party sharing of costs also increases participation.
Finally, efficient administration helps to keep participation rates high and expenses low, especially with the payroll deduction of premiums.
Employees also have a special incentive to participate in life and health insurance programs offered by the employer, because, as nontaxable fringe benefits, they can be given the benefit completely tax-free: free of federal income taxes, and Social Security and Medicare taxes.
Group Insurance Eligibility Requirements
Generally, insurers have certain eligibility requirements that must be met before the insurance becomes effective, the primary purpose of which is to reduce adverse selection.
Eligibility requirements for group insurance are determined by the insurance company and by state law. Group insurance is generally given to certain types of groups including employees of an employer, labor unions, creditor-debtor groups, fraternities, sororities, and alumni groups, and so on.
Insurers generally require that groups be a certain size to reduce adverse selection and to reduce expenses for the group, some of which are fixed regardless of the size the group. Hence, the expenses per group member is proportionately reduced by the size of the group.
Employees must satisfy certain requirements before they can participate in the insurance:
- they must be full-time employees
- a probationary period must elapse before they may become eligible for the insurance
- they must apply for the insurance during the eligibility period, and
- they must be at work when the insurance becomes effective.
Full-time work is generally considered to be a minimum of 30 hours. The probationary period usually ranges from 1 to 6 months. Every business, some more than others, has a high turnover of employees, so the probationary period requirement saves enrollment expenses for those who will only be there temporarily.
The eligibility period, typically a month or longer, is when the employee can sign up for insurance without presenting evidence of insurability. This prevents people from signing up for insurance just when they need it (adverse selection). Additionally, the employee must be actively at work on the day the insurance becomes effective, to eliminate employees who might otherwise choose to have the insurance when they become ill. Thus, the requirement to be at work when the insurance becomes effective. If the plan is contributory, then the employee must request coverage either before or during the eligibility period.
Group Insurance Tax Requirements
For the employer and the employee, there are certain tax advantages to group insurance, but only if additional rules are followed, primarily qualification and nondiscrimination rules. The qualification rules require that the plan:
- be in writing
- create legally enforceable rights for the employees
- be enforced indefinitely, and
- be for the exclusive benefit of employees.
The nondiscrimination requirements for tax-advantaged group insurance do not allow plans that favor key or highly compensated employees.
Additionally, the federal government has passed many laws affecting group insurance, with the more prominent ones being the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) and the Health Insurance Portability and Accountability Act of 1996 (HIPAA)
COBRA rules require that large employers allow workers or their spouses or children to continue their group health insurance coverage for up to 36 months after a qualifying event, including: when the employee leaves the group or dies. Additionally, a spouse can continue COBRA coverage after getting divorced from the employee or a child can continue coverage after no longer being a dependent of the employee. The person must continue paying the premium to the employer, but the cost will usually be much less than if the health insurance had to be purchased individually. However, COBRA benefits could be terminated, if:
- the employer stops providing health insurance benefits for all of its employees
- the insured does not timely pay the required premiums
- or the beneficiary obtains group health insurance under another plan, such as with another employer.
Worker mobility allows the economy to function more efficiently and effectively. HIPAA was designed to facilitate worker mobility, so that people may more freely switch to jobs or professions that are in more demand without worrying about health coverage. For group health plans that cover at least 2 employees, an employee or dependent cannot be excluded from coverage because of:
- health status
- medical history
- genetic information
- claims experience.
Many small and medium-sized businesses will find group insurance to be cost-effective, but, for greater control of costs, many larger employers choose to self-insure for health insurance or disability. However, they usually hire a third-party administrator (TPA), which is usually an insurance company, to administer the plan. Additionally, employers may carry some insurance to cover larger losses during some years, especially if they have fewer employees, since there will be greater variation in losses from year to year.