Top 3 Life Insurance Compliance Obligations for Employers

Group life insurance plans are a valuable benefit many employers offer to their employees. Employers may also provide employees the opportunity to purchase additional voluntary coverage for themselves or their dependents.

Administering a group life insurance plan may appear innocuous, however, failure to comply with 3 general requirements can have significant financial consequences for the employer.

1 – Evidence of Insurability

Most insurance policies are designed to have a coverage level amount (e.g., $50,000) that employees may elect that is a “guaranteed” level of coverage. This amount is known as a “guaranteed issue” and is available to all employees when they are first eligible to enroll in coverage. If an employee wants to enroll in an amount higher than the guaranteed issue or is enrolling at a time other than when they were first eligible for the coverage, the insurance provider requires the employee to complete an evidence of insurability (EOI) form.

Until the employee has returned their EOI form and the insurance provider has notified the employer of their approval of the employee’s level of coverage above the guaranteed issue, the employer should only deduct premiums from an employee’s paycheck for the guaranteed issue amount.   

Why does this matter? 

If the employee fails to return their EOI form, or the insurer does not approve the increased life insurance amount, the insurer has no contractual obligation to pay a life insurance benefit above the guaranteed issue amount.

What does this mean? 

By taking premium payments for the full amount of coverage the employee elected, the employer may be misrepresenting to the employee the amount of their life insurance coverage. If the employee were to pass away, the employer may be responsible for paying the difference between the guaranteed issue benefit amount and the amount elected by the employee. (Example:  Van Loo v. Cajun Operating Co., 703 Fed. Appx. 388 (6th Cir. 2017))

2 – Portability or Conversion Rights

Most group life insurance plans have portability or conversion provisions that allow an employee to continue their coverage after the employee terminates employment or is no longer actively working (e.g., disability leave). The provisions explaining the employee’s rights are found in the life insurance policy documents (e.g., summary plan description).

In addition to making sure employees receive a copy of the insurance plan documents, it is a best practice for an employer to notify an employee who is losing coverage of their rights by providing a portability or conversion form, or instructions on obtaining a form in an employee’s termination packet.

Why does this matter? 

If the employee does not elect to continue their policy, the insurance carrier is no longer obligated to pay life insurance benefits if the former employee passes away.  

What does this mean? 

If an employee is terminated from employment or is out on a leave of absence and an employer failed to provide a former employee of their rights to keep the coverage in place, they may be liable to pay the life insurance amount.

3 – Terminating coverage according to policy terms

Keeping an employee on benefits when they are not actively at work is risky. Group life insurance policies contain rules that define when an employee is eligible for coverage and how long coverage remains in effect when an employee is no longer actively at work.  

Employers need to be familiar with the terms of their group life insurance plan and properly terminate coverage when an employee is no longer eligible.

Why does this matter? 

An insurer is not responsible for paying a life insurance benefit for an employee who passes away if they were ineligible to be enrolled on the plan.

What does this mean? 

The employer may be liable to pay the life insurance benefit if they misrepresented to the employee that coverage was in effect. (Example: McBean v. United of Omaha Life Insurance Co. and By Referral Only, Inc., Case No. 18cv16MMA (JLB) (S.D. Cal. Apr. 5, 2019).

Best Practices for Administration

An employer needs to read their policy and be knowledgeable about the rules. If an employer requires clarity on how to apply the rules or their responsibility, they should contact the insurance provider for assistance or seek guidance from legal counsel.

If you have questions about the above or need help with an employee benefits administration question, please contact us. We would love to hear from you!

The Compliance Rundown is not a law firm and cannot dispense legal advice. Anything in this post or on this website is not and should not be construed as legal advice. If you need legal advice, please contact your legal counsel.

WARNING: Keeping an Employee on Benefits When They Are Not Actively at Work Is Risky

Employers who are trying to be generous by keeping employees on their benefits plan, may be making a costly mistake.

There are eligibility rules known as “actively at work clauses” for employer group benefits including medical, dental, vision, life, and disability. These provisions allow the insurer to exclude coverage for employees who are not working a minimum number of hours each week, such as when they are on a leave of absence because of an illness or furloughed.

If you have a fully insured plan, the carriers define the rules on how long an employee who is on an unprotected leave of absence (e.g., not out due to a reason covered by the Family Medical Leave Act (FMLA)) may remain on the plan before coverage must be terminated and continuation coverage (e.g., COBRA) offered. If you are self-insured, it is a conversation that should have been discussed when creating plan documents with the stop-loss carrier.

If an employer does not follow this provision and fails to terminate an employee and offer them continuation coverage, then the carrier may not cover any claims, leaving the employer financially responsible. It has been my experience, although the carrier leaves eligibility verification up to the employer, before paying a large claim, many carriers are thorough and review an employee’s status by asking for payroll records.

There is no standard rule for when an employee who is not actively at work must be terminated from active coverage. Often, for ease of administration, carriers will permit an employee to remain on the plan for up to 12 weeks to be the same as a protected leave of absence under the FMLA. However, an employer must check their plan documents and never assume. Once the employee no longer meets the definition of actively working, the employer should terminate the employee and offer continuation coverage. This includes providing port/covert paperwork for life and disability coverage.

If you have questions about the above, or need help with another employee benefits administration question, please contact The Compliance Rundown. We would love to hear from you!

The Compliance Rundown is not a law firm and cannot dispense legal advice. Anything in this post or on this website is not and should not be construed as legal advice. If you need legal advice, please contact your legal counsel.

What is Imputed Income?

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In general, if an employer has adopted a cafeteria plan, their employees are not taxed on the cost of employer-provided benefits for the employee and their tax dependents. However, there are three benefits-related exceptions to this rule:

  1. Cost of group term life insurance – in certain situations
  2. Long-term disability (LTD) “gross up” amounts
  3. Benefits for domestic partners and other individuals who do not meet federal tax law definitions of “dependent”

In these situations, the cost of the benefits provided is considered “imputed income” to the employee and therefore the cost or “fair market value” of the benefits are added to the employee’s gross (taxable) income.  This non-cash taxable compensation (i.e. benefit) is treated as income and included in the employee’s form W-2 for tax purposes. Imputed income is subject to Social Security and Medicare tax and employment tax withholding.

Cost of Group Term Life Insurance 

An employer must impute income for:

  1. Life insurance coverage for any employee above $50,000
  2. Employer-paid coverage for spouses or dependents on amounts greater than $2,000
  3. If a plan is discriminatory, the cost of coverage in any amount for “key employees”

Life insurance coverage for any employee above $50,000

In 1964, Congress adopted Code §79 which begins by stating a general rule that the cost of group-term life insurance is included in gross income. It then carves out a limited exception for the cost of up to $50,000 of group-term life insurance coverage per employee.

If any employee (highly compensated or non-highly compensated) receives more than $50,000 of employer-provided life insurance, then employers are required to impute income on the cost of coverage in excess of $50,000.

IRS Publication 15-B “Employer’s Tax Guide to Fringe Benefits”, explains in detail how the calculation is determined, however, here is a high level overview:

 To calculate the value of the excess benefit coverage:

  1. Determine the excess of the life insurance (Value of life insurance – $50,000 allowable).
  2. Divide the excess amount by 1,000.
  3. Multiply the result by the age-appropriate value in Table 2-2 (page 14 of IRS publication 15-B (2019) table below)
  4. Multiply that result by the number of months of coverage.
  5. Subtract after-tax premiums paid by the employee.

Example: an employee is 40 years old and does not pay any of the premiums for life insurance for the whole year*. The value of the life insurance was $75,000.

  1. Determine excess (Value of life insurance – $50,000 allowable) – $75,000 – $50,000 = $25,000 (excess)
  2. Divide the excess amount by 1,000 – $25,000 /$ 1,000 = 25
  3. Multiply the result of #2 by the age value found in Table 2-2 (IRS pub. 15-B page 14 (2019) table below) – 25 x $0.10 = $2.50
  4. Multiply the result of #3 by the number of months of coverage – $2.50 x 12 (months) = $30.00

$30.00 is the amount to be added to the employee’s W-2 as income for the premiums paid by the company on the excess $25,000.

Table 2-2. Cost Per $1,000 of Protection for 1 Month
Age                                          Cost
Under 25 ……………………….  …. $ 0.05
25 through 29 ………………………… 0.06
30 through 34 ……………………….. 0.08
35 through 39 ……………………….. 0.09
40 through 44 ……………………….. 0.10
45 through 49 ……………………….. 0.15
50 through 54 ……………………….. 0.23
55 through 59 ……………………….. 0.43
60 through 64 ……………………….. 0.66
65 through 69 ……………………….. 1.27
70 and older ………………………… 2.06

(*Ideally, imputed income amounts are being taxed over the course of the year, but if they were not, at a minimum, the amount should be included on employees’ W-2 at the end of the year.)

Coverage in excess of $2,000 for spouses or dependents.

If an employer pays for life insurance coverage for an employee’s spouse or dependents in an amount more than $2,000, the entire premium amount is imputed income for the employee.

Note:  There is no imputed income for the employee if the coverage amount paid by the employer for the employee’s spouse or dependents is less than $2,000. In this case, it may be considered a  “de minimis” fringe benefit and excludable from income.  (See IRS Notice 89-110 for more details.)

If a plan is discriminatory, the cost of coverage in any amount for “key employees”

If the group life insurance plan favors either as to eligibility or as to the kind or amount of life insurance benefits to any “key employee” (as defined by paragraph (1) of section 416(i)) then all “key employees” covered under the plan must also include in taxable income the higher cost of the first $50,000 of coverage or Table I cost.

Long-term disability (LTD) “gross up” amounts

If an employer wants their employees to have a tax-free LTD benefit in the event the employee becomes disabled, the employer would need to “gross up” (i.e. increase) the employee’s salary by the amount of the employer-paid premium and report the premiums as taxable wages on the employee’s W-2.

Otherwise, if the disability premium is paid pre-tax, the LTD monthly benefit the employee receives if they become disabled and cannot work, will be taxed just like their income is taxed when they are working. e.g. disabled employee receives 60% of their monthly earnings less taxes.

Most carriers will offer a tax choice plan (will apply a slight load to the LTD rate) when the employer pays for the premium, the employer can either:

  1. Treat the premium payments as employee paid and include in W-2 income (taxable premiums but non-taxable benefits);
  2. Treat the premium payments as employer paid with no W-2 income (non-taxable premiums but benefits are taxable); or,
  3. Give employees the choice between options 1 and 2.

Benefits for Domestic Partners (DP) & Their Children

Most domestic partners do not meet the financial dependency criteria to qualify as an employee’s tax dependent for group health plan purposes. Under federal law, the fair market value of coverage for the cost of the non-tax code dependents (minus any after-tax contributions paid by the employee) would be included (i.e. imputed) in the employee’s gross income for federal (and most state) tax purposes and reported as taxable earnings on their W-2 Form. The imputed income is subject to federal income tax withholding as well as FICA and FUTA.

However, if a domestic partner (and their children) qualifies as the employee’s tax dependent, (something an employee needs to determine, not the employer**) there is no imputed income.

(**Best practice is for an employer to require a signed affidavit from the employee as to whether or not a domestic partner qualifies as a Tax Code dependent.)

This information is an overview and should not be considered tax or legal advice.

Life Insurance – Portability & Conversion

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When an employee goes out on a leave of absence or terminates employment, it is important for employers to have a dedicated process for notifying employees of critical changes to their benefits and what is required of an employee to continue their benefits.

Often employers remember to advise about COBRA eligible benefits but forget they are also responsible for providing information about life insurance, including portability or conversion information to employees who are losing benefit eligibility.

Background: Both the portability and conversion provisions allow the employee to continue life coverage that is lost due to an employment status change.  Policies may vary, so one needs to refer to their specific policy for clarification.

  • Portability –  When an employee ports coverage, they keep the group term life coverage offered by their employer along with some, but not all of the optional benefits that were included.
  • Conversion – When an employee converts coverage, they are converting to an individual whole life (or permanent life) insurance policy. The converted policy only provides life insurance and does not include the optional benefits such as Waiver of Premium, Accidental Death and Dismemberment.

In the case of, Erwood v. Life Insurance Company of North America and WellStar Health System, Inc., a federal district court awarded $750,000 in damages to Patricia Erwood, the wife of a deceased former employee of WellStar Health System whose life insurance lapsed while he was out on disability, and the employer failed to notify him of his conversion rights.

Even though the employer had sent the employee an FMLA leave packet that included information about it being possible to continue his life insurance benefits, the court noted that the FMLA packet did not include the materials necessary to convert, where to find the materials nor when the materials would be due if he was interested in continuing his coverage. 

This is just one of several cases which demonstrates relying on the benefit plan documents or a generalized communication may not be sufficient. Employers need to be mindful they have an ERISA fiduciary duty to adequately inform participants of their benefits and provide complete information regarding the steps necessary to keep their insurance benefits, including portability and conversion.