Lesson:1

Introduction to Risk and Insurance

Insurance provides protection against some of the financial consequences of loss or harm
(also called perils), such as death or illness. The underlying purpose of insurance is to
compensate for financial loss, not to provide an opportunity for financial gain.

To understand insurance and how it works, it is important to understand the concept of risk
and which types of risk are insurable.

Risk exists when there is uncertainty about the future. Both individuals and business
experience two kinds of risk: speculative risk and pure risk.Speculative risk involves three
possible outcomes: loss, gain or no change. Pure risk involves no possibility of gain; either a
loss occurs or no loss occurs. This possibility of financial loss without the possibility of gain
(pure risk) is the only kind of risk that can be insured.

Risk
Individuals are at risk due to potential financial losses that may result from unexpected
occurrences such as:

 Death
 Disability
 Illness
 Accident
 Outliving one’s savings

Risk Management
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Risk management is the process of identifying, assessing (or measuring) and dealing with the
exposures to risk. Once exposures to financial risk have been identified and their impact
measured, various methods (or tools) of risk management can be used to eliminate or reduce
the exposure to risk.

There are primarily four methods that can be used to eliminate or reduce exposure to
financial risk, and a decision with respect to the best method, or combination of methods, to
use must be made. The four methods include:

Risk avoidance
This method focuses on avoiding the risk altogether.

Controlling risk
Also known as risk prevention and reduction. This method focuses on reducing the chance
that a loss will occur (risk prevention) and/or reducing the magnitude of a loss if it does occur
(risk reduction).

Accepting risk
Also known as risk retention. This method retains or bears the risk internally, which is
commonly referred to as self-insuring against the risk.

Transferring risk
This method focuses on transferring the financial consequences of any loss to another party .

Purchasing Insurance Coverage

The most common method used to transfer financial risk to another party is to purchase
insurance coverage. When an insurance company agrees to provide an individual or business
with insurance coverage, the insurer issues an insurance contract or policy.

An insurance contract or policy is a written document that contains the terms of the
agreement between the insurance company (the insurer) and the owner of the policy. In
general terms, it is an enforceable contract under which the insurance company agrees to pay
a certain amount of money (called a benefit) when a specific loss occurs. In return, the
individual or business pays a specified amount of money called a premium.

Insurers can afford to be financially responsible for the financial risks of the individuals they
insure by using a concept known as risk pooling. With risk pooling, individuals who face the
uncertainty of a particular loss—for example, the loss of income because of a disability—
transfer this risk to an insurance company.

Insurers know that not everyone who is issued a disability income policy will suffer a disability.
In reality, only a small percentage of the individuals insured by this type of policy will actually
become disabled at some time during the period of insurance coverage. For example, a policy
may have 200 individuals paying premiums each month, but only a small percentage are
expected to ever go on disability. By collecting premiums from all individuals and businesses
that wish to transfer the financial risk of disability, insurers spread the cost of the few losses
that are expected to occur among all the insured persons. Insurance, then, provides
protection against the risk of financial loss by applying the principle of risk pooling. If the
financial losses that actually result from a given peril, such as disability, can be shared by
large numbers of people who are all subject to the risk of such losses and the probability of
loss is relatively small for each person, then the cost to each person will be relatively small.

Group Insurance Arrangement

A group insurance arrangement involves the issuance of a group insurance policy by an
insurer to a party that is purchasing insurance coverage for a specific group of people. For
example, group insurance may be purchased by an employer to provide life or health
insurance coverage to its employees and, sometimes, to the dependents of covered
employees. Life and health insurers provide group insurance to various types of groups in
addition to employer-employee groups. The different types of groups are described later in
this section.

The group insurance policy provides insured coverage for specific types of losses and pays
benefits to members of the insured group when they have an eligible loss.

Predictions of future losses are based on the concept that, although individual events such as
the disability or death of a particular person occur randomly, the observations of past events
can be used to determine the likelihood, or probability, that a given event will occur in the
future. A key concept that helps explain the accuracy of predictions about the probability of
an event occurring is the law of large numbers.

The law of large numbers states that, typically, the more times a particular event is observed,
the more likely it is that the observed results will approximate the “true” probability that the
event will occur.

Five Characteristics of an Insurable Risk

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There are five basic characteristics that define an insurable risk and form the foundation of
the business of insurance. A potential loss that does not have these characteristics generally
is not considered to be an insurable risk.

The loss must occur by chance.

It should be caused by an unexpected event or one that is not intentionally caused by the
insured person.

The loss must be definite.

It must be definite in terms of time and amount, for most types of insurance. An insurer must
be able to determine when to pay a benefit and how much to pay.

The loss must be significant.

It should have financial significance to the insured. The administrative expenses associated
with minor losses would drive the cost of insurance so high in relation to the potential loss
that purchasing insurance would no longer be affordable for most people.

The rate of the loss must be predictable.

The number and timing of the losses for a given group of insureds should be predictable by
the insurer. The insurer is then able to determine the proper premium amount to charge the
owner of each policy.

The loss must not be catastrophic to the insurer.

A loss should not cause or contribute to catastrophic financial damage to the insurer
(otherwise, the insurer could not responsibly promise to pay benefits for the loss).

Note that these are standard characteristics. Some benefits do not exhibit all these
characteristics, for example, basic dental.

Basic dental
Basic dental insurance typically covers diagnostic and preventative services, such as oral
exams, x-rays, scaling and topical fluoride treatments, in addition to services triggered by an
unexpected event. The cost of dental services is generally predictable and there is lower risk
that dental services will result in a cost that is catastrophic in nature.

Insurable Groups
There are four main types of insurable groups in the marketplace that buy group life and
health insurance products:

1. Single-employer group
 2. Multi-employer group
3. Association group
4. Creditor group.

The fundamental purpose of group insurance is to provide groups of individuals with

insurance protection against various types of losses. All of the foregoing groups
are buyers within the group insurance marketplace.

Single-employer groups are the most common type of group covered by insurance
companies. These groups are also referred to as employee-employer groups and are
considered desirable from a risk perspective.

Single-Employer Group
A single-employer group covers the employees of one employer and is usually defined as a
company (whether incorporated, a partnership, or a sole proprietorship). Government
organizations and government-sponsored agencies, such as school boards and social work
agencies, are also considered to be employer groups.

A single-employer group is not always only one company. It can be made up of two or more
companies, such as a group of affiliated companies or a parent company and its subsidiaries.
However, for insurance purposes, the operation of these companies must be centralized at
some level so that all matters and decisions made concerning the group benefits plan are
handled by only one manager or department.

Multi-Employer Group
A multi-employer group generally covers members who work for more than one employer and
who are typically members of a single union in a particular industry and/or area, and where
employer contributions are determined in accordance with one or more collective bargaining
agreements.

The plan arrangement for such a group is referred to as a multi-employer plan (MEP). A trust
structure is commonly used to hold plan assets for MEPs. This arrangement permits delivery
of benefits to large groups of employees with different employers. One or more trustees, often
with equal representation from labour and management, have a fiduciary responsibility for
the trust assets. The trust “sponsors” the plan to provide coverage for members and
determine benefit levels and other aspects of plan design.

Association Group
There are two types of association groups eligible for group insurance:

1. An association of employers, often in the same industry or type of business, such

as the Canadian Direct Marketing Association or the chamber of commerce of a
particular community.
2. An association of individuals, often in the same profession, such as Engineers
Canada, the Canadian Bar Association, the Canadian Real Estate Association, or
associations with another point of commonality, such as the alumni of a university.

In order to be eligible for group insurance, the association must have been formed for reasons
other than obtaining group insurance .

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Why Participate in an Association Group Insurance Program
Many chartered accountants are covered by group plans provided by their employers. Those who are
self-employed and are members of their professional association may elect to apply to participate in
the group insurance program sponsored by the association. Those covered under employer-sponsored
group plans may choose to supplement their group insurance coverage by applying to participate in the
group insurance program sponsored by their professional association.

Creditor Group
Money-lending institutions contract with insurers to provide protection from debt losses due
to the death, disability and, sometimes, the unemployment of their borrowers. The borrowers
are covered in a group referred to as a creditor group. Any benefits payable under the terms
of the group insurance contract are paid to the financial institution as repayment of the
outstanding amount of the borrower’s loan. The borrower pays premiums for the insurance.

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Mortgage Insurance
A bank may enter into a contract with an insurer to offer life insurance protection to
individuals with mortgages with the bank. The individual would be given the opportunity to
purchase the financial protection at the time he or she applied for the mortgage. If the
mortgagee dies while insured, the insurer would pay the outstanding amount of the mortgage
to the bank.

Lesson:2
Types of Group Insurance
In this lesson, you will learn to:

 Describe types of life and health insurance companies

 Describe parties involved in a group insurance arrangement
 Define general categories of group benefits
 Describe types of benefits provided under each category .

Introduction to Insurance Companies

Insurance companies provide protection against the risk of financial loss caused by
specified events. A life and health insurer issues and sells products that insure against
financial losses that result from the personal risks of death, disability, illness, accident and
outliving one’s savings.

 Types of Insurance Companies

 Life and Health Insurance Companies
 Most life and health insurance companies in Canada are regulated for solvency
by the federal government through the Office of the Superintendent of
 Financial Institutions (OSFI). The Autorité des marchés financiers (AMF)
performs the same function for companies incorporated in Quebec.
 Life and health insurance companies have some flexibility in how they are
organized to do business. The two primary types of insurers are organized as
stock insurance companies or mutual insurance companies.
 Stock Insurance Companies
 The majority of life and health insurance companies are established and
organized as stock companies. A stock insurance company is an insurer that is
owned by the people and organizations that purchase shares of the company’s
stock. The investors who purchase stock—ownership shares—in the corporation
are known as the shareholders. From time to time, a portion of the company’s
operating profits may be distributed to these shareholders in the form
of shareholder dividends.
 Mutual Insurance Companies
 Life and health insurance companies also can be organized as mutual
companies. A mutual insurance company is an insurer that is owned by its
policyowners, and a portion of the company’s operating profits are, from time
to time, distributed to these policyowners in the form of policy dividends.
 Over the last few decades, many mutual companies reorganized to become
stock companies through the process of demutualization. The primary reason a
mutual insurer might wish to demutualize is that, as a stock company, it can
more easily raise operating funds by selling additional shares of stock to the
public.

Reinsurance
Reinsurance is insurance that one insurer (known as the ceding company) purchases from
another insurer (known as the reinsurer) to transfer risks on insurance policies that the ceding
company issued. To cede insurance business means to obtain reinsurance on that business by
transferring all or part of the risk to a reinsurer.

A life insurance company typically sets a maximum amount of insurance (known as

its retention limit), which it is willing to carry on any one life without transferring some of the
risk to a reinsurer. Some insurance companies act only as reinsurers. Other insurance
companies issue policies directly to people and businesses as well as acting as reinsurers.

A reinsurer also sometimes cedes risks to yet another reinsurer in a transaction known as
a retrocession. The reinsurance company that accepts the risk in a retrocession is known as
a retrocessionaire.

Apply Your Knowledge

Reinsurance: Maria
The Omega Life Insurance Company has established a retention limit
of $750,000. Omega recently issued a $1,500,000 policy to Maria.
Omega has entered into a reinsurance agreement with the Epsilon
Reinsurance Company. Under the terms of the reinsurance
agreement, when Omega issues a life insurance policy with a face
amount that exceeds its retention limit, the amount in excess of the
retention limit is automatically ceded to Epsilon. Epsilon also has a
retention limit. Its limit is $500,000.
As a result of the reinsurance agreement, $750,000 of the coverage
Omega issued Maria will be ceded to Epsilon. Epsilon in turn will
cede $250,000 to a retrocessionaire. If Maria dies while the policy is
in effect, Omega will pay the policy benefit of $1,500,000. Epsilon
will reimburse Omega for $750,000 of the policy benefit payable.
The retrocessionaire will reimburse Epsilon for $250,000 of the policy
benefit payable.

Group Insurance Arrangements

Insurance companies sell their group products to employers and other group benefits plan
sponsors who wish to provide protection to a group of individuals such as employees or
members of a specified group.

When an insurer agrees to provide a group with insurance coverage, the insurer issues an
insurance policy (also known as a group benefits policy). The group benefits policy is a written
document that contains the terms of the agreement between the insurer and the owner of the
policy. The policy is a legally enforceable contract under which the insurer agrees to pay a
certain amount of money—known as the policy benefit, or the policy proceeds—when a
specific loss occurs, provided that the insurer has received a specified amount of money,
called the premium.

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Group Insurance Arrangements: Interior Dezine
The Omega Life Insurance Co. issued a group life insurance policy to Interior Dezine Inc., the
owner of the policy. The terms of the group benefits policy specifies that a benefit of $20,000
will be payable in respect of the death of any of Interior Dezine's employees who die while
insured under the policy. Interior Dezine Inc. pays Omega a premium to ensure that it meets
its financial obligation under the terms of the agreement.

Parties in a Group Insurance Arrangement

Plan Sponsor
The plan sponsor is the party that establishes and maintains the group insurance
arrangement, which is:

1. The employer, in the case of an arrangement maintained by a single

employer; for example, a family-owned clothing store located in Regina,
Saskatchewan
2. The association—for example, a provincial bar association
3. The committee, joint board of trustees or other similar group of
representatives of the parties involved, in the case of an arrangement
maintained by one or more employers and one or more employee
organizations—for example, the committee that represents union members of
the plumbing industry. The plan sponsor is the buyer in a group insurance
arrangement.

1. Advisors
An advisor is an individual or company that provides advice to group benefits plan sponsors.
There are several types of advisors.

1. Consultant: provides expert business, professional or technical advice and acts for
and represents the plan sponsor in dealings with the insurer
2. Agent: acts for or represents the plan sponsor in dealing with the insurer and
generally represents only one insurer (referred to as a “captive agent”)
3. Broker: acts for or represents the plan sponsor in dealings with the insurer. Unlike
an agent, a broker is self-employed or independent from all insurers and can sell
products from a number of insurance companies.

A. Insurer(s)
The insurer is the party to the insurance contract who promises to pay losses or benefits

B. Third-Party Administrators (TPA)

A TPA is a person or organization that performs administrative services in accordance with a
service contract. A TPA is neither the insurer (provider) nor the insured (employees or plan
participants). A TPA handles the administration of the plan, which can include enrollment,
billing and recordkeeping. Some TPA arrangements also include the processing, adjudication
and payment of claims.

2. Plan Member
A plan member is any employee or member (or former employee) who is eligible to be
insured for any benefit under a group insurance arrangement. Sole proprietors or partners
in a partnership are also eligible to be plan members even though they are not employees.

A. Dependent
A dependent is generally the spouse or child of an individual covered under a group insurance
plan. Eligible dependents are defined in the policy and obtain coverage if designated by the
plan member. For example, a plan member’s spouse and children can be covered under a
dental, extended health care, dependent life and optional accidental death and
dismemberment (AD&D) policy. In addition, a member’s dependents may be covered under
an optional life policy.

B. Beneficiary
A beneficiary is a person designated by a plan member, or by the terms of a group benefits
plan, who is or may become entitled to a benefit under the plan. For example, a basic group
life plan requires that the plan member designate a beneficiary to receive the proceeds of any
death benefit payable under the terms of the plan. The concept of beneficiary is only
applicable to death benefits.

Apply Your Knowledge

Selecting Group Insurance: Mason
Mason Howe, president of the Sweet Apple Company, wishes to provide his employees
with a basic group life benefit. He has decided that a plan advisor should be involved
in securing group insurance for the benefit.

Mason has several options available. He can select a captive agent, or he can select a
broker or consultant. If he chooses a broker or consultant, that individual can
represent multiple insurers to “shop the market” for the best possible terms and cost
from multiple insurers; if he chooses an agent, the agent will represent only one
insurer.
Group Benefits Program and Group Benefits
Plan Defined
Group benefits are generally provided by plan sponsors in a package—a combination of
several different types of individual benefits (e.g., life insurance, health care and dental
insurance). The terms package and program are used interchangeably to describe the overall
collection of benefits provided by a plan sponsor.

Plan is another frequently used term, often used interchangeably with program or
package. Plan is also used to describe an individual benefit (e.g., a dental plan and a life
insurance plan are two components of the plan sponsor's group benefits program).

For the purpose of this course, the term program is used to describe the overall collection of
benefits provided and plan is used to describe an individual benefit.

General Categories of Group Benefits

Death benefits

 Basic life
 Optional life
 Dependent life
 Basic AD&D
 Optional AD&D
 Retiree life

Income replacement benefits

 Salary continuance
 Sick leave
 Weekly indemnity/short-term disability (WI/STD)
 Long-term disability (LTD)

Extended health care benefits

 Hospital
 Prescription drugs
 Vision
 Private duty nursing
 Paramedical practitioners
 Out-of-province/out-of-country

Dental care benefits

 Basic
 Major restorative
 Orthodontic

Ancillary benefits

 Employee assistance
 Health care spending accounts
 Wellness
  Critical illness
 Life Insurance
 Life insurance benefits that an employer might offer include:

 Basic Life Insurance
Basic life insurance provides a benefit in the event of an employee’s death while employed
by the employer. It is typically provided to all active full-time employees, and premiums are
usually paid by the employer.

 Optional Life Insurance
Optional life insurance is a voluntary benefit that is supplementary to the basic life
insurance benefit (i.e., members can purchase additional life insurance benefits to
supplement the basic coverage). Premiums are paid by the employee/member and
coverage may be extended to the employee’s/member’s spouse.

 Dependent Life Insurance
Dependent life insurance provides a modest lump-sum amount in the event of the deaths
of the employee’s/member’s eligible dependents. Generally, the benefit provides
protection of $5,000 to $25,000 in respect of the spouse and a lesser amount of $2,500 to
$12,500 in respect of each eligible child. The premium is typically paid by the employer.

 Retiree Life Insurance

Retiree life insurance provides a benefit in the event of the death of a previously active full-
time employee of the employer. Coverage is generally significantly less than the basic life
insurance in effect during employment and is typically a flat amount. The employer
typically pays the premium.

 Apply Your Knowledge
 Life Insurance: Interior Dezine
 Basic Life Insurance
All active full-time employees of Interior Dezine Inc. are provided with a basic
life insurance benefit of $20,000. The company pays the premium required
by the insurer.

 Optional Life Insurance
AlI active full-time employees of Interior Dezine Inc. have the opportunity to
apply for optional life insurance. If they wish to supplement the $20,000
basic life insurance benefit paid by their company, they may apply for
coverage in units of $10,000 up to a maximum of 20 units or $200,000. If
coverage is approved, employees are required to pay 100% of the premium
for this optional life insurance. They may also choose to apply for an amount
of optional life insurance for an eligible spouse.

 Dependent Life Insurance

Interior Dezine Inc. provides a dependent life insurance benefit to its active
full-time employees, which covers the employee's spouse for $5,000 and all
their eligible children for $2,500 each. The company pays the premium for
 this coverage.

 Retiree Life Insurance

When previously active full-time employees of Interior Dezine Inc. retire, the
company provides them with a retiree life insurance benefit. The retiree
coverage is $5,000 and the premium is fully paid by Interior Dezine Inc.

Accidental Death and Dismemberment

(AD&D) Insurance
 Basic AD&D Insurance
Basic AD&D insurance provides a level of protection in respect of the employee’s death
due to accidental means. It also provides benefits for certain injuries sustained in an
accident (e.g., for loss of a body part or loss of use of certain body parts/faculties, such as
sight, speech or hearing). The premium is typically paid by the employer.

 Optional AD&D Insurance

Optional AD&D insurance is a voluntary benefit. Death benefits are only payable if death is
due to accidental means. Optional AD&D also provides benefits for stipulated injuries
sustained in an accident. Certain optional AD&D plans extend coverage to an
employee’s/member’s family. The employee pays the premium for optional AD&D
insurance. The benefit is also known as voluntary AD&D.

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AD&D Insurance: Interior Dezine
Interior Dezine Inc. provides its active full-time employees with a basic AD&D
insurance benefit. This employer-paid benefit provides employees with $10,000
coverage in respect of their death due to accidental means and protection for
specified injuries sustained in an accident (for example, loss of hearing in one ear is
covered for one-fourth of the principal sum of $10,000, or $2,500).

Short-Term Disability (STD) Insurance

STD insurance is also referred to as weekly indemnity or weekly income. For this course, we
will use the acronym WI/STD.

WI/STD insurance pays an income-replacement benefit to a disabled employee/member as

long as he or she remains disabled, up to a specified period. The maximum benefit period
usually ranges from 15 to 26 weeks. Benefits typically begin after a specified number of days
of illness ranging from three to seven days following the last day worked by the employee.
The majority of plans provide benefits on the first day of absence if the disability is due to an
accident or the employee is hospitalized.

The amount of income replacement benefit typically ranges from 55% to 70% of the
employee’s predisability earnings, and a maximum amount of benefit applies. Benefits are
paid on a weekly basis. The premium for WI/STD may either be paid by the employer or the
employee but is rarely based on a shared-cost arrangement.
Apply Your Knowledge
STD Insurance: Interior Dezine
Interior Dezine Inc. wishes to protect its employees from income loss during a period
of short-term disability. The company-paid WI/STD benefit achieves that purpose by
paying employees 60% of their regular predisability earnings for up to 17 weeks.
Benefit payments begin the fourth day following the last day worked by the employee.
If the employee is disabled due to an accident or is hospitalized, the three-day waiting
period is waived. The WI/STD plan covers only active, full-time employees.

Long-Term Disability (LTD) Insurance

LTD insurance provides an employee/member with income replacement for a portion of his or
her income lost (typically 50% to 75%) due to serious and prolonged illness or injury. Benefits
begin at the end of an elimination period. This period is generally defined as the STD benefit
period or a specified period of salary continuance during disability. It can also be linked to the
period of benefit entitlement under a government-sponsored plan such as Employment
Insurance (EI). The benefit typically continues until the earliest of the employee’s (a)
recovery, (b) retirement, (c) no longer meeting the definition of disabled under the policy or
(d) attainment of age 65.

The premium for LTD insurance can be paid by the employer or the employee or both;
however, in practice, premiums are rarely on a shared-cost arrangement. The tax status of
any benefit received under the policy depends on which party has made the premium
payments. If any part of the premiums has been paid by the employer, the benefits are
taxable; however, if the entire premium has been paid by the employee, benefits are
nontaxable.

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LTD Insurance: Interior Dezine
Interior Dezine Inc. wishes to ensure that its active full-time employees have some
protection against the financial losses that can occur during a prolonged period of
disability. It extends the period of protection provided under its STD plan by providing
the employees with an LTD plan. For employees who meet the LTD insurance plan's
definition of disability, benefits under the plan begin after the STD period of 17 weeks.
The benefit is 60% of the employee’s predisability monthly earnings and is taxable
because Interior Dezine lnc. pays the premiums for the LTD insurance.

Extended Health Care Insurance

Extended health care insurance can cover an array of health care benefits that are not
covered under government-sponsored plans. Coverage is generally available to employees
and their eligible dependents. Typical benefits include:

 Semiprivate hospital room

 Prescription drugs
 Emergency out-of-province/out-of-country coverage
 Vision care (glasses and lenses)
 Services of paramedical practitioners
 Private duty nursing.
While some benefits, such as semiprivate hospital rooms, may be reimbursed at 100% of the
eligible expense, it is common to include an element of cost sharing for other benefits. This
cost sharing can be in the form of either a deductible amount or coinsurance or both.
A deductible is an amount of out-of-pocket expense that must be paid by the employee before
a benefit is payable by the insurer. Coinsurance is a form of cost sharing in which the insurer
and the employee share in the cost of the expense/claim. For example, the insurer may pay
80% of the expense, and the employee is required to pay the remaining 20% out of pocket.
Health care insurance premiums may be entirely paid by the employer or the employee or
may be on a shared-cost basis.

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Extended Health Care Insurance: Interior Dezine
Interior Dezine Inc. realizes the health care benefits provided under government plans
do not adequately address some of the more common health care costs incurred by
its employees. It therefore provides a health care insurance plan that offers some
additional health care expense protection for its active full-time employees and their
dependents. The benefits provided under the plan are those not covered under the
government-sponsored plans (e.g., prescription drugs, semiprivate hospital rooms and
the services of some paramedical practitioners). The company pays the premium for
the extended health care benefits, but employees indirectly share in the cost by
paying part of the health care expenses out of their own pockets. The plan does not
pay anything for the first $50 of expenses (the deductible) but pays 80% of the
balance of the employee's claims in any year. The employee pays the other 20%.

Dental Insurance
Dental insurance provides employees with reimbursement for the expenses incurred for basic,
major restorative and orthodontic services. The coverage is typically extended to include
reimbursement for expenses incurred by the employee’s eligible dependents. Benefits are
generally reimbursed at a higher level of coinsurance for services with the lowest cost and
highest frequency, such as basic services, than for the less frequent, higher priced services
such as major restorative care and orthodontia. Cost-sharing arrangements for dental
insurance are the same as those available for health care insurance. The plan may have a
deductible and/or coinsurance, and premiums may be paid by either the employer or the
employee or on a shared-cost basis.

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Dental Insurance: Interior Dezine
Interior Dezine Inc. provides its active full-time employees with a dental insurance
plan. The plan design encourages employees and their dependents to adopt the
practice of having regular dental checkups by paying 100% of expenses for basic
dental care. Employees share the cost of the plan with Interior Dezine Inc. on a 50/50
basis. While not currently covered, Interior Dezine has the option of adding the higher
priced services such as major restorative care and orthodontia to the dental plan at a
later date.

Critical Illness Insurance

Critical illness (CI) insurance is neither a life insurance benefit nor a disability benefit; an
individual does not have to die or be unable to work due to disability in order to collect a CI
benefit. CI provides a lump-sum tax-free payment to an insured who has been diagnosed with
and survived a life-threatening illness such as cancer, stroke or heart attack. More
comprehensive plans may also cover kidney failure, organ transplants, paralysis, blindness,
Alzheimer’s disease and brain tumors.

CI insurance is intended to cover additional medical expenses or activities that support the
employee dealing with a critical illness; however, it can be used by the employee as he or she
wishes. It may be used to pay for experimental treatments (or other medical costs not
covered by provincial/territorial health plans or other private insurance plans) and lifestyle or
mobility changes resulting from the illness.

CI coverage can be offered under a basic or enhanced group plan. The basic plan typically
covers four to six illnesses, including strokes and heart attacks. If offered on a mandatory
basis, premiums are often 100% employer paid. An enhanced plan covers a more
comprehensive list of life-threatening conditions, including coronary artery bypass surgery,
kidney failure and multiple sclerosis.

Coverage is typically offered on a voluntary basis, with employees paying 100% of the
premiums. If offered as a mandatory benefit, the premiums are typically 100% employer paid
but can also be on a shared-cost basis.

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Critical Illness Insurance: Interior Dezine
Interior Dezine lnc. covers its active full-time employees with a CI insurance plan. The
company pays the premium for a basic plan that covers five illnesses, including heart
attacks and cancer. If an eligible employee is diagnosed with one of the five illnesses
and survives a specified waiting period, he or she will be provided with a lump-sum
benefit payment of $50,000. The payment can be used in any way the employee
chooses; i.e., it does not have to be used to cover the expenses incurred due to the
illness. For example, the payment can be used to make modifications to the home or
for travel, education, etc.

LESSON-3

The Nature of a Group Insurance Contract

The master group insurance contract is the document required for the operation of a group
insurance plan. It defines the terms of the group insurance plan and is the instrument used by
the insurer to determine an individual’s right to benefits (and their amount) under the plan.

The parties to a master group insurance contract are the insurance company (insurer) and the
group policyholder. The group policyholder is the person or organization that enters into the
group insurance contract—known as the plan sponsor. The plan sponsor decides what types
of group insurance coverage to purchase for the group members, negotiates the terms of the
group insurance contract with the insurer and purchases the group insurance coverage.

The master group insurance contract is also referred to as the master contract or, more
typically, the group policy. A typical policy period is one year. In some cases, premium rates
may be guaranteed for longer than one year; however, policies typically renew once a year on
the anniversary date of the policy.

The plan sponsor receives a copy of the group policy. There is no requirement to provide the
individual plan members with a copy of the policy; however, they must be provided with a
certificate of insurance. Many policyholders describe the coverage in a benefit booklet. In
such cases, the benefit booklet contains the information that would be included in a
certificate, and the booklet serves as the group insurance certificate.
Policyholder vs. Policyowner
The term policyholder is used rather than the term policyowner (used in individual insurance
policies) because the group policyholder (plan sponsor) does not have the same ownership
rights in the group insurance policy that a policyowner has in an individual insurance policy
(e.g., when an individual buys life insurance for himself or herself). Instead, some of these
rights are granted to the insured group members.

For example, each group member insured under a group life insurance policy has the right to
name the beneficiary who will receive the benefits payable upon that group member’s death.
In contrast, an individual life insurance policy grants that right to the policyowner, rather than
to the insured.

Apply Your Knowledge

Policyholder vs. Policyowner: Adam and Alice

Adam has a new job and he just got married. His spouse, Alice, wanted to
ensure that they were both adequately protected with life insurance, so she
arranged to purchase two policies—one on her own life and one on Adam’s. She
is the policyowner under both policies. Adam is the beneficiary under the policy
on Alice’s life and she is the beneficiary under the one on Adam’s life.

As the policyowner, only Alice has the right to change the beneficiary under
either of these two individual policies.

Adam is also covered under the basic life insurance plan with his new
employer. Under this plan, Adam chooses his own beneficiary because his
employer is a policyholder rather than a policyowner.

Forming a Valid Contract

To form a valid group insurance contract, the policyholder (plan sponsor) and the insurer
must:

1. Mutually agree to the contract’s terms

2. Both have contractual capacity
3. Exchange legally adequate consideration
4. Form the contract for a lawful purpose.

Rights of Insurance Companies

In general, insurance companies that are party to group insurance contracts have the right to:

 Be provided with accurate information so that they can adequately assess the risks
involved, assess the validity of claims for benefits and set the premium rates
appropriately
 Inspect group policyholders’ payroll (and other) records to assess the eligibility of
employees
 Adjudicate (i.e., process) claims as per the terms of their contracts
 Underwrite and decline business
 Decline to renew policies
  Sell all of, or a part of, their book of group clients to another insurer. A book refers to
a section or portfolio of policies.
 Refuse to deal with a specific advisor and refuse to quote on any specific group
 Deal only in those locations (provinces or countries) allowed by law and where
proper services can be provided
 Change underwriting procedures, reserve formulas, interest credit formulas,
retention formulas, underwriting guidelines and benefit wording (with the signature
of the insurance company's president or chief executive officer on the contract
and/or amendment page)
 Change standard commission scales on future business
 Change service procedures, service staff and service locations
 Change internal administrative procedures
 Invest monies in their pools as the insurers see fit (and as permitted by law)
 Decline coverage for any amount over the nonmedical maximum coverages if the
employee cannot pass medical underwriting approval
 Cancel benefits for employees who are not actively at work, for example, during a
strike
 Increase or decrease premium rates at any time, subject to any guarantees that may
have been provided to a group policyholder.

Rights of Policyholders
In general, policyholders (plan sponsors) that are parties to group insurance contracts have
the right to:

 Determine the design of the benefits plan within the parameters of what the insurer
is prepared to underwrite
 Determine which benefits are to be included, if this meets underwriting approval
 Determine the funding method to be used, if this meets underwriting approval
 Determine the premium sharing between the employer and the employees
 Cancel the policy at any time and not replace it, unless specific employment
contracts, union or employee association agreements say otherwise
 Change insurers at any time, as long as no employee loses group life or disability
insurance coverage
 Change the premium-sharing arrangement with the employees at any time
 Change the agent of record at any time. The agent of record is the individual or
company that is designated to represent the insured in purchasing, servicing and
maintaining an insurance policy. Smaller policyholders using a captive agent (i.e., an
insurance agent who only works for one insurance company) may be able to change
only to another agent of record within that insurer if they wish to retain their policy
with that specific insurer. All others can change at any time to whomever they wish.
 Collect and remit the employee share of the premium
 Expect that the insurer will deliver the services and pay the claims as per the terms
of the policy, including any changes to the contract and anything promised verbally
or specified in writing by the insurance company representatives
 Cancel or stop paying premiums for benefits when employees are not actively at
work, such as during a strike, except where required by law
 Receive and keep refunds of premium without refunding to employees their
share. Refunds may be accomplished in the form of a premium holiday, where
employees remain insured but are not required to contribute to premiums for a
specified period, or by investing the refund in other areas that directly benefit
employees.
 Apply Your Knowledge
 Rights of Policyholders: Mason
 Mason, president of the Sweet Apple Company and plan sponsor
(policyholder) has been having financial challenges lately. He has
reviewed all aspects of Sweet Apple’s expenses and determines he must
do something to reduce costs. He could either reduce the company's
 costs of the group insurance plan by having employees pay 50% of the
premium, or he could revise the plan to reduce the level of benefits
available to employees. He has not made a decision yet but is relieved to
know that he has the right to do either under the terms of the group
insurance contract.

Rights of Plan Members

In general, plan members who are insured under group insurance contracts have the right to:

 Expect notification of any change to benefit wording within a reasonable time period
and, preferably, before a change takes place
 Be provided with copies of a current employee booklet
 Expect the employer to make proper deductions and to remit the premiums in a
timely manner so as not to jeopardize the policy or the claims payments
 Change their own revocable beneficiaries of a life insurance benefit at any time. In
Quebec, a spouse as beneficiary is irrevocable, unless explicitly indicated as
revocable.
 Expect the employer to look after their best interests in terms of setting up coverage
and handling the funding of the benefits in a judicious manner
 Expect the employer to enroll employees on time so as not to cause a delay in the
employee or dependent coverage or the possible declination of that coverage
 Expect the employer to submit timely eligibility information (e.g., enrollment of new
employees, salary changes, etc.)
 Expect privacy and confidentiality of all personal information and all information that
pertains to their claims or the claims of their dependents. No information that is
attributable to or identifiable with a specific employee can be released without the
employee's or the dependent spouse's written permission.
 Decline coverage, unless the policy’s administration is set up by the employer as a
condition of employment. A refusal card or some other form of waiver must be
signed and dated by the employee and submitted to the insurer.

Apply Your Knowledge

Rights of Plan Members: Molly

Molly, a new employee at the Waterford Watch Company in Waterloo, Ontario
wants details of what is covered under the health care benefit of the employee
benefits plan. She also wants to be certain she can change her beneficiary
under the basic life insurance when she gets married.

As a new employee of the Waterford Watch Company, Molly has a right to

receive a current benefit booklet. It will provide her with details of the coverage
available under the health care benefit as well as the other benefits provided
under the employee benefit plan. Molly should not have any concerns about
changing her beneficiary under the basic life insurance when she marries. She
has the right to name a new beneficiary at any time.

Rights of Advisors
In general, advisors appointed by the policyholder as the agent of record have the right to:
  Participate in the analysis of group insurance quotes as requested by the
policyholder
 Request and inspect the overall premiums, claims and premium rate history for each
benefit of the policy
 Request, inspect and clarify employee data required by insurers to provide
competitive and accurate quotes
 Request from the insurer, on behalf of the policyholder, clarification of the terms and
conditions of the group contract
 Request assistance from an insurer (via the group office) in reevaluating a particular
claim if permission has been granted by the policyholder and the plan member
 Assist the policyholder in the group insurance administrative functions as requested
by the policyholder and as allowed by the insurer and by law
 Request employee and dependent information on behalf of the insurer. Once
requested, the information can be sent directly to the insurer by the policyholder.

The Underwriting Process

When an insurer receives an application for insurance, it must assess the degree of financial
risk it will accept if it agrees to issue the policy. Underwriting is the process of identifying and
classifying the potential degree of risk represented by an insurance applicant. The results of
the underwriting process are used in the development of the pricing of the insurance (i.e.,
determining the premiums).

The general rules of risk selection used by underwriters are known as underwriting guidelines.
The term underwriter can mean:

1. The insurer that receives the premiums and accepts responsibility for fulfilling the
policy contract
2. The insurer’s employee who decides whether or not the insurer should assume a
particular risk.

Five Fundamental Principles of Group

Insurance
The insured employee must be permanent and be actively at work.
The most significant principle in underwriting a group insurance policy is that the insured
employee must be permanent and actively at work. The assumption is that such a person is in
a reasonable state of health and may be insured without requiring evidence of state of health.
This is the most fundamental principle on which all group insurance rests.

The insured employee cannot determine the amount or type of coverage.

This is designed to prevent employees from only selecting coverage for those benefits they
are likely to utilize. This would be beneficial to them but detrimental to the plan as a whole.
For example, if left to individual discretion, only employees who wear glasses might choose
vision care coverage.

Any employee contributions are made through payroll deductions.

This arrangement simplifies the administration process for the policyholder (plan sponsor)
who is contractually responsible for premiums and minimizes plan expenses.

The employer must contribute at least some of the cost of the plan.
This indicate the employer’s commitment to operate the plan along sound principles and to
continue the plan for a number of years.
There must be a spread of risk.
There must be a sufficient number of employees in the group to reduce, as much as possible,
the chance of fluctuations in the amount of claims incurred (by application of the law of large
numbers). Insurers have requirements for the minimum number of employees who must be
enrolled (two or more) and require that these participation rates be met

Apply Your Knowledge

Actively at Work Principle: Delta Gamma
The Delta Gamma Insurance Co. is aware of the importance of the actively at work
principle when underwriting a group insurance policy. While it accepts that not all
risks are the same, it is clear to the insurer that individuals who are away from their
workplace due to illness are perhaps greater-than-average risks. It would not be
prudent to accept the risk for these individuals until they return to work on a
permanent, active basis.

Significance of Adverse Selection in

Assessing Risk
When an insurer receives an application for insurance, it must assess the degree of financial
risk it will accept if it agrees to issue the policy. An insurer cannot afford to presume that each
proposed risk (e.g., each applicant under a group optional life policy) represents an average
likelihood of loss. Not all individuals of the same sex and age have an equal likelihood of
suffering a loss. Further, those individuals who believe they have a greater-than-average
likelihood of loss tend to seek insurance protection to a greater extent than do those who
believe they have an average or a less-than-average likelihood of loss. This tendency is
called adverse selection. It is also known as antiselection.

Adverse selection is also known as “selection against the insurer”—as the insurer is the party
in a group insurance arrangement that requires protection against antiselection. This is a
primary reason that insurers need to carefully review applications to properly assess the
degree of risk the company will be assuming if it issues the policy.

Apply Your Knowledge

Adverse Selection: Irene, Isabelle and Izetta
The triplets, Irene, Isabelle and Izetta are all employees of the Charles Chocolate Co.
Their employer‘s group benefits program includes an optional life plan underwritten
by the Delta Gamma Insurance Company. The terms of the plan with the insurer
require that employees must provide evidence of good health when they apply for
optional life coverage. Each of the sisters applies to the Delta Gamma Insurance
Company for $250,000 of coverage under their employer's group optional life plan.
Irene has recently been diagnosed with having both diabetes and high blood pressure,
but her sisters have no known illnesses or medical conditions. Irene has applied for
optional group life insurance because her recent diagnosis has made her aware of her
mortality. Her sisters have applied because they are concerned their health might
decline at some time in the future and want to secure coverage while they are in good
health.

The Delta Gamma Insurance Company reviews each of the triplets’ applications for
optional life insurance. The insurer determines that while Izetta and Isabelle are
acceptable risks, Irene has a greater-than-average likelihood of dying before either of
her sisters. Delta Gamma Insurance Company accepts Izetta and Isabelle for coverage
under the Charles Chocolate Co. group optional life plan but declines Irene’s
application due to unacceptable medical evidence of insurability. Acceptance of
Irene’s application would have resulted in adverse selection.

Underwriting Guidelines
Each insurer establishes its own underwriting guidelines; however, the group underwriter
considers specific characteristics of a group when evaluating whether the group is an
acceptable risk. These risk characteristics include:

 Normal activities of the group

 Reason for the group’s existence
 Size of the group
 Flow of new members into the group and stability of the group
 Required percentage of eligible group members who must participate in the plan
 Way in which benefit levels will be determined (e.g., flat amount for all employees or
varied by classification of employee)

 Normal Activities of the Group
 Based on its normal activities, a group can be assigned a risk classification of preferred,
standard, substandard or declined.
 If the group's activities are expected to contribute to a significantly less-than-average
loss rate, then it is classified as a preferred risk.
 If the group’s activities are not expected to contribute to a greater-than-average loss
rate among its members, then the group is classified as a standard risk. Most employer-
employee and association groups qualify as standard risks.
 If a group’s activities are expected to lead to a higher-than-average loss rate among its
members, then it is classified as a substandard risk and is charged a higher premium
rate than a standard risk group.
 If the group’s activities are extremely dangerous, some insurers will decline the group
for coverage.

Reason for the Group's Existence

The likelihood of adverse selection in a group formed solely to obtain group insurance
coverage would be very great because people who think they would not qualify for individual
insurance would be more likely to join such a group than would individuals who can obtain
individual insurance. In order to be eligible for group insurance, a group must have been
formed for reasons other than obtaining group insurance.

Group Size
One of the underwriter’s goals is to determine the group’s predicted loss rate. The predicted
loss rate is a forecast of the expected claims experience—in broad terms, a comparison of:

(Claims paid + Insurer’s expenses) ÷ Premium paid or payable by the plan’s

sponsor

The size of the group has a strong impact on the underwriter’s ability to predict the group’s
probable loss rate. In general, the larger the group, the more likely it is that the group will
experience a loss rate that approximates the predicted loss rate.

For very small groups, such as groups with fewer than 15 members, group underwriting
guidelines may require each individual member of the group to submit satisfactory evidence
of insurability. For a slightly larger group (between 15 and 50 members), the underwriter may
combine several groups that are of the same approximate size and are in the same business
sector. By considering the expected experience of a number of small groups, the underwriter
can expect the experience of those small groups, taken as a whole, to approximate the
experience of a single large group.

Flow of New Members into the Group and

Stability of the Group
Young, new members are needed to:

1. Replace those who leave the group and, consequently, to keep the group size stable
2. Keep the age distribution of the group stable.

If a group does not add young, new members for a number of years, then the increasing age
of the group’s original members would adversely affect the group’s age distribution, and the
group’s loss rate and premium rate would increase as a result. If young, new members are
continually joining the group, the age distribution of the group should remain more stable, as
should the expected loss rate.

Apply Your Knowledge

Flow of New Members: Merlin Insurance
On January 1, 2008 the Merlin Insurance Company issued two new group life
insurance policies—one to Andersen Metalworks Ltd. and the other to Copenhagen
Metalworks Ltd. Both companies were located in the same town, had a vibrant
workforce with an average age of 35 and competed for staff. Andersen Metalworks’
wages and benefits attracted new, young employees over the years. Copenhagen
Metalworks did not fare quite so well. It lost some of its younger employees to
Andersen and did not attract any new, young employees. Its older employees
remained loyal and stayed with the company. At the end of 2018, the average age of
Andersen’s employees remained at 35; however, the average age of the employees
working at Copenhagen Metalworks had risen to 51 over the ten-year period.

The flow of new, young employees into the Andersen Metalworks Ltd. group life plan
has resulted in keeping the age distribution of the group stable. The Merlin Insurance
Company has been able to maintain the original premium rate for Andersen
Metalworks over the ten years. The significant increase in average age under the
Copenhagen Metalworks’ plan is an indicator that there has been an increase in the
expected loss rate under the policy. The insurer had to take the increased risk into
account and has increased Copenhagen’s premium rate over the ten-year period.

Minimum Participation Requirements

Minimum participation requirements are designed to guard against the effects of adverse
selection. Generally, underwriters require 100% participation on mandatory benefits.
Minimum participation requirements on voluntary benefits vary by underwriter.

Benefits typically offered on a voluntary basis include optional life and optional AD&D
insurance. Some underwriters have minimum participation thresholds (e.g., 10% of the group
or ten insured members electing coverage), while others have no minimum participation
requirement.

Some underwriters will agree to offer core benefits such as LTD and dental insurance on a
voluntary basis. In these rare situations, participation requirements are generally higher, e.g.,
75% of the group.
The larger the group, the better the spread of risk, and the more consistent the average age
and health of the group will remain from year to year. This protects the insurer against loss
and adverse selection and protects the employer from large fluctuations in premium rates
from year to year. All other factors being equal, a larger group may also have less expensive
per capita insurance costs due to economies of scale.

Way in Which Benefit Levels will be

Determined
Generally, the way in which benefit levels will be determined must be equitable and
nondiscriminatory.