[Life/Health License] - CH 5 - Life Insurance Policy Provisions, Options and Riders

Living Benefits for Life Insurance

1. Accelerated Benefits - Accelerated benefits allow policyowners to use their policy's death benefits tax-free while they are still alive, or if they are terminally or chronically ill. Examples of terminal and chronic illnesses are cancer and AIDS. A terminally ill person must be expected to die within two years. A chronically ill person within the past 12 months as certified by a medical practitioner: is unable to perform at least two activities of daily living without assistance, has a disability, or is cognitively impaired and requires supervision to ensure health and safety. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) requires that proceeds from accelerated benefits are exempt from federal income tax. 2. Viatical Settlements - A terminally or chronically ill insured can sell his life insurance policy to a third party in exchange for payment of a large portion of the death benefit. The insured may receive anywhere from 50-80% of the death benefit. This may be a feasible option for insureds that need a large sum of money to pay medical bills prior to death. Viatical settlements are completely separate from life insurance contracts. HIPAA requires that proceeds from a viatical settlement are exempt from federal income tax. 3. Life Settlement - Life settlements work the same way as viatical settlements, in that a life insurance policy is sold to a third party in exchange for a large portion of the death benefit, except that the insured is not terminally or chronically ill.

Riders Affecting the Death Benefit Amount

1. Accidental Death Benefit (Multiple Indemnity) Rider 2. Accidental Death and Dismemberment Rider 3. Guaranteed Insurability Rider (GIR) 4. Cost of Living Adjustment Rider (COLA) 5. Return of Premium Rider 6. Return of Cash Value Rider 7. Term Rider 8. Annuity Rider

Designation Options for Beneficiaries [Life Insurance]

1. Individuals - One or more individuals may be named as beneficiaries. - If more than one person is named, then the policy proceeds are divided as indicated in the policy. 2. Business 3. Estates - The insured's estate may be named as beneficiary. This designation is used in cases where there are no living beneficiaries, the policyowner did not name any beneficiaries, or the beneficiary is found guilty of murdering the insured. The insured's estate is defined as all of the insured's assets and liabilities. - The advantages of naming the insured's estate as beneficiary are to provide liquid capital to pay for estate taxes, the insured's final expenses and the insured's outstanding debts. Disadvantages are as follows: policy proceeds must go through probate court because they are considered part of the insured's gross estate for tax purposes. This can be costly, time-consuming and subject the policy proceeds to creditors. 4. Minors - A minor can be named as a beneficiary, but because a minor cannot legally receive policy proceeds, a guardian or trustee must be appointed who can legally receive the policy proceeds and manage them until the minor reaches the legal age. A trust can be established if a guardian cannot be relied upon to manage the funds. In most cases, minors should not be named as beneficiaries. - Insurance companies may make restricted life payments to an adult guardian on behalf of the minor beneficiary. The insurer may also keep the policy proceeds to accrue interest until they may be paid to the minor when he reaches the age of majority or when an adult guardian has been appointed. Finally, the insurer may put the policy proceeds in a trust on behalf of the minor. 5. Trusts - A trust can be named as the beneficiary. In this scenario, the policyowner gives the legal title of the insurance policy to another person - the trustee for the benefit of the trust beneficiary. Legally, the trustee cannot benefit from the trust, but is paid to manage the property on behalf of the trust beneficiary. - The advantage of naming a trust is that it is a secure way to establish a scholarship fund, give money to an institution, or to assure that policy proceeds are disbursed exactly as the policyowner intends. Drawbacks include the high costs of administering a trust and the trust beneficiary's inability to intercede if the trustee is not managing the trust correctly. 6. Charities 7. Classes or beneficiaries - Classes of individuals may be named as beneficiaries. Naming a class of beneficiaries allows the policyowner to name a group of individuals generally, without naming each individual member of the group. This saves the policyowner the hassle of changing beneficiaries when births and deaths occur. Examples of class designations are "all my children," "all of my living siblings," or "all living and active players of the Wildcats team." Per Capita - Per capita is defined as "by the head". Under this class designation, only the living heirs receive a portion of the policy proceeds. Example: Bill names his four children - Jenson, Judy, Mary and Peter - as per capita beneficiaries. Jenson has two children of his own. Judy, Mary and Peter are single and do not have any children. If Jenson and Peter are predeceased upon Bill's death, then Judy and Mary each would receive ½ of the policy proceeds. Per Stirpes - Per stirpes is defined as "by the root". Under this class designation, deceased beneficiaries would have their portion of the policy proceeds distributed to their children. This means that the insured's grandchildren are eligible to receive policy proceeds if the insured's child predeceases the insured. Example: Suppose Bill names his four children as per stirpes beneficiaries instead. Now, if Jenson and Peter are predeceased upon Bill's death, then the policy proceeds would be divided as follows: Jenson's children would each receive ⅙ of the policy proceeds accounting for a total of ⅓; Judy receives ⅓, and Mary receives ⅓.

Collateral Assignment for Life Insurance

A collateral or partial assignment is the partial and temporary transfer of rights to another person or entity. Collateral assignments are usually intended for securing a loan. Once the policyowner pays off the loan, he resumes the partially assigned rights. Instead of purchasing a credit life policy, policyowners may make a collateral assignment of their existing life insurance coverage to secure a loan. Collateral assignments are also called conditional because in order for the assignee to receive the portion of policy proceeds assigned, there must be a balance on the loan at the time of the insured's death. Example: An individual with a $75,000 mortgage assigns his $150,000 life insurance policy in order to secure the debt. - In this situation the assignee and the mortgagee receive a check payable to them jointly.

Term Rider [Life Insurance]

A term rider adds term coverage to an existing life insurance policy. There are several varieties of term riders, including: spouse/other insured, children, family, return of premium and return of cash value, among others.

Absolute Assignment for Life Insurance

An absolute or complete assignment occurs when the policyowner assigns all rights including cash values to another person or entity. Absolute assignment means the policyowner has surrendered all rights, and the assignee, in essence, becomes the new policyowner. The original policyowner typically cannot reclaim any rights, and the assignment is permanent. The assignee does not need to have insurable interest in the life of the insured. Usually the only right that the original policyowner retains is the right to continue to pay premiums. Absolute assignments are made willingly, so they are also called voluntary assignments. An example of absolute assignment is making a gift of life insurance to a charitable organization.

Rights of Ownership

As discussed earlier in the course, life insurance policyowners own their policies. Ownership rights include... - naming beneficiaries - choosing the settlement option (how the policy proceeds will be paid) - right to select nonforfeiture options - right of assignment - right to policy cash value, (if any) - right of policy loan if there is policy cash value, choice of premium payment mode - dividend options, (if any) - right of conversion if the policy is a convertible term policy. Only the policyowner has the right to request permitted changes to the policy. Only an authorized officer of the insurer can make changes to a policy. All changes must be made in writing, attached to the policy, and signed by the authorized officer of the insurer. Insurance producers cannot make any changes to a policy. In most cases, the policyowner, applicant and insured are the same person; however, when the policyowner and the insured are different people, the life insurance policy is owned by a third party. In third-party ownership the three parties to the contract are the policyowner, insured and insurer. The policyowner must have an insurable interest in the life of the insured. The ownership clause is used in cases where the insured is a minor and the applicant is the minor's parent, grandparent or guardian applying for coverage on the minor's life. - The applicant maintains control over the policy until the insured reaches the age of majority.

Disability Riders

As stated earlier, riders "ride on" existing policies. Riders add to or take away from policy benefits. The rider, synonymous with "endorsement," is attached to the policy. Riders customize policies to meet policyowners' unique needs. 1. Guaranteed Insurability Rider 2. Waive of Premium Rider 3. Automatic Premium Rider 4. Payor Provisions Rider 5. Accidental Death Benefit Rider 6. Cost of Living Rider 7. Other Insured Rider

Cash Surrender Nonforfeiture Option for Life Insurance

As the name implies, the cash surrender option allows the policyowner to receive the policy's cash value. In most states, policies that build cash value must begin to accrue cash value by the end of the third policy year. For industrial life policies, cash value must be available after five years. During the first two policy years, premiums are used to pay acquisition and administrative expenses. Once the cash surrender value is exercised, no death benefit will be paid and the policy cannot be reinstated. Any outstanding policy loans plus interest would be deducted from the cash surrender value. A surrender fee is charged at the time of cash surrender. Depending on the state, the insurance company may be permitted to delay payment of cash surrender for up to 6 months from the request. This is called the delayed payment provision and provides insurance companies a buffer if they encounter a financial crisis.

Beneficiaries [Life Insurance]

Beneficiaries are the named individuals or entities designated by the policyowner to receive the policy proceeds upon the insured's death. The policyowner may name any person or legal entity as beneficiary. More than one beneficiary may be named. An estate, trust, charitable organization, institution or other legal entity may be named as a beneficiary. The policyowner is not required to name a beneficiary. The beneficiary does not need to have an insurable interest in the life of the insured.

Types of Beneficiary Designations

Beneficiary designations are the ways beneficiaries are classified. This establishes how beneficiaries receive policy proceeds, such as in what order, and how benefits are paid when one beneficiary predeceases another beneficiary. Succession Naming beneficiaries in succession allows the policyowner to name up to three levels of prioritized beneficiaries: Primary Secondary Tertiary Secondary and tertiary beneficiaries are called contingent because they only receive policy proceeds if the primary beneficiary predeceases the insured. The primary beneficiary is the first person to receive policy proceeds upon the insured's death. If the primary beneficiary predeceases the insured, the secondary or successor beneficiary will receive the policy proceeds. If both the primary and secondary beneficiaries predecease the insured, the tertiary beneficiary will receive the policy proceeds. The beneficiaries at lower levels of priority (secondary and tertiary) do not receive policy proceeds unless the higher level(s) beneficiaries predecease the insured. Multiple primary, secondary and tertiary beneficiaries may be named. - Example: Bill could name Jenson and Judy as primary beneficiaries and Mary and Blain as contingent beneficiaries. In this case, Bill would need to specify how the policy proceeds would be divided (i.e., Jenson ¼; Judy ¾). The insured's estate becomes the beneficiary if all named beneficiaries predecease the insured.

Lump Sum Settlement [Life Insurance]

Cash payment, or lump-sum payment, of the policy proceeds is still prevalent today. If the policyowner does not choose a settlement option for the beneficiary, the policy proceeds default to payment in lump-sum. In this case, the beneficiary is permitted to choose a settlement option upon the insured's death. However, if the policyowner does select a settlement option, it cannot be changed. Lump-sum distribution is not taxed.

Felony Clause for Life Insurance

Death that occurs as a result of the insured committing a felony may be excluded. For example, - if an insured is shot and killed by police during the commission of an armed robbery, his death may result in the insurer's refusal to pay out death benefits.

Standard Policy Provisions

Entire Contract - no prior statements not written in the contract aren't part of it. Insuring Clause - Insurer's promise to pay covered losses as long as the insured pays the premiums and abides by the terms and conditions. Free Look Provision - Right to Examine (10 days) Consideration Clause - A required provision in a life insurance policy stating that a policy owner must pay a premium in exchange for the insurer's promise to pay benefits. Grace Period - stipulated period of time policyowners are allotted to pay an overdue premium during which the policy remains in force. The grace period protects the policyowner from an unintentional policy lapse. Reinstatement - Provision in individual health insurance policies stating that a lapsed policy may be reinstated on the 45th day after an application is submitted, unless denied. Accidents will be covered immediately upon reinstatement, but sicknesses have a 10-day waiting period.

Tax Treatment of Proceeds

Generally, life insurance benefits paid to a beneficiary are tax-free. However, interest earned on reinvested policy proceeds is subject to tax, because installment payments contain interest, which is taxable. Likewise, dividends are not taxable because they are a return of overcharged premium; - however, if the dividend is reinvested with the insurer, any growth earned on the dividend (interest) is taxable.

Nonforfeiture Options for Life Insurance

Guarantees that are required by law to be part of life insurance policies that build cash value. Insurers are required to make nonforfeiture values available when policyowners discontinue premium payments for any reason. 3 nonforfeiture options: 1. Cash surrender 2. Extended term insurance 3. Reduced paid-up insurance

Transfer for value rule

If a life insurance policy is assigned for valuable consideration and the insured under the life insurance policy dies, the new owner of the policy will be responsible for paying taxes on the amount of proceeds (including premiums that were paid by the original owner) paid that exceed the valuable consideration. The exceptions to this rule are: transfers to the insured, a business partner of the insured, or a corporation in which the insured is a stockholder or officer.

STOLI - Stranger-Originated Life Insurance

In Stranger-Originated Life Insurance, or STOLI, a consumer purchases a life insurance policy with the agreement that a third party agent/broker or investor will purchase the consumer's policy and receive the proceeds as a profit upon the consumer's death. The stranger may purchase the policy, naming himself as beneficiary, or use it for resale to an investor. Upon the insured's death, the stranger or investor receives the policy proceeds. The insured receives some sort of small financial benefit in this arrangement. Under STOLI arrangements the insured is usually a person who is elderly (typically age 65 to 85) or terminally ill. STOLI arrangements are used to make a profit on these individuals who are near death. In a sense, it is gambling on a person's life because the stranger or investor is betting the insured will die before they pay out a lot of money in premiums.

Special Situations

Insurers have some special situations to consider when paying policy proceeds, such as the simultaneous death of the beneficiary and insured. Other situations include creditors' attempt to seize policy proceeds and beneficiaries not designated in the policy. This section will cover these special circumstances. 1. Uniform Simultaneous Death Act 2. Common Disaster Clause & Short Term Survivorship 3. Spendthrift Trust Clause 4. Facility of Payment Provision

3 Situations Where the Insurance Company Has the Right to Contest or Void the Policy

Lack of insurable interest - if there was not an insurable interest at policy outset, the insurer may contest the policy at any time. Impersonation - if the applicant for a life policy is not the person who signs the application or undergoes the medical exam, the insurer may contest the policy and the death claim. Murder - if the applicant is shown to have applied for a life insurance policy with the intent on murdering the insured, the insurer may contest the policy and the death claim.

Policy proceeds paid upon the insured's death

Lump-sum proceeds paid to a beneficiary are exempt from federal income tax. If the policy contains a double indemnity rider or paid-up additions, those policy proceeds are also exempt. Policy proceeds that are reinvested and paid out to the beneficiary as an installment are subject to federal income tax, only up to the amount of each benefit that is interest (annuity rule - the portion of proceeds that formed the principal are not taxable, but the portion of proceeds that form interest are taxable). With the interest-only life insurance settlement option, installment payments are taxable because they are 100% interest earned on the principal, but the principal when paid out in a lump-sum is not taxable.

Dividend Options for Life Insurance

Mutual companies issue participating policies, meaning that policyholders participate in the profits of the insurer through the receipt of dividends. This is contrary to most stock insurers who issue nonparticipating policies and do not issue dividends to policyholders. Though not guaranteed, participating policies pay dividends to policyowners at the end of each year when the company experiences a surplus. Dividends become payable at the end of the first or second policy year. Recall that dividends are a return of overcharged premium, and are not taxable. Policyowners may not use dividends to buy stock in the insurance company. Dividend options are the choices available to policyowners for settling dividend payment. There are five dividend options: Cash Payment 1. Reduction of Premium Payments 2. Accumulation at Interest 3. One-Year Term Option 4. Paid-up Additions

Exclusions for Life Insurance

Policy exclusions are optional, and may be included in life insurance policies at the discretion of the insurer. These provisions exclude or limit coverage and are intended to protect the insurer from adverse selection and misuse of policies. 1. Suicide Clause 2. Aviation Clause 3. War or Military Service CLause 4. Hazardous Occupation or Hobby Clause 5. Felony

Third-party Ownership Options for Life Insurance

STOLI IOLI

Riders Covering Additional Insured

Spouse/Other-insured Term Rider Family Term Rider Children's Term Rider

Accelerated Living Benefit Rider

The accelerated benefit rider, also referred to as a living benefit rider, allows the insured to receive a portion of the death benefit prior to death if the insured has a terminal illness. Depending on the policy, life insurance premiums may be waived upon payment of the accelerated benefit. This accelerated benefit rider is intended to provide a terminally ill insured with necessary funds to pay medical expenses and nursing home costs during a terminal illness while the insured is living, and relieves financial burdens associated with terminal illness. The long-term care rider is a type of accelerated benefit, which is used to pay long-term care costs. The long-term care rider may be separate from the life policy, in which case the accelerated benefit does not reduce the death benefit, or may be incorporated into the life insurance policy, thereby reducing the death benefit or policy cash value. An example of the integrated accelerated benefit is the living needs rider which pays the accelerated benefit as long as the insured is expected to die within one to two years. A living needs rider may pay up to 80% of the death benefit. Prior hospitalization is often required for the rider to kick in. Conditions for Payment In order for an insured to receive the accelerated benefit, the insured must have a terminal illness, or in some policies confinement to a nursing home suffices for payment. The amount of the accelerated benefit varies by policy, but is usually anywhere from 25-80%. Insurers are permitted to pay out the entire death benefit. The accelerated benefit is not subject to tax since the funds are used to pay for medical care. Effect on Death Benefit The death benefit is the face amount reduced by the amount of accelerated benefit paid to the insured. Example: If Linda has a $100,000 life insurance policy and receives $40,000 accelerated benefits for her terminal illness and the insurer loses $200 of interest, then Linda's beneficiary will receive $59,800 in death benefits when she dies.

Accidental Death and Dismemberment Rider [Life Insurance]

The accidental death and dismemberment rider may be added to a life insurance policy to pay benefits for dismemberment. The loss must occur within a certain time period of the accident, such as 90 days. The accidental death and dismemberment rider pays a principal sum if the insured loses any of the following due to an accident: Both hands Both arms Both legs Vision in both eyes

Facility of Payment Provision

The facility-of-payment provision allows the insurer to choose a beneficiary if the insurer cannot get in contact with the named beneficiaries after a certain amount of time. Usually this provision is used in policies with face amounts of $1,000 or less (group life policies and industrial policies). The insurer typically chooses a blood relative of the insured. Even though the person chosen is not a named beneficiary in the policy, that person has a valid right to the policy proceeds. The facility-of-payment provision is used when the named beneficiary is a minor, the named beneficiary has predeceased the insured, a claim has not been submitted, or it is known to the insurer that another party has paid the deceased insured's final expenses and burial costs.

Automatic Premium Loans for Life Insurance

The insurer often includes the automatic premium loan (APL) provision in policies at no extra cost, or will include the provision at the policyowner's request. This provision allows the insurer to automatically use the policy cash value to pay an overdue premium. The APL provision prevents policies from unintended lapse because of nonpayment of premium. Only policies that build cash value can have the APL provision. If the policy runs out of cash value, then the APL provision has no effect. An APL is like any other policy loan, and if not repaid will reduce the death benefits by the amount of the premium loan with interest.

Advantages of a Reinstated Policy vs. Purchasing a New Policy:

The new policy's provisions may be more strict. The reinstated policy's premium may be lower. The reinstated policy uses the insured's original age; whereas, a new policy uses the insured's attained age. The interest rates may be more favorable.

Paid-up Additions for Life Insurance

The paid-up additions option allows the policyowner to use the dividend as a single premium to purchase an additional amount of whole life coverage. The amount of coverage that can be purchased is based on the insured's attained age when the paid-up addition is purchased. A new policy is not issued with paid-up additions. Instead, the paid-up addition coverage is added onto the policy's face amount. Insurers usually require that the type of coverage purchased with paid-up additions is the same type as the original policy. If the policyowner does not select a dividend option, the insurer will automatically use the paid-up additions option. Unlike the one-year term option, paid-up additions do not expire - they are added onto the policy's face amount. Unlike the accumulate at interest option, the dividend used to purchase the paid-up additions contributes to the policy's cash value. The paid-up additions dividend option is appropriate for policyowners who wish to maximize policy death benefits for the policy beneficiary or who are concerned with long-term benefits. - By purchasing more life insurance, the policyowner who selects the paid-up addition is maximizing the death benefits for the intended beneficiary. Example: Tom has $100,000 of whole life insurance. He receives a $500 dividend and decides to use the paid-up additions option to purchase $1,000 of whole life coverage. Tom's whole life policy now has a face amount of $101,000.

Reduced Paid-up Option for Life Insurance

The reduced paid-up insurance option allows the policyowner to purchase paid-up whole life coverage at a reduced face amount based on the amount of the policy cash value. The cash value acts as a single premium to purchase reduced paid-up insurance. Any outstanding policy loans plus interest would be deducted from the cash surrender value prior to purchasing reduced paid-up insurance. In other words, the reduced paid-up nonforfeiture option provides continuing cash value build up, even though the policyholder is no longer contributing any money into the policy. With the reduced paid-up insurance option, the policy may be reinstated to the original face amount within the terms of the reinstatement provision. Key points about the Reduced Paid-up Option: - The policy is paid-up with the cash value used as a single premium to purchase the reduced face amount coverage. - No more premium payments are made. The insured's attained age is used to determine the amount of reduced paid-up coverage. - Reduced paid-up insurance is the same type of whole life coverage as the original policy, except all policy riders are eliminated.

Waiver of Cost of Insurance Rider [Life Insurance]

The waiver of cost of insurance, or waiver of monthly deductions rider, allows a universal life policyowner who becomes disabled to waive the cost of death protection, but does not waive the cost of premium required to build cash value. Example: If the minimum premium is $900 and the target premium is $1100, the waiver of cost of insurance rider will only cover the $900 to keep the death protection in force.

Assignment Clause

Unique to life insurance, policyowners have the right to transfer policy rights to another person or entity. Assignment does not change the named insured or the face amount of the policy. Assignment merely transfers who has ownership rights. The policyowner must make the assignment in writing and submit it to the insurer. The assignment clause must coordinate with the beneficiary's rights. For example, if an irrevocable beneficiary has been named, that beneficiary must consent to the assignment in writing. There are two kinds of assignment: absolute and collateral. A business assignment of life insurance policies between partners is made in order to protect the financial interest that the lender has in the insured. The assignment insures that if the insured dies before the loan is paid off, the lender will be paid. 1. Absolute Assignment 2. Collateral Assignment

Interest Only Settlement [Life Insurance]

With the interest only option, the insurer retains the policy proceeds, which become the principal, and pays out only the growth on the principal to the beneficiary on a scheduled basis such as monthly or annually. The principal is paid out in cash or via another settlement option at some point in the future. A minimum guaranteed interest rate is quoted to the beneficiary. In many cases, the interest only option is used in tandem with other settlement options especially in situations where more than one person is receiving payments from the policy proceeds. Sometimes the policyowner will specify the beneficiary's right of withdrawal of the principal, such as after a certain number of years or upon a certain age. fIf the beneficiary dies before the funds are depleted, then a contingent beneficiary will receive payments.

Withdrawals or Partial Surrenders for Life Insurance

Withdrawals or partial surrenders of policy cash value can be made from life insurance policies. The policy specifies how much can be withdrawn, at what frequency, and the service charge. The interest portion of a cash withdrawal may be taxed. Any outstanding loans will be deducted from the amount of the cash surrender

Annuity Rider [Life Insurance]

An annuity rider can be added onto a life insurance policy. Annuities, which protect against the chance of depleting income for prolonged life, are discussed in detail in a later chapter.

Hazardous Occupation or Hobby Clause for Life Insurance

If the insured dies as a result of a hazardous occupation or hobby, the insurer will not pay the claim. Examples of hazardous occupations or hobbies include acrobatic pilots, professional auto racers, and skydiving. Instead of excluding coverage all together, sometimes insurers will charge a higher premium for those involved in hazardous occupations or hobbies.

Disability Income Rider [Life Insurance]

If the policyowner becomes totally and permanently disabled, the insurer will pay the insured a periodic income, and in some policies it also waives the policy premiums. The periodic income is based on the policy's face amount and is paid weekly or monthly during the insured's disability. There is usually a waiting period of 3 or 6 months once the policyowner becomes disabled to establish that the disability is permanent.

IOLI - Investor-originated life insurance

Investor-originated life insurance (IOLI) is a type of STOLI. With IOLI, investors solicit elderly people to purchase life insurance, and an agent or broker agrees to loan insureds money to pay the premiums for a period of time, with the agreement that after two years of paying premiums the investors become the policyowners, and receive the policy death benefits upon the insured's death. Investors supply funds to a "pool" of STOLI-type policies with the expectation that the insureds die very soon, so that they earn a profit on the death benefit. In most cases, the lender is the investor, who uses the STOLI policy as collateral on the loan. If the insured dies during the 2-year loan period, the investor/stranger repays the loan and then receives the death benefit. If the insured is alive after the 2-year loan period, the policy is sold to investors in an amount that is greater than the policy's cash value, but less than its death benefit. In exchange, the insured receives a nominal lump-sum payment for essentially facilitating a third party's profit upon their upcoming death. STOLI and IOLI are ethical dilemmas because the investor or stranger does not have insurable interest in the continued life and well-being of the insured. They want the insured to die very soon, so that they will receive the policy death benefits. Often times, once the policy has been sold to a stranger/investor, the insured will be contacted several times a year to see if he/she has died.

Children's Term Rider [Life Insurance]

The children's term rider permits children to be insured under term rider protection on a life insurance policy for a certain length of time. Children's term riders usually expire when children reach the age of 18 or 21. When children reach the limiting age, they are usually given the option to convert their term coverage to whole life. Biological, step and legally adopted children can be insured under term riders.

Cash Loans for Life Insurance

Policyowners can make a policy loan in an amount up to the current cash value, less any existing indebtedness (prior loans with interest). - Loans need not be repaid, in which case the amount of the outstanding loan with interest would be deducted from the policy proceeds upon the insured's death. - Outstanding policy loans do not cause the policy to lapse unless the cash value in the policy is less than the total amount of indebtedness against the policy. - If this happens, the insurer is required to provide the policyowner and any assignees with written notice and 30-day grace period. Insurers may postpone a policy loan request for a maximum of six months from the date requested, unless the policy loan is requested to pay a premium.

Changing Beneficiaries [Life Insurance]

Revocable vs. Irrevocable Beneficiaries may be named as revocable or irrevocable. The policyowner can change revocable beneficiaries without their consent. However, with irrevocable beneficiaries, the policyowner must receive their written consent to exercise any ownership rights, except for the right to pay premiums. In this case, the policyowner must receive the irrevocable beneficiary's written consent to change the beneficiary, take out policy loans, assign the policy, or any other policy change. Irrevocable beneficiaries can be thought of as both policyowner and beneficiary of a policy. Irrevocable beneficiaries are either absolute or reversionary. For absolute, the beneficiary has a vested interest in the policy even if he/she predeceases the policyowner. With reversionary, if an irrevocable beneficiary predeceases the insured, the policyowner no longer requires that beneficiary's written consent to exercise policy ownership rights. Revocable beneficiaries typically cannot assign a portion of the policy proceeds because the policyowner can remove them at any time. However, an irrevocable beneficiary has a good chance of assigning a portion of the policy proceeds. If an irrevocable beneficiary makes an assignment, but predeceases the insured, the assignment is cancelled unless it was made in writing or the policyowner agrees to the assignment in writing.

Guaranteed Insurability Rider (GIR) [Life Insurance]

Sometimes referred to as the future increase option. Permits the policyowner to buy additional permanent life insurance coverage at specific points in time in the future (i.e., marriage, births, etc.) without requiring the insured to provide proof of insurability. If the future increase option is not exercised within a specified time period, such as 90 days, of each option age, then the option is forgone. The added coverage is rated at the insured's attained age. Each policy specifies how much additional coverage can be purchased. The GIR is not exclusive of other riders, so if the policyowner has the waiver of premium rider and the GIR, it is possible for both riders to be exercised simultaneously. The guaranteed insurability rider usually drops off when the insured reaches the age of 40.

Other Provisions

Statements of the Insured - The applicant's statements in the application are considered representations and not warranties, unless fraudulent. - Representations are statements made to the applicant's best knowledge. - If the insured's statements are fraudulent and material to the contract, the insurer can void the policy. Execution Clause The execution clause states that the policy is executed (established) when all parties to the contract have met the policy's conditions. Payment of Premiums The payment of premiums provision stipulates when premium payments are due, how and to whom they must be paid. The premium mode is stipulated. - Premium modes include: monthly, quarterly, semiannually or annually. - In some cases, a single premium is paid for the entire policy. - In most cases, premiums are paid in advance and to the producer or the insurer's home office. - The less frequent premiums are made, the lower they will be. - More frequent premium payments incur additional administrative costs; on top of that, the insurer loses earnings since it does not have the premium for the entire year. - Paying annual premiums is the least expensive premium payment mode. Payment of Claims Once the insurer receives notice of the insured's death and receives the death certificate, the insurer must pay the claim within a certain number of days, usually 60. - The death benefit is paid to the beneficiary. - If there is no beneficiary, the death benefit is paid to the insured's estate. Legal Action The legal action provision places a limit on the period in which a claimant can file suit against an insurer. - In most states, legal action against an insurer cannot be taken until 60 days have passed since the insurer received proof of loss and within two years from the date proof of loss was submitted to the insurer. Modifications Modifications are policy changes and must be made by an authorized officer of the insurer and attached to the policy. Only the policyowner has the right to request changes. Insurance producers cannot make any policy change. Changes to the policy can only be implemented by an executive officer of the insurer. Medical Examination and Autopsy Insurers may require the proposed insured undergo a medical examination prior to issuing coverage at the insurer's expense if necessary, such as for large amounts of coverage. The insurer may also request a deceased insured to undergo autopsy for good cause, if not prohibited by state law, while a claim is pending. Excess interest provision A provision stating that when a life insurance policy's interest rate becomes greater than the assumed interest rate, the policy will build excess cash value. The insurer will provide options for paying the excess cash to the insured via cash dividends or paid-up additions.

Accidental Death Benefit (Multiple Indemnity) Rider [Life Insurance]

The accidental death benefit (ADB), also referred to as a multiple indemnity rider, pays an additional sum, termed the principal sum, to the beneficiary if the insured dies due to an accident. The amount paid is a multiple of the policy face amount such as double or triple. Each policy stipulates how an accidental death is defined. Furthermore, the insured must die within a certain time period of the accident, usually 90 days. The rider usually excludes death from accidents occurring while the insured is at war, committing a crime, or in an aviation incident, other than in a regularly scheduled commercial flight. The ADB typically expires when the insured reaches a certain age, such as 65. The ADB does not build cash value and only multiplies the policy's face amount. If a policy's face amount is increased by dividend options, then the ADB only applies to the original policy face amount.

Accumulation at Interest Option for Life Insurance

The accumulation at interest option allows the insurer to retain the dividend to be invested and grow in value. The dividend earns a rate specified in the policy. The policyowner can withdraw the dividend at will tax-free, but any interest earned on the dividend is taxable. Dividends left to accumulate at interest are separate from the policy's cash value.

Aviation Clause for Life Insurance

The aviation exclusion states that the insurer will not pay the claim if the insured dies due to involvement with aviation, such as a military pilot flying a jet aircraft. Individuals flying in commercial aircraft as fare-paying passengers would not be excluded from coverage. Each policy's aviation clause is different. Some policies specify that flights must be regularly scheduled; whereas, other policies cover nonscheduled flights as well. Most insurers today will not deny coverage to people involved in aviation; instead, insurers will charge higher premiums to compensate for the added risk.

Common Disaster Clause and Short Term Survivorship [Life Insurance]

The common disaster clause protects the contingent beneficiaries' rights by stipulating a certain number of days the primary beneficiary must outlive the insured after a common accident causing near-simultaneous death in order for the primary beneficiary to receive the policy proceeds; otherwise, the contingent beneficiaries receive the policy proceeds. Short term survivorship requires that the insured and primary beneficiary's deaths are from unrelated causes. If the primary beneficiary dies before the insured, then the policy proceeds are paid to the contingent beneficiaries, or if none, to the insured's estate. If the insured dies before the primary beneficiary, then the policy proceeds are paid to the primary beneficiary only if he outlives the insured by the specified number of days. The stipulated period is usually 15 or 30 days.

Cost of Living Adjustment Rider (COLA) [Life Insurance]

The cost of living adjustment (COLA) rider allows the policy face amount to be adjusted to account for inflation based on the consumer price index (CPI). If the face amount is increased, the premium will be increased. If the face amount is decreased, the premium will be decreased. If the face amount cannot be adjusted, then an increasing term rider is added to the coverage. The policyowner has the option of accepting or declining such changes to the policy.

Extended Term Option for Life Insurance

The extended term option permits the policyowner to use the policy's cash values to buy paid-up term insurance. The cash values act as a single premium to purchase the extended term coverage, and the amount of the paid-up coverage is equivalent to the original policy's face value. The length of the term protection is based on the amount of cash value in the original policy and the insured's age at the time the extended term is purchased. Any outstanding policy loans plus interest would be deducted from the cash surrender value prior to purchasing extended term coverage. The insurer institutes the extended term option by default if the policyowner cannot be reached after the grace period lapses or if the policyowner does not select a nonforfeiture option. However, if the insured has a rated policy, meaning the insured is a higher risk, the insurer will typically not offer the extended term option because of adverse selection. With the extended term option, the original policy may be reinstated within the terms of the reinstatement provision.

Fixed-amount Installments Settlement [Life Insurance]

The fixed-amount installment option uses an annuity to pay the policy proceeds, but the payment amount is specified instead of period of time. Payments consist of principal and interest and are paid until the principal and interest reach zero. The length of time installments will be paid is based on the amount of the policy proceeds, the amount of each payment, and the interest rate. The larger the payment amount, the shorter time period payments will be received. More favorable interest rates will lengthen the payout period. This settlement option guarantees that the entire amount of the policy proceeds will be paid out. If the beneficiary dies before the balance reaches zero, then a contingent beneficiary will receive the remaining payments.

Fixed-period Installment Settlement [Life Insurance]

The fixed-period, or period certain, installment option uses an annuity to pay the policy proceeds to the beneficiary for a certain number of years. Payments consist of principal and interest, and the principal reduces to zero by the end of the period. The amount of each installment is based on the length of the period, the amount of the policy proceeds and the interest rate. Longer payment periods result in lower payments. Income is guaranteed for the entire period specified, so if the recipient dies before the period ends, then a contingent beneficiary would continue to receive payments until the period lapses.

1035 Policy Exchanges [Life Insurance]

The gains on exchanges of life insurance policies, endowments, or annuities, are in most cases subject to taxation. Section 1035 of the Internal Revenue Code allows for certain exchanges without recognizing a gain or loss for tax purposes. The following exchanges may occur without tax consequences: 1. Life insurance policies may be exchanged for another life insurance policy or endowment. 2. Endowments may be exchanged for another endowment. 3. Annuities may be exchanged for another annuity. Insured's Estate Upon the insured's death, life insurance and any accumulated dividends are includable in the insured's gross estate for federal estate tax purposes.

Incontestable Clause for Life Insurance

The incontestability clause prevents the insurer from denying a claim or voiding a life insurance policy, except for nonpayment of premiums, after the policy has been in force for a certain number of years. In most states, the incontestability clause is two years. The two-year period for a policy to be incontestable starts at the date of issue. The incontestability clause will not protect the insured from misstatements of age, which will simply be adjusted for by the insurer as necessary, upon discovery of the misstatement During the contestable period (the first two years of the policy), the insurer has the right to contest a claim or void a policy for inaccurate information in the application. Misstatements of age or sex are not subject to the contestability period. If the insurer discovers the applicant made a misstatement of age or sex, the mistake will be corrected and the policy face amount will be adjusted accordingly. After the contestability period, the insurer cannot deny payment of death benefits based on the statements in the application, any material misstatement, concealment or fraud. The incontestability clause applies to the policy's face amount and any additional riders that pay an additional death benefit. For accidental death benefits, the insurer has the right to investigate a claim because the circumstances for accidental death may not be straight forward.

Life Income Settlement [Life Insurance]

The life income settlement option uses an annuity to pay the policy proceeds. The beneficiary is provided with income that cannot be outlived: income is guaranteed for the beneficiary's entire life. The amount of each payment depends on the beneficiary's life expectancy (age and gender), the amount of the policy proceeds, interest rate, and any payout guarantees. There is some risk inherent in the life income option. If the beneficiary lives well beyond his expected lifespan, the insurer must pay out-of-pocket after the principal has been depleted. However, if the beneficiary dies earlier than expected, the balance of the principal is forfeited to the insurer. Because of the risk involved with the life income option, insurers provide additional options to ensure that part or all of the policy proceeds are disbursed. These additional guarantees lower the amount of the payments. There are several versions of the life income option including the following. These will be discussed in greater depth in the annuities chapter. 1. Cash refund 2. Installment refund 3. Straight life 4. Life with period certain 5. Period certain 6. Joint and survivor

Misstatement of Age or Sex Clause

The misstatement of age or sex provision allows the insurer to adjust the policy benefits and/or premium if the insured's age or sex is misstated on the policy application. The benefits and/or premium would be adjusted to an amount that would have been required if the insurer had the correct age or sex If the misstatement is discovered while the insured is alive, the insurer may adjust the amount of future premiums and/or the face amount. If the age is understated, the insurer will lower the death benefit or increase the premium. If the age is overstated, the insurer will increase the death benefit or refund overpaid premiums. If is the misstatement is discovered upon the insured's death, the death benefit will be adjusted. Remember, the misstatement of age or sex provision is not subject to the incontestable clause.

One-year Term Option for Life Insurance

The one-year term option or fifth dividend option allows the policyowner to use the dividend as a single premium to purchase one-year term protection. The amount of the term coverage is based on the insured's attained age, and the face amount can be no more than the amount of the policy's cash value. Example: Tom receives a $200 dividend, and he has $70,000 in cash values. If $125 of the dividend suffices to buy $70,000 worth of one-year term coverage, then Tom can use the remaining $75 of the dividend on other dividend options. If the insured dies while the one-year term coverage is in effect, the insurer will pay the face amount on both the permanent policy and the one-year term coverage.

Payor Rider [Life Insurance]

The payor rider is used for juvenile life insurance. The payor rider states that if the individual paying the premiums becomes disabled or dies before the child reaches a certain age, such as 21 or 25, the policy premiums will be waived until the child reaches the specified age. The policy will stay in force while the premiums are waived. This rider protects parents or guardians who purchase life insurance on their children from lapsing coverage if they become disabled or die before the child is of age to assume policy ownership.

Changes Policyowners can make [Life Insurance]

The policyowner can change beneficiaries at any time without their consent as long as they are named as revocable. The policyowner must receive the irrevocable beneficiary's written consent to change a beneficiary. The policyowner may request a change to the named beneficiary either by filing (contacting the insurer via phone or in writing and requesting the change - the recording method) or by an endorsement (changing the policy itself to indicate the change in beneficiary). It is important to note that the changing of a designated beneficiary cannot be done through a will. In addition to a change in revocable beneficiary, the owner of a life insurance policy also has the power to make a policy loan or surrender the policy for its cash value, without the beneficiary's consent. However, the policyowner may not increase the amount of the insurance without the beneficiary's consent.

Reduction of Premium Payments Option for Life Insurance

The reduction of premium payments option allows the policyowner to use the dividend to offset the cost of a future premium payment. Example: If the next year's annual premium is $1,500 and the dividend received is $300, then the next year's premium would be reduced to $1,200.

Return of Cash Value Rider [Life Insurance]

The return of cash value rider allows a whole life policy's cash value to be included in the death benefit. Similar to the return of premium rider, this rider doesn't actually return the policyowner's cash value; instead, the rider provides the additional benefit through an increasing term rider that always equals the policy's cash value. The return of cash value rider was created as a response to policyowners who misunderstood how cash value in permanent life insurance accrues interest to equal the policy face amount.

Return of Premium Rider

The return of premium rider pays the total amount of premiums paid into the policy as long as the insured dies within a certain time period specified in the policy. The death benefit is comprised of the face amount plus the total premiums paid into the policy. Most policies drop the return of premium rider when the insured reaches age 60. The return of premium rider is simply an increasing term rider that matches the total premium input. This rider can be costly because as the insured ages, the cost of term protection increases.

Spendthrift Trust Clause

The spendthrift clause is used to prevent creditors from seizing life insurance policy proceeds provided there is at least one named beneficiary, excluding the insured's estate. The spendthrift clause protects the policy proceeds from the claims of the policyowner's or beneficiary's creditors. The spendthrift clause only protects policy proceeds paid in installments over a period of time - funds held by the insurance company to be paid to the beneficiary at some point in the future. It does not prohibit creditors from reaching benefits received in a lump sum payment.

Spouse/Other-insured Term Rider [Life Insurance]

The spouse other-insured term rider gives term protection for a specific period of time and amount. The rider typically expires when the spouse/other-insured reaches a certain age, such as 65.

Substitute Insured Rider (Exchange Privilege Rider) [Life Insurance]

The substitute insured rider, also known as the exchange privilege rider, allows the insured under a life insurance policy to be changed. The substitute insured rider is useful for business life insurance contracts where key employees change employers or retire. Rather than go through the policy replacement process, the substitute insured rider allows the policy to continue with the same face amount; however, the policy premiums will be refigured based on the new insured's age, health, sex, and insurability.

Suicide Clause for Life Insurance

The suicide clause is one of the most common exclusions. The suicide clause is intended to prevent individuals, whether sane or insane, who are considering suicide from purchasing life insurance. It states that the policy will be voided and no death benefit will be paid if the insured commits suicide within a stipulated time period. In most states, the suicide clause is in effect for one or two years from the policy effective date. After the stipulated period passes, the insurer will pay the death benefit even if the insured commits suicide. If the insured commits suicide while the suicide clause is in effect, the insurer will refund the premiums paid without interest.

Uniform Simultaneous Death Act

The uniform simultaneous death act solves the problem of determining who receives the policy proceeds if the insured and the primary beneficiary are killed at the same time due to a common accident. If there is no conclusive evidence of who died first, then the Uniform Simultaneous Death Act states that the policy proceeds will be paid as if the primary beneficiary died first and the insured died last, in which case the policy proceeds are paid to the contingent beneficiaries or to the insured's estate. In most policies, the primary beneficiary must die within a certain number of days of the insured, such as 30, 45 or 60, in order for the primary beneficiary to be considered to have died first. If there is evidence that the insured died first, then the primary beneficiary or his estate would receive the policy proceeds.

Waiver of Premium Rider [Life Insurance]

The waiver of premium rider allows the policyowner to waive premium payments during a disability, and keeps the policy in force. Waiver of premium rider coverage requires an additional premium charge. The waiver of premium rider is an option that may be rated or denied by the insurer. The disability must be total and permanent. After a certain age (usually 60 or 65), the waiver of premium rider is void. If the policyowner becomes disabled right before the rider expiration date, the rider will still apply. There is usually a waiting period of 3 or 6 months once the policyowner becomes disabled before the first premium will be waived. The policyowner is not required to pay back the waived premiums if he recovers from the disability. The waiver of premium rider can only be added to a term policy because there is no cash value. Example: Becky becomes disabled 10 months before she turns 65 and her disability lasts for 36 months. Under the waiver of premium clause, the company will waive her premiums for 30 months (30 months)-(6 month waiting period.)

War or Military Service Clause for Life Insurance

There are 2 kinds of war or military service exclusions: 1. Status clause - the insurer will not pay the claim if the insured dies while in active military service. 2. Results clause - the insurer will not pay the claim if the insured dies due to an act of war. The war or military service clause is only in effect during wartime.

Settlement Options

There are five settlement options: 1. Lump sum 2. Interest only 3. Fixed-period installments 4. Fixed-amount installments 5. Life income Settlement options are the ways, other than lump-sum, that life insurance policy proceeds are paid out to beneficiaries upon the insured's death or when the policy endows. Before life insurance settlement options were introduced, the only payout method available was one lump-sum cash payment. While still available, the lump-sum payout may not be the best way to distribute policy proceeds, especially if the beneficiary does not manage money well. The introduction of settlement options made additional methods available for disbursing policy proceeds other than lump-sum. Settlement options allow the policy proceeds to be retained by the insurer and paid out gradually. Because the policy proceeds are reinvested, they earn interest, and the interest portion of payments is taxable.

Policy proceeds paid while the insured is alive

When a life insurance policy is surrendered for its cash value, taxes apply to any portion of the proceeds that exceed the cost basis. Policy proceeds received as an accelerated death benefit or viatical settlement for chronically or terminally ill insureds are not subject to federal income tax. However, for chronically ill insureds there is a maximum amount, indexed annually, that may be tax-sheltered for an accelerated benefit. In 2010 this amount was $290 per day.