Basics of Group Insurance

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 GROUP INSURANCE

Definition of Group Life Insurance

Group Insurance is a plan of insurance, which provides cover to a large number of individuals
under a single policy called the Master Policy. The individuals covered under the Master
Policy are not parties to the contract. The contract will be between the Insurer and a body that
represents the group of individuals covered. This body may be the Employer, who is interested
in obtaining benefits for his Employees through insurance. The body may be an Association of
individuals through whom the collective interest of the Members are safeguarded, like a trade,
or professional association. A Lending Institution can make arrangements through a group
policy to protect its interest against defaults of the debt by the debtors. Group Insurance can
best be defined by comparing it with individual insurance. However, we have a definition given
by an American Judge, seventy years ago.

Group Life Insurance is that form of Life Insurance covering not less than fifty employees with
or without medical examination, written under a policy issued to the employer, the premium on
which is to be paid by the employer or by the employer and employees jointly and insuring only
all of his employees or all of any class or classes there of, determined by conditions pertaining to
the employment for amounts of insurance based upon some plan which will preclude individual
selection for the benefit of persons other than the employer, provided, however, that when the
premium is to be paid by the employer and employees jointly and the benefits of the policy are
offered to all eligible employees, not less than seventy five percent of such employees may be so
insured. (A Seventy year old American definition)

Objects of Group Life Insurance

The object of Group Insurance is to combat economic insecurity in which an employees family
will find itself in the event of his premature death, while in service, with the income coming to a
stop. It enables employers to ensure the payment of a predetermined sum of money to the family
of an employee if he unfortunately dies in harness. When death intercepts an employees working
life, particularly in the early years, the truncated accretions to his credit in the provident fund and
gratuity may not measure up to provide adequate financial support to his family. Provision of
some level of protection against the loss of earning power is, therefore, a must for every wage
earner and that is the object of Group Life Insurance Schemes.

Group Insurance as distinguished from Individual Insurance

Individual Insurance is a contract between an individual and an insurance company. That
decision to insure is voluntary on the part of the individual. Usually, there are only two
parties to an individual contract.

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 Group Insurance is generally a contract covering several persons under a single policy
contract. The insured persons are not actual parties to the contract. The contract is
entered into between the insurer and a party representing a group of individuals. The
representative may be an employer, trustees, a labour union or an association. Therefore,
there is no direct contractual obligation between the individuals insured under the policy
and the insurance company.

The proposal forming the basis of the contract is signed by the representative of the
insured, who may be an employer etc., and presented to the insurer for consideration.

Another special consideration of group insurance is that the consideration called premium
is changed generally from year to year according to the ages of the insured in the
respective years. Whereas in individual insurance a level premium is charged from the
insured throughout the contract.

Like an individual insurance, a group insurance contract is also of a continuing nature. A

group insurance contract may last long beyond the life assured. New persons are added
to the group from time to time and exit from the group result in termination of life cover.

In an individual scheme of life insurance it is the eagerness of the proposer to propose

and the willingness of the insurer to accept that leads to the conclusion of the contract of
assurance. In group insurance, once the group is accepted for assurance, it is required that
all or substantially all eligible persons in the given group should participate in the
scheme. In non-contributory arrangements, all employees or all employees in a given
class must be insured.

In an individual insurance scheme, a policy evidencing the contract is given to the life
assured. In a group life assurance scheme, a Master policy containing all the names of
the members of the group is issued. The Master policy is given to the representative of
the group viz the employer, the union president or the head of the association.

In a group life insurance policy, there is no possibility of any assignment or nomination,

which is usually allowed under individual cover.

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 In a group life insurance policy, the claim amount is paid to the representative by the
insurer and not to the individual, whose life was assured.

Generally, group policies may contain an option whereby individual employees who
leave the service of the employer before attaining a specified age may effect assurance on
their own lives under the insurers ordinary tables without medical examination. No such
choice is allowed to an individual policy holder.

The distinguishing characteristics of Group Insurance are:

a) Group selection instead of individual selection
b) The use of a Master Policy or Master Contract
c) Low Administrative cost
d) Flexibility in contracts
e) The use of Experience rating

Conditions for Eligibility

A group must fulfill the following conditions so as to be eligible for group coverage. These
conditions ensure the test of homogeneous character of the group and operate to eliminate the
possibility of adverse selection against the insurer and ensure continuation of the scheme over
the future years without breaking down.

1. The group must have been formed and maintained for purposes other than obtaining insurance
coverage. The most important requirement is that the group must not have been formed for the
purpose of taking advantage of this scheme. The group must have some other bonding. Entry
into or exit from the group must be for reasons other than the availability of cover under this
scheme.

2. There should be a steady stream of young and energetic new entrants into the group and exit of
old / retired and impaired. In short the group should be dynamic.

3. There must be a minimum number of members in the group. Twenty Five would be
considered adequate. Generally, in many cases, the members would be in hundreds.

4. Concept of Uniform & Graded Cover: - Amount of insurance should be determined by a

method which precludes individual selection. The individual beneficiary will not choose the

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 amount of insurance cover. The amount will be determined on criteria, which are applied
uniformly to all the members of the group. For example, the cover may depend on age, or years
of membership or income or rank. If the criterion is of age or rank, then all individuals of the
same age or rank will get the same cover. If the criterion is of income, the cover can be a fixed
multiple of income. The income, depending on output, may be a suitable criterion, when the
group consists of say, farmers or beedi workers or milkmen supplying milk to Diary.

5. Another essential element is the requirement that all or substantially all eligible persons in a
given group should participate in the scheme. In non-contributory arrangements all employees or
all employees of a given class must be insured. In contributory schemes, where the employees
share a portion of the premium, it is required that at least seventy five percent of the eligible
employees must join at the inception of the scheme and all new eligible employees must
compulsorily join thereafter. This is meant as a positive safeguard against an undue proportion
of substandard lives.

6. There should be some party other than the insured members to pay a portion of the total cost.
In a group insurance schemes where the members pay all premiums, if the mortality rates
increase sharply with the age, it is unlikely that the scheme will last long. In order to avoid this
contingency, it is stipulated generally that the employer also must contribute a portion of the
premium.

7. Safeguards should be established to produce a normal distribution of risk and to avoid the
inclusion of undue proportion of the total insurance of the group upon substandard (unhealthy)
lives or on few lives or on the lives of advanced ages.

8. There should be a single administrative organization able and willing to act on behalf of the
insured.

9. The inclusion of members in the scheme also is a matter on which the member will have no
choice. Everybody fulfilling specified criteria will have to compulsorily join the group.

These are methods to avoid adverse selection.

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Eligible Groups
1. The most common type of eligible group is the individual Employer group in which
the employer may be a corporation, a partnership, or a sole proprietorship. Here, the
employer takes out a master policy for the welfare and benefit of his employees.The
master policy may be taken out in the name of the employer or trust formed to
administer the scheme. Many group schemes for the employer employee groups are
taken out by the employers to meet their statutory and other liabilities, such as,
employees gratuity benefits, pension benefits, and benefits under EDLIS (Employees
Deposit Linked Insurance Schemes in connection with PF).

2. Creditor-Debtor Groups
The Master Policy is taken out by the creditor to cover the outstanding amount of loans
granted to debtors. In case of death of a debtor, the claim amount would be applied
towards repayment of loan outstanding in his / her name. Here, the creditor may be an
employer, an organization giving housing loans, a cooperative credit society etc.,

3. The Professional Groups

These may be Associations of Professionals like, Doctors, Lawyers, Accountants,
Engineers, Journalists, Pilots etc.,

4. Other Groups
There may be many other forms of groups eligible for group insurance. e.g, Co-
operative Societies, Welfare Associations etc. The group should have a reliable identity
and should have been formed for some purpose other than group insurance. Many
Nodal agencies, such as state / central government departments and welfare
organizations are being allowed to take group insurance schemes covering some
identified, specific groups of weaker sections of the society.
Examples of such sections are:
0 The Jana Shree Bima Yojana / Aam Admi Bima Yojana scheme covering the landless
agricultural labourers.
1 IRDP Loanees Group Insurance Scheme, implemented through DRDAs (District Rural
Development Agencies) Swarnajayanthi Gram Swarojgar Yojana.
2 Milk Producers Group Insurance Scheme, implemented through some Milk co-operative
unions etc
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Group Size and Minimum Participants
A fundamental aspect in group insurance relates to the number of persons required to constitute a
viable group. There are certain well-defined size specifications relating to minimum number of
persons and the minimum percentage participation of the entire group.
Generally, in a group the accepted minimum was hundred lives. Accumulated experience of the
past had resulted in the progressive reduction of the number required to constitute a group. This
depends upon, the type of the group, underwriting practice, business potential, general
experience and the amount of the benefit.
A membership of Twenty Five can be rewarded as a reasonable minimum. However, this is left
to the practice and experience of the insurer.

There are two basic reasons for stipulating a minimum membership under group insurance
schemes. They are:
a) To reduce individual selection against the insurer, and
b) To spread the administrative expenses, in order to reduce the average rate of expense per
member. The larger the group size, the greater is the spread of risk and lesser is the
proportion of impaired lives. Another important element in deciding minimum group
size is that of expenses. There are certain initial and renewal per scheme expenses
which must be met regardless of the size of the group and it is obvious that the smaller
the number, the greater the rate of expense on a per person or per-unit-of-insurance basis.
Economics directly flowing from large scale operations will be achieved when
membership is large.

The extent to which the members within a given group participate in a scheme is significant for
the same reason as is the minimum size of the group. They are viz. the avoidance of adverse
selection against the insurer and the reduction of expenses per unit. In view of this, every effort
should be made to secure a high percentage of participation at the inception of the scheme and
full participation in subsequent years.

Contributory / Non-contributory
There are two types of meeting the cost of group insurance. In the first method, known as
contributory, the cost is shared between the employer and the employee. In the other scheme,
known as non-contributory, the entire cost is paid by the employer.

Under non contributory schemes, that is where the employer bears entire cost, it is usually
compulsory for all eligible employees to join since they do not make any contributions towards
the cost and as such, they should not have any discretion whether to join or not.

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 Group Selection
The most important of the fundamental characteristics of the group technique is that of group
selection. The effect of this technique is to provide life insurance coverage on an individual life
without any enquiry as to the quality of the individual risk. This unique element has permitted a
rapid extension of group life insurance to a vast majority of people.

In group insurance, the underwriting rules rest logically on three basic objectives:
a) To obtain the proper balance between mass and homogeneity of risk to permit
predictability of future results.

b) To establish standards, to permit the acceptance of a large majority of groups at standard

premium rates.

c) To secure the largest possible proportion of the average and better than average risks
within each classification.

Group selection is not concerned with the health, morals or habits of any particular individual in
the group. Group Insurance is usually issued without medical examination or other evidence of
individual insurability, so long as the individual belongs as a member of a constituted group.
Group selection is aimed at obtaining a group which will contain reasonably average cross-
section of risks from which predictable rate of mortality could be expected. The process of
selection must ensure that in the insured group the poorer risks are not represented in unduly
large numbers. The unit of selection is not an individual but a group.

The most important underwriting principles of group insurance are:

Insurance should be incidental to the group. It is desirable that the insurance be only a secondary
or unessential feature motivating the formation and existence of the group.

0 The amount of insurance cover is determined in some automatic manner, which precludes
individual selection by either the employer or employees.

1 Another essential element is the requirement that all or substantially all eligible persons in a
given group are covered by insurance.
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7 To counteract any possible selection against the company, the companies usually require
evidence to show that a prospective policy holder is in good health on the date the proposal is
made.

8 While dealing with the group, the conditions of insurability can be prescribed so simple and
liberal that even some lives, which may be considered uninsurable according to the normal
standards, are usually granted insurance protection.

9 Under schemes with medium membership, it may be stipulated that cover will be granted subject
to the employees fulfilling certain simple tests of insurability such as active at work rule.

10 If the individuals comprising the group are eligible for high and varying amount of
insurance depending upon factors like salary, position etc., an element of heterogeneity is
introduced. In such cases, evidence of health will be required for granting the insurance which is
beyond the cut off point. This limit is also known as no evidence limit or free cover limit.
The cover, if any, above the free cover limit will be granted after obtaining usual medical
requirements applicable to individual assurances.

11 If the benefit is within the free cover limit, there will not be any medical examination at
all.

12 The insurer reserves the right to cancel the scheme of Insurance after due notice on
grounds of inadequate size or participation.

13 The rates of premiums will also be renewed periodically by the Insurer.

Benefits of Group Insurance Schemes

1 At a low cost insurance protection can be provided to a considerable segment of the
organized working population.
2. Up to free cover limit under each scheme, risk cover can be extended to those persons who
are uninsurable under individual insurance, provided they are members of a recognized
group.
3. Through group gratuity schemes, the employees are eligible for higher gratuity payouts,
when compared to the gratuity payable under the Gratuity Act 1972, particularly in cases
of early death after joining the service.

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4. The Group schemes can be so designed, to provide some rider benefits, like sickness,
injury, disability and accident, in addition to carrying the usual risk cover.
5. Employers can avail Group Insurance Schemes in conjunction with Group Superannuation
Schemes.
6. Employers can avail Group Insurance Scheme in lieu of EDLIS with the advantage of
higher life cover.

7. As per the amendments to the Company Act, made in 1988, and Accounting standards,
employers have to fund the liability for employees leave encashment including medical
leave encashment. Group schemes enable such funding.

8. Group Insurance is a convenient medium for Government to pursue its social security
goals. Group Insurance schemes promote social security.

Experience rating
The premiums charged under group insurance policy are subject to experience rating. This
means that claim experience and expenses in connection with the group insurance are
periodically reviewed and in the light of such experience, appropriate adjustments in premiums
charged are made.
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EMPLOYEES DEPOSIT-LINKED INSURANCE SCHEME 1976
In order to supplement the benefits available under the Provident Fund upon death, the
Government introduced the Employees Deposit-Linked Insurance Scheme, 1976 (EDLIS) by
amending the Employees Provident Funds and Miscellaneous Provisions Act, 1952.

The EDLI Scheme is administered by the Central Board of Trustees appointed by the Central
Government and the Regional Committee shall advise the Central Board on matters relating to
the administration of the Scheme. As in the case of Employees Family Pension Scheme, the
Government has a financial stake in the Scheme since it contributes towards the cost of life
assurance benefit.

On death during service additional benefits by way of insurance amount based on the average
balance to the credit of the deceased employee in his PF account during the last 12 months are
payable.

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In case the average balance exceeds Rs.35000/- the insurance cover of Rs.35000/- plus 25% of
the amount in excess of Rs.35000/- subject to a maximum of Rs.1,00,000/- is payable.

All employers to whom the Employees PF and Misc. Provisions Act 1952 is applicable, have a
statutory liability to subscribe to the above said insurance scheme.

An employer can make an application for exemption from contributing to the above statutory
scheme provided he has opted for better benefits through some alternative scheme of an Insurer,
under Sec. 17 (2A) of the Act, to the Central / Regional Provident Fund Commissioner.

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GROUP GRATUITY SCHEMES

Evolution of Gratuity as a Service Benefit

Gratuity as the word signifies has its genesis as a gratuitous payment a parting gift.

Gratuity payments symbolize an expression of goodwill, a voluntary gesture or an

acknowledgement on the part of a prosperous employer, towards his employees for their
long and faithful service.

There were no formal rules or formula to calculate the amount of gratuity. Length of
service was the basis for calculation.

Such schemes were designed at the discretion of the employer aimed to encourage loyal
service.

These schemes instilled a sense of security in the minds of employees, but they could not
exercise it as a matter of right.

Gradually over time gratuity payments became a convention and were seen as the price
for cessation of service.

For some employers, it became a convenient device to superannuate old employees when
their ability to work got impaired.

Some employers did not cede to the demands of gratuity payments from employees.

The introduction of death-cum-retirement gratuity schemes by the government for its

employees, strengthened the demand for gratuity schemes in other sectors, and
subsequently became a cause of industrial unrests.

Disputes were settled either through agreement or adjudication.

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 With growing demand for these benefit payments, the need for formulating an uniform
pattern of gratuity payments schemes was felt necessary by the law-makers.

Courts and tribunals could not decide the cases uniformly because judgments were based
on the merits of each case.

The judgments were pronounced taking into considerations the following issues:

- Financial capacity of the employer

- Profitability of the business and past profits

- Extent of reserves and the chances of replenishment

- The claim for capital invested

Above factors constrained the designing of fair scheme of gratuity, as the information
totally depended on the accounting systems.

While workers in bigger organizations with stronger bargaining power could legitimize
their demands, the smaller Employers went Scot free as their labour force could not
legally enforce their demands.

Land mark judgment was pronounced by the Supreme Court of India in the Indian Hume
Pipe Co. Ltd Vs. its workmen,

Gratuity is a legitimate demand and can give rise to industrial disputes

By virtue of this decision, gratuity shed its gratuitous charter and acquired legal sanction
through an evolutionary process.

The states of Kerala and West Bengal pioneered legislations in this direction vide Kerala
Act, 1972, and West Bengal Act, 1971.

Finally, the Indian Parliament passed a Central Act-- the Payment of Gratuity Act, 1972,
to ensure uniform pattern of payment of gratuity throughout the country.

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 However, both the Central Act and the State Acts will continue to co-exist, but the
Central Act will prevail where the State Acts are inconsistent with the Central Act.

Thus, gratuity became a service benefit, backed by statutory sanction.

Gratuity payment schemes at rates higher than stipulated are also payable by the
employer, but no scheme can provide less than the Act benefit.

In the words of Supreme Court

Gratuity is one of the efficient devices meant for orderly and humane elimination of
superannuated and disabled employees whose retention in service would be detrimental to
efficiency
Objective of the Gratuity Scheme
The object of the gratuity scheme is to provide for the employees a lump sum benefit on
their retirement from service after attaining the age of Superannuation.

The Income Tax Act, 1961 outlines the objective of the gratuity benefits scheme as follows:
The gratuity scheme shall have for its sole purpose the provision of gratuity to employees in
the trade or undertaking on their retirement at or after a specified age or on their becoming
incapacitated prior to such retirement or on termination of their employment after a minimum
period of service specified in the rules of the fund or to the widows, children or dependants of
such employees on their death.

Gratuity Payment Provisions

The scheme envisages for the payment of gratuity to employees engaged in
- Factories, mines, oilfields, plantations, ports, railway companies,
- Shops or other establishments, as notified by the Central government in which ten
or more persons are employed, or were employed, during the preceding twelve
months.
This act extends to the whole of India except to the State of Jammu and Kashmir.
Gratuity shall be payable to an employee on the termination of his employment after he has
rendered continuous service for not less than five years, -
(a) On his Superannuation, or

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 (b) On his retirement or resignation, or
(c) On his death or disablement due to accident or disease

Completion of continuous service of five years shall not be necessary where the termination of
the employment is due to death or disablement

Gratuity in case of death of the employee, whilst in service, is payable to his nominee, or his
legal heirs or to the controlling authority who shall invest the same for the benefit of such minor
in such bank or other financial institution until such minor attains majority.

Nature of Gratuity Liability

The financial implications of gratuity liability are very complex and hence require careful
assessment and understanding of the nature of this liability:

Gratuity is a deferred wage.

Payment of gratuity is contingent upon the happening of events such as superannuation /

withdrawal from service / death whilst in service.

Liability accrues with every year of completed service and grant of every increment in
salary.

Gratuity is based on the terminal salary of the employee and the number of completed
years of service.

Increase in salary increases the past and future service gratuity liability.

Gratuity is payable on superannuation for those employees who continue till the age of
superannuation.

In the event of death / cessation from service, gratuity payment becomes payable
immediately.

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Need for Funding Gratuity Liability

The employers obligation for payment of gratuity increases with every additional year of service
completed by his employees. Prudent and sound financial principles demand that a liability
should be met when it is incurred. Hence gratuity payments must be planned as the liability
accrues on yearly basis, otherwise:-

Financial position of the business may be adversely affected when number of employees
retire / leave service.

Additional funds may be required for disbursement of gratuity liability.

Profits of the business may be over stated when no provisions are made annually, until
gratuity liability arises.

Unwise dividend distribution & additional tax liability is incurred by business as there is
no tax relief.

Prudent business and financial principles desire gratuity payments out of accumulated
funds set apart each year.

Gratuity liability estimates should be reviewed from time to time.

Adequate reserves must be created based on actuarial techniques for quantification of

contingent liabilities based on the probabilities of death and survival and also discounting
the liabilities over a period of time.

Different ways of Meeting Gratuity Liability

The Gratuity liability of an employer as per the provisions of the Gratuity Act, 1972, is of a
contingent and deferred nature. There are a number of ways that he may choose to provide for
this liability, which include:
(i) An employer may not make any provision for the liability but make the gratuity
payments as and when they fall due. This system is called pay as you go
method.
(ii) An employer may set up an internal reserve in the books of account based on an
actuarial valuation of the liability.

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 (iii) An employer may set up an irrevocable gratuity trust fund which is approved
under Part C of the Fourth Schedule of the Income-tax Act, 1961 and the
trustees may manage the investments of contributions and payments of gratuity
themselves.
(iv) An employer may set up a trust fund as stated in (iii) above and the trustees may
enter into a group gratuity scheme with any life insurance company.

Payment by Employer
This method will enable an employer to use the monies which otherwise would have been set
apart towards the gratuity liability for business purposes. This also implies lesser burden of
borrowings for the business. But this method is not in tune with prudent business policy, which
demands application of sound financial principles. Under this method the security of future
gratuity of the employees may also be adversely affected because payment depends upon the
future financial position of the employer.

But when the financial position of a company becomes bad or when the company goes into
liquidation, the employees would find themselves in a difficult position to realize their dues
although the employees dues will have a first charge on the assets of the company. The
employees would also in their own interest want that the funds required to meet the gratuity
liability be out of the control of the employer. Thus, from an economic and financial perspective,
pay as you go method is not an advisable method of funding gratuity liability for the employer.

Creation of Internal Reserve

As per Section 40A (7) of the Income-tax Act, effective from 1-4-1973, income tax relief is not
admissible on the Internal Reserves created by mere accounting provisions in the books of
accounts. This method is almost similar to the pay-as-you-go method. The internal reserve
becomes a source of working capital for the company and this reserve is supported by assets of
the firm such as plant, machinery, buildings, stocks, securities etc which would be in varying
orders of liquidity. These reserves in the accounts of the firm, even if separated and of adequate
amounts, are still reserves in the firms own accounts and are not protected in liquidation, either
enforced or voluntary, against claims of creditors. From the employees point of view this method
does not give adequate security to future gratuity payment, hence this method is also not an
advisable method for funding gratuity liability for the employer.

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Funding through trust
The other two methods of creating irrevocable trust and paying into it the contributions
determined on an actuarial basis are the correct ways of funding the gratuity liability. In this
method, the employer is required to part with the proprietary control over the funds, hence the
security of the employees gratuity fund is ensured. The gratuity rights of the employees become
independent of the fortunes of the business because the funds representing the reserves are
invested outside the business.

The reserves are set up on the basis of the concept of a going concern where most of the
employees would retire from service on attaining the specified age while the other employees
would either leave the service of the employer voluntarily or due to disablement or die whilst in
service.

Sometimes, even the funds built up to meet the gratuity liability on a scientific basis would prove
inadequate in the event of liquidation or closure of the business. In such cases, the gratuity
liability in respect of every employee will fall due and the total funds will not be equal to the
total liability. There is bound to be a shortfall, which will have to be made good by the employer
from the value of the assets available on liquidation. At that time the employer, may not be able
to meet his gratuity liability if there is a sudden liquidation of the business. This presents a
funding risk for the employer.

However, there are two ways by which the Gratuity Fund can be administered. It can be either
managed by the Trustees, or can be administered via an insurance company.

(A). TRUSTEE-ADMINISTERED FUND

Under the trustee administered mechanism, the trustees are vested with the management of the
gratuity fund. They are responsible to arrange for investments of the contributions according to
the pattern prescribed under Rule 101 of the Income-tax Rules, 1962. The rate of contribution is
scientifically determined by an actuarial valuation of the liability and the same is reviewed
periodically. The Actuary takes into consideration the scale of gratuity, projected salary scales,
future service of employees up to the retirement age, interest rates likely to be earned over the
future years and the withdrawal and death experience of the group.

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The trustees must ensure efficient management of the fund to realize maximum yield. In turn
they are also responsible with the day-to-day work of the scheme, like investment of funds,
collection of interest, maintenance of files, accounts, sale of securities, and finally payment of
benefits.

A trust imparts complete protection to the employees in so far as their accrued gratuity rights
are concerned and the employer also gets the income-tax relief immediately on payment of
contribution.

(B). INSURED GROUP GRATUITY SCHEME

Under this method, the gratuity fund is administered through an insurance company. This method
grants the advantage of immediate income-tax relief to the employer and also ensures security to
the employees.

By entering into a Group Gratuity Scheme with an insurance company, the additional benefits
available to an organisation include:

- Relieving the trustees of the responsibilities of investment of the contribution and

administration of the fund
- Provisioning of higher amounts of gratuity payable in the event of death of the
employees while in service enhanced death benefit**
- Designing combined assurance plans to provide both survival benefits as well as
death benefits

A Group Gratuity Scheme is a typical example of such a combination. One year renewable
term assurance and pure endowment plans are judiciously combined to provide for gratuity
payable on death and retirement, respectively.

ENHANCED DEATH BENEFIT UNDER A GROUP SCHEME

The Group Gratuity Scheme designed by the insurance company envisages provisioning of
enhanced benefit payable in the event of death of an employee while in service.

Ordinarily, under the payment of Gratuity Act, the gratuity payable to the nominee upon death of
an employee is calculated on the basis of the service actually completed by the deceased
employee up to the date of death.

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In the case of premature death, this amount is very small, particularly when death occurs in the
early years of service.

This shortcoming is eliminated in the Group Gratuity Scheme by providing death benefit on the
basis of the total expected service, which the employee would have rendered if he were to
continue in service up to the retirement date but for earlier death. This additional death benefit
constitutes a measure of employee welfare, which will impart a sense of security and loyalty on
the part of the employees.

APPROVAL OF GROUP GRATUITY SCHEME MANDATORY

In order to get advantage of a group gratuity scheme, the employer has to set up an irrevocable
trust and draw up rules for its administration and payment of benefits. The rules are as follows:

- The fund should be approved by the CIT (Commissioner of Income Tax) under Part C
of the Fourth Schedule of the Act.
After the fund is constituted, the trustees should make an application to CIT with a copy
of the instrument under which the fund is created and with two copies of the rules.
According to the Income tax rules 103 & 104, the ordinary annual contribution and the
initial contributions should not exceed 81/3% of the salary of the employee for each year
of service in respect of which the contribution is paid.

The contribution to the fund becomes admissible for tax deductions only after the fund is
approved.
The employer can make ordinary annual contributions for securing future service
gratuity and initial contributions for securing past service gratuity benefits.
The initial contribution is payable either in one lump sum on the date of entry of the
employee into the scheme, or in not more than five annual installments commencing from
the date of entry.
If an employer does not wish to pay the initial contribution for securing past service
gratuity, the whole of the gratuity can be secured by paying only ordinary contributions.
In such case, the annual contributions will be at a higher rates but not exceeding the limit
of 81/3 %

EVALUATION OF TRUSTEE-ADMINISTERED SCHEME VS. INSURED

SCHEME
The choice of funding gratuity- liability either through a Trustee-administered scheme or a
Group gratuity scheme is mainly influenced by the scope for getting a slightly higher yield on

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investments tied with the problems of investment in the case of the former and the availability of
investment services coupled with provision of additional life insurance benefit in the case of the
latter.

When the investment function is managed by the trustees efficiently, it may be possible to realize
a slightly higher yield in view of the more favorable pattern of investments prescribed for the
private funds and to that extent the employer's cost of the scheme would be lesser.

But, in practice, it is very difficult to achieve this result in view of the various problems that
confront the trustees, namely, the need to retain some liquid funds uninvested for meeting the
current gratuity payments, prompt collection of interest, the difficulty and expenses involved in
buying securities for small amounts, and the expenses involved in obtaining legal, taxation and
actuarial advice and other day-today work, all of which is not allowed as admissible expenses for
the employer.

On the other hand, funding the liability through group gratuity scheme relieves the trustees of the
problems of investment and makes available liquid funds whenever a payment becomes due.
Further, at a nominal additional cost, the employees are insured for higher death benefits, thus
extending a measure of financial security to their family.

In the case of withdrawals, the Pure Endowment based Group gratuity schemes do not provide
full-accrued gratuity, and as such, the employer is required to make good the shortfall. By
payment of a withdrawal premium to cover such shortfall such occasions can be avoided. The
Cash Accumulation system of funding gratuity liability removes this shortcoming and as a result
full Accrued Gratuity is made available in the case of withdrawals.

GRATUITY SCHEME WITH LIFE INSURANCE BENEFIT

Under the scheme, the benefit payable to the nominee in the event of death of a member is equal
to the benefit, which the member would have received if he were to continue in service and retire
on attainment of the age of superannuation, but based on the salary, which he received on the
date of death. The amount of life cover is equal to the difference between the sum assured under
the pure endowment that is the total expected gratuity and the benefit payable on death under the
said pure endowment, that is, return of premium with interest.

The scheme has been specially designed to provide equal benefits on retirement and premature
death. This is achieved by combining two plans of assurance, which provide for life assurance
benefit and survival benefit.

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GROUP SUPERANNUATION SCHEMES

Object of the Scheme

1. When the employees of a business undertaking reach the age of Superannuation or

retirement, they are assured of an income, otherwise called pension, sufficient to support
them for the remainder of life at a reasonable standard of living.

2. A few employees may be compelled to retire prematurely before reaching the normal age
of retirement owing to ill-health or for other reasons and therefore, the secondary object
of the Scheme is provision of some income for such employees.

3. To make provision for the widows and dependants of employees who happen to die while
in service of the undertaking.

In view of the needs arising on these contingencies, the Income-tax Act, 1961 rightly lays
down that the Scheme shall have for its sole purpose the provision of annuities for
employees in the trade or undertaking on their retirement at or after a specified age or on
their becoming incapacitated prior to such retirement or for the widows, children or
dependants of persons who are or have been such employees on the death of those persons.
Thus, the term pension symbolizes a long term relationship between an employer and his
employee of faithful service rendered by the latter normally spanning his whole working life.

Different methods of setting up Superannuation Schemes

The various alternatives available for setting up of a Superannuation Scheme for the purpose of
making provision for the employees and their dependants are:

4. Payments by Employer
Funding Through Trust
Insured Schemes

Payments by Employer
Several employers do not undertake any responsibility to pay pensions to their retiring
employees. They would like to grant only benefits which they are obliged to give by the law of
the country. Nevertheless, when some employees, who had made significant contribution for the
success of the business by rendering long and meritorious service, retire from service, the
employer may be pleased to reward them with the grant of a monetary benefit intended to
support them during the rest of their life time. No definite rules are required to be made and no
specific scheme needs to be formulated to give shape to their intentions. It can be achieved by a

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Board resolution deciding to grant a pension for a specified amount to the concerned employees.
The recurring liability on account of this commitment need not be funded and no monies are
required to be set apart for the benefit. As and when each months payment falls due, it can be
paid out by charging the current revenue of the employer. Even if a regular pension scheme is
announced, the employer can proceed with the disbursement of the payments from the current
resources. A further step in making each pension commitment financially secure, irrespective of
the future business conditions, will be for the employer to purchase an immediate annuity policy
from an insurance company by paying the required amount of premium. The insurance company
will then make the pension payments in the manner desired by the employer. But then, taxation
may adversely affect the employees.

Payment of pension by the employer out of current revenue is generally not a satisfactory
method. According to sound financial principles, the pension liability incurred in a particular
year for the service completed by the employees should be met in that year and, therefore,
adequate financial provision should be made every year for meeting the liability under this
method, the accumulated liability is met by the employer in some future year or years. Thus, the
amount required in a particular year to meet such a liability is totally unrelated to his ability to
pay and the total annual outlay for payment of such pensions is liable to rise very steeply as the
number of pensioners increases.

The benefit which could have accrued to the employer by way of income-tax relief, if a
contribution were to be made for funding the pension liability, will be delayed. That will also
tend to reduce the profits of the business in those years when heavy pension payments are made.
What is more, it does not provide any security of income to the pensioners since the payments
will depend upon the continued goodwill of the employer and the fortunes of the business. If
unfavorable business conditions prevail, the amount of pension may be reduced or the whole
pension itself discontinued. In modern times, the employees and the employers do not accept
this as a satisfactory arrangement.

Funding Through Trust

For introducing a Superannuation Scheme, the employer can make use of the medium of a Trust
for funding his pension liability. By entering into an agreement with the Trustees appointed for
the purpose, a Trust Fund can be established and the contributions, both employers and
employees, if any, are paid into it. The management of the Trust Fund will vest in the Trustees
and it will be their responsibility to invest the monies according to the pattern prescribed by the
revenue authorities and secure the pensions for the members`when they become due. The Fund
will have to be approved by the Commissioner of Income-tax under Part B of the Fourth
Schedule of the Income-tax Act, 1961. This method of funding the pensions affords complete

23
security to the employees in respect of their future pension payments. The following two
alternatives are available to the Trustees for managing the Trust.

(i) To enter into a scheme of insurance with the insurance companies and pay into it
the contributions received from the employer for securing pension benefits, or
(ii) To accumulate the contributions in approved investments and approach the
insurance companies to purchase annuities for members as and when pensions
become payable to the particular employees.

Setting up a Trust Fund and entering into a Group Superannuation Scheme with the insurance
companies relieves the Trustees of the task of making investment of the contributions and
administering the scheme. Insurance companies will issue a Master Policy to the Trustees
wherein the contributions will be treated as premiums to secure pensions and thus insure under
one contract all the members of a scheme. Where the contributions are predetermined by the
Rules as a percentage of the salary of the employees, whatever amount is received for an
employee will be separately utilized to purchase a pension for him. On the other hand, if the
pension is predetermined, then the rate of contribution will be determined on an actuarial basis.

This rate will have to be reviewed from time to time in order to ensure a proper relationship
between the contributions and benefits so that the funds on hand together with the contributions
to be received in future will be equivalent to the value of the benefits which the scheme has to
provide. However, the Income-tax Rules, 1962 has prescribed an upper limit of 25% of salary
less the employers contribution to the Provident Fund for each employee and as such, the
pension has necessarily to be provided within the permissible limit. When the pension becomes
due, it will be paid to the employee directly by the insurance companies after obtaining written
authority of the Trustees. The insurance companies allow a reasonable rate of interest on the
premiums which it receives and will render necessary assistance to the Trustees in actuarial, legal
and taxation matters. The premium and annuity rates are determined by the insurance companies
based on a rate of interest fixed having regard to the gross interest earned on the investments of
Superannuation Schemes funds.

Trustee Administered Schemes

If the Trustees themselves administer the Fund, they will have to shoulder the responsibility of
managing the investments made according to the pattern prescribed by the Central Board of
Direct Taxes. The investment of contributions and other administrative matters of the scheme
must be managed with utmost efficiency in order to realize maximum yield. Collection of
contributions, purchasing from and selling of securities in the market, collection of interest,

24
obtaining tax exemption certificates from the concerned authorities, dealing with the insurance
companies and maintenance of books of account are some of the major functions to be carried
out by the Trustees. The management of the Trust involves handling of enormous funds by
individuals. The Trustees should always be vigilant to ensure full safety of the funds. When a
pension becomes payable upon the contingency arising, the Trustees should make available-
liquid funds for purchasing that pension from the insurance companies. Under schemes where
pensions for specified amounts are to be provided, the Trustees will have to consult a qualified
Actuary for valuing the liability and determining the rate of contribution. The rate once
determined should be reviewed at frequent intervals to ensure a proper relationship between the
contribution and the benefits and keep the Fund in a state of solvency. Needless to add, the rate
of contribution should not in any case exceed the limit prescribed by the revenue authorities.

While the Actuary will make his estimate as accurate as possible, the estimate has necessarily to
take into consideration, various factors such as the yield which the investments are likely to earn
over long future years, progression and escalation of salaries of the employees, mortality and
withdrawal experience and the annuity rates quoted by the insurance companies.

It is obvious that these are factors which cannot be predicted with any reasonable degree of
accuracy; nor can the other factors, which will affect the solvency of the Fund, be forecast
exactly. While such a Fund does constitute a specific reserve for the provision of future benefits
for the members, there is no guarantee that it will, in fact always purchase the benefits to be
provided in full and there is always the danger that at some future date, either the benefits will
have to be reduced or the rate of contribution will have to be increased within the prescribed
limit. On the other hand, it is also likely that the rate of contribution determined earlier may
prove to be more than adequate, in which case it will be possible to increase the scale of benefits
or to reduce the future contributions.
The Central Board of Direct Taxes has been prescribing from time to time the pattern for the
investment of contributions pertaining to Trustee administered Superannuation funds. The
patterns of investment applicable to insured Superannuation Schemes and privately administered
Superannuation Schemes are different, in that the post-office time deposits are not available to
the former. As these carry a higher rate of interest, if the Trustees manage the investments in the
above manner, it may be possible to earn, for some of them, a slightly higher yield on the
contributions and to that extent, the accumulation of contributions in respect of each member
will be more and consequently fetch him higher pension. If, however, the amount of pension is
fixed under a Scheme, the contributions payable to secure the pensions will be lesser. However,
the Trustees will have to purchase the pension from the insurance companies when it commences
because pensions can be paid only through the insurance companies by effecting policies. The
Trustees have also to set up administrative machinery to deal with the day to day work such as

25
investment of funds, collection of interest, realization of investments and maintenance of books
of accounts and files. Occasionally, they have also to deal with auditors, income-tax authorities,
the insurance companies and legal and actuarial advisors in connection with the scheme. All
these will mean expenses to the Fund and to that extent the net yield to the Fund will be reduced.

The relative advantages and disadvantages of an insured scheme as compared to a Trustee

administered Fund.

Advantages of an insured scheme

The Trustees themselves cannot pay the pensions out of the Superannuation Funds but are
obliged to purchase an annuity from the insurance companies or to enter into a scheme of
insurance with the insurance companies for securing the pension. In view of this
statutory requirement, self administration will permit investment of contributions
according to the prescribed pattern only up to the time of the contingency arising for
payment of pension. When the pension has to commence, the Trustee should realize the
accumulations in respect of the employee and pay the monies to the insurance companies
as premium towards an annuity policy. Insurance companies will then undertake to
provide the stated amount of pension throughout the lifetime of the employee.
A life insurance company has specialized in dealing with the various types of problems
arising in the course of administration of a pension scheme. It can afford to employ a
staff of experts and, by reason of its wide experience and facility for making large
investments can, in many instances, produce far more satisfactory results. It would
therefore, be prudent on the part of the employer to entrust the management of the
scheme to an expert agency in the line and devote his full attention for the promotion of
his business.
It is generally felt that a scheme of insurance is more costly than a Trustee administered
scheme, because the life insurance company will have to meet its management expenses
and also make a profit. As against this, it is argued on behalf of the insurance companies
that the charge for expenses and profit is relatively small and, in fact, the same could be
covered by more favorable yield obtainable for the funds through more skilful
investments and through wider opportunities for investments available to large insurance
companies.
In India, the choice between a Trustee administered scheme and a scheme of insurance is
mainly influenced by two factors, namely, the expected yield on contributions and the
size of membership.
When the membership is small, the Trustees will find it difficult to arrange for the
investment of funds according to the prescribed pattern and they would, therefore, not

26
 like to undergo the investment and other problems of administration even if a higher yield
could be obtained.
When the time for payment of pension comes, the securities will have to be realized
which might entail a loss.
As regards yield, the Trustees may be able to earn slightly higher in view of the more
favorable pattern of investments available to them. But, to achieve the same, they will
have to manage the whole process of investments most efficiently.
The Trustees, being individuals and the funds available being limited, there are various
constraints and in practice they will find it rather difficult to earn the maximum yield so
as to justify self-administration.
If a company which is considering a pension scheme, has a large body of employees and
has adequate staff trained to cope with the administration and further if it is able to
satisfactorily invest the large sums of money and to keep such sums invested, then a
Trustee administered Fund may be justified. However, if the company cannot comply
with these conditions, then the protection offered by the insurance companies will be
worth far more and should be preferred.
An insured scheme is often criticized as being rigid or less flexible than a Trustee administered
scheme, in that, standardization becomes necessary to achieve economy in administration. The
main advantage of a Trustee administered Fund is that since all the risks are borne by the Fund, it
is possible to provide a wide gamut of benefits for specified amounts like, disablement pension,
discretionary pension, early retirement pension and ill-health retirement pension without any
difficulty. Under insured schemes the benefits are restricted to pensions dependent on life. If the
employer wants to provide to an employees widow a pension which ceases on death or earlier
re-marriage, then the insurance company may not be willing to allow for the probability of re-
marriage, in the calculations. This is one example of a need-based pension which cannot be
conveniently provided under an insured scheme.
Another factor which goes against an insured scheme is the pace of funding. The insurance
companies calculate the premiums on the basis of the future service of the various employees
and these premiums are payable as contributions to the scheme. The pace of funding i.e. the rate,
at which the fund is built up, is determined by the insurance company. In the case of a Trustee
administered Fund, it may be possible for the Trustees to vary the pace of funding depending on
the circumstances obtaining year after year.
The insurance companies have now eliminated the much magnified rigidity by introducing a
newly devised deposit administration technique in the administration of the schemes. The
insurance companies Cash Accumulation system of securing pensions under Superannuation
Schemes is a fitting reply to this criticism. Not only has it all the favorable features of a Trustee
administered scheme, but it also relieves the Trustees of the botheration of the investment

27
problems. What is more, the saving made because of the reduction in the management expenses
is passed on to the Trustees in the form of higher interest.
The insurance company also gives guarantee of premium and annuity rates and certain risks are
thereby transferred from the employer to the insurance company. It implicitly guarantees the rate
of accumulation also and to this extent even the investment risk is transferred.
The financial security afforded by the insurance companies to payment of pensions to the
pensioners and to the huge funds involved in the schemes, small and big, is absolute and
unparalleled and, therefore, the employees generally favor insured schemes. To sum up, the
insured scheme relieves the Trustees of much of the work, removes the responsibility of
managing the investments and offers the participants greater security; in certain circumstances, it
may cost somewhat more and may be less elastic in operation but in view of the vital need to
protect the accumulated funds and provide complete security, the insured scheme should
certainly be considered very carefully before a decision is taken.

Defined Benefit and Defined Contribution Schemes

The Group Superannuation Scheme can be taken under a Defined Benefit Scheme or a Defined
Contribution Scheme.

Defined Benefit Scheme: In case of a Defined Benefit Scheme the contributions to be made by
the employer in respect of an employee depends on the entitlements to benefits as per the rules of
the scheme and this aspect is to be taken into consideration when advising the funding
requirements of the scheme. The scheme can be contributory also wherein employees can make
contributions into the fund.

Defined Contribution Scheme: In the case of a Defined Contribution Scheme, the accumulated
value of the contributions received in respect of a member is utilized to purchase a pension.
Since contribution rates are defined in the rules of the scheme no premium calculation is
necessary. Such contributions may be made entirely by the employer or employees may also
contribute to the fund.

At commencement the employer can remit contributions for providing for past service benefits.
The past service contributions can be paid in lump sum or in installments spread over 5 years.

Defined Contribution Superannuation Schemes

In this type of schemes, the contributions may be predetermined as percentage of salary or it
may be a fixed amount for all or it may be varying rates or amounts for different categories of
employees. The contribution paid for each member will be earmarked for securing whatever
pension it may purchase.

Defined contribution schemes are more popular in India for various reasons. The main reason is
that unlike in the U.K., the Income-tax law places a ceiling on the quantum of contributions and

28
not on the quantum of pension. Naturally, it is convenient to fix the rate of contribution.
Another reason is that it is the bonus which is rearranged as a contribution to the scheme in the
case of high salaried executives and as the bonus payable will always be a proportion of the
salary, the scheme is usually arranged as a defined contribution scheme. Further, it will be easier
for an employer to make a provision in his budget for a contribution equal to so many time
salaries. All these tend to influence the employers to set up this type of scheme. However, there
is one disadvantage under this system and that is, no attempt is made to provide a need based
pension related to the standard of living attained by an employee at the time of retirement. To
this extent, the schemes which are in vogue in India are not real pension schemes.

The question of salary strain does not arise in this system. Its merit lies in the fact that the
benefits to be provided in respect of a years contribution are paid for directly by the
contributions received in that year. But, this system has a tendency to provide pensions which
are more than sufficient for some employees and inadequate pension for others. Every thing
depends on how the salaries have progressed in respect of various employees.

One Year Renewable Group Term Insurance Scheme

Members are covered for specific amount payable on death while in service.
Since only death risk is covered premiums are less.
Benefits the families of members who may die during their early years when they might not have
sufficiently built assets.
This is helpful to cover the liabilities of the borrowers.

Group Savings Linked Insurance Schemes

Provides a savings linked insurance cover.
Number of members opting for this scheme has to be substantial.
Scheme is administered by the Employer / Master Policy Holder but monthly contributions
would be by the members.
Life insurance cover could be on graded basis depending on a predetermined formula:
contributions vary according to this.
A separate GSLI account would be maintained for each member.
Yearly certificates would be provided to the members showing the credits in their account.

Review Questions:
1. Explain in detail the difference between Group Insurance and Individual Insurance.
2. Explain the salient features of One Year Renewable Group Term Insurance Scheme.
3. What are the retirement benefits available to an employee and the options available to an
Employer to provide these benefitsDiscuss

29
4. What is Employees Deposit Linked Insurance Scheme and discuss the alternate options
available to the Employers in this regard.
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