How do you offer better life insurance benefits for key employees while holding down costs for all employees? One solution is to “carve out” the top executives.
Sometimes, you read articles that make carve-out plans sound as if they are simply vehicles for giving executives better benefits. In the group life market, theres more to it than that.
Most employers with good benefits packages offer their employees group term life insurance. Group term life is easy to implement, administer and understand.
One key aspect of group term life is that the rates are determined based on the overall mortality experience of the group. “Experience rated” means that all insured employees in the group are in the same risk pool and that claims will adversely affect the rate for the entire group.
When it comes to the executive population, average ages, incomes and amounts of insurance tend to be higher, and that often dictates the pricing for the entire group term plan.
In a case like this, carving out the top executives and putting them in a separate pool-rated product can improve the situation of everyone involved.
Placing the top executives in a separate group policy where the rates are determined based on the mortality experience of the entire pool of participants potentially can keep costs in check. Spreading the risk of the higher amounts of insurance over insured employees from several employers can stabilize the costs for the carve-out plan as well as the group term life plan for the remaining employees. By separating the key employees from the remainder of the group, the value of the life insurance benefit is enhanced for both the employer and insured employees.
One type of pool-rated life insurance program, which is marketed effectively by some carriers, is group universal life insurance. GUL plans, as their names imply, are first and foremost permanent group universal life insurance plans designed to insure and protect the executives financial future.
In most GUL plans the employer pays premiums to cover the cost of insurance as they would in a group term life plan. In more generous plans, the employers use bonuses to cover the cost of additional premiums for the key employees to increase the certificates account value.
While creating some level of current income for insured executives, the benefits and flexibility of these programs make them attractive options.
In addition to funding flexibility for employers and tax-free death benefits for the beneficiaries of the executives, GUL plans can offer the following features:
- A chance for participants to pay additional premiums that accumulate on a tax-deferred basis while in the contract.
- A chance for executives to use surrenders and withdrawals to recover an amount equal to all premiums paid by both the employer and the employee before incurring any income taxes.
The last point is significant. The premiums paid to cover the cost of life insurance protection are treated as cost basis when determining the amount of cash withdrawals that can be made from the certificate without incurring income tax. Under a traditional group term life program, participants cannot accumulate cash value in the contract or, for that matter, pay additional premiums. Thus, the value of the premiums paid by the employer under a group term life program for the cost of the life insurance provides only a death benefit.
Under a GUL plan, participants may make voluntary premium payments. The premiums paid by the employer to cover the cost of life insurance protection are combined with the participants voluntary premiums and treated as cost basis. So, executives who choose to pay voluntary premiums benefit at retirement when they can withdraw an amount equal to not only their premium payments, but premiums their employer contributed on their behalf for the cost of insurance, before incurring any income taxes. (Note: If the contract is a modified endowment contract, withdrawals and loans are taxable to the extent of gain and may be subject to a 10% tax penalty.)
Certificate values grow tax-deferred while they remain in the contract, making the GUL program a tax-efficient way for executives to accumulate funds for retirement or other needs. If an increasing death benefit option is selected, any account value is added to the face amount and passed to the beneficiary as a part of the income tax-free death benefit.
Another flexible option is for the executive at some point to stop paying voluntary premiums and leave the account value to grow tax-deferred, using the account value and future growth to pay the cost of insurance charges after retirement, keeping the death benefit in force. While this option will need to be monitored closely to ensure that there is always sufficient cash value to cover the future cost of insurance charges, it demonstrates the flexibility of the GUL program and the reason for its popularity among companies and executives.
Generally speaking, it is executives and highly compensated employees who benefit the most from a GUL plan, because they usually have disposable income to pay voluntary premiums. In many cases, executives and highly compensated employees are looking for ways to supplement 401(k)s and other savings and retirement plans, and accumulate additional funds on a tax-favored basis. The combination of the need for life insurance protection, which in many cases is already paid for by the employer, combined with executives/highly compensated employees need for additional tax deferred savings, and employers need to lower coverage costs for rank-and-file employees, make GUL carve-out plans very attractive for both the employees and employers.
John Laprade is managing director, GUL sales, large corporate markets, with Massachusetts Mutual Life Insurance Company, Springfield, Mass. He can be reached at [email protected].
Reproduced from National Underwriter Edition, November 18, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.