Basics of Group Insurance27Basics of Group Insurance GROUP INSURANCEDefinition of Group Life InsuranceGroup 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 InsuranceThe 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.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.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:Group selection instead of individual selectionThe use of a Master Policy or Master ContractLow Administrative costFlexibility in contractsThe use of Experience ratingConditions for EligibilityA 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 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. Eligible GroupsThe 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).Creditor-Debtor GroupsThe 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., The Professional Groups These may be Associations of Professionals like, Doctors, Lawyers, Accountants, Engineers, Journalists, Pilots etc., Other GroupsThere 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: The Jana Shree Bima Yojana / Aam Admi Bima Yojana scheme covering the landless agricultural labourers. IRDP Loanees Group Insurance Scheme, implemented through DRDAs (District Rural Development Agencies) Swarnajayanthi Gram Swarojgar Yojana. Milk Producers Group Insurance Scheme, implemented through some Milk co-operative unions etc.Group Size and Minimum ParticipantsA 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:To reduce individual selection against the insurer, and 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-contributoryThere 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. 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:To obtain the proper balance between mass and homogeneity of risk to permit predictability of future results.To establish standards, to permit the acceptance of a large majority of groups at standard premium rates.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.The amount of insurance cover is determined in some automatic manner, which precludes individual selection by either the employer or employees.Another essential element is the requirement that all or substantially all eligible persons in a given group are covered by insurance.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.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.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.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. If the benefit is within the free cover limit, there will not be any medical examination at all. The insurer reserves the right to cancel the scheme of Insurance after due notice on grounds of inadequate size or participation. The rates of premiums will also be renewed periodically by the Insurer. Benefits of Group Insurance Schemes1 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. 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 ratingThe 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..EMPLOYEES DEPOSIT-LINKED INSURANCE SCHEME 1976In 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.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.GROUP GRATUITY SCHEMESEvolution of Gratuity as a Service BenefitGratuity 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.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 employerProfitability of the business and past profitsExtent of reserves and the chances of replenishment The claim for capital investedAbove 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 disputesBy 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.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 CourtGratuity 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 SchemeThe 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 ProvisionsThe 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 (b) On his retirement or resignation, or (c) On his death or disablement due to accident or diseaseCompletion of continuous service of five years shall not be necessary where the termination of the employment is due to death or disablementGratuity 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.Need for Funding Gratuity LiabilityThe 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 LiabilityThe 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: 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.An employer may set up an internal reserve in the books of account based on an actuarial valuation of the liability.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.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 ReserveAs 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.Funding through trustThe 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 fundUnder 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.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 SCHEMEThe 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. 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 MANDATORYIn 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 SCHEMEThe 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 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 BENEFITUnder 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. GROUP SUPERANNUATION SCHEMESObject of the Scheme 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.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.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 SchemesThe various alternatives available for setting up of a Superannuation Scheme for the purpose of making provision for the employees and their dependants are:Payments by EmployerFunding Through TrustInsured SchemesPayments by EmployerSeveral 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 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 TrustFor 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 security to the employees in respect of their future pension payments. The following two alternatives are available to the Trustees for managing the Trust.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 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 SchemesIf 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, 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 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 schemeThe 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 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 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, itmay 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 SchemesThe 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 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 thecontributions 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 SchemeMembers 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 SchemesProvides 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:Explain in detail the difference between Group Insurance and Individual Insurance.Explain the salient features of One Year Renewable Group Term Insurance Scheme.What are the retirement benefits available to an employee and the options available to an Employer to provide these benefitsDiscussWhat is Employees Deposit Linked Insurance Scheme and discuss the alternate options available to the Employers in this regard. ---000---