Chapter 9 Policy Provisions
Policy Change Provision (Conversion Option) The policy may contain a provision that permits the insured to exchange a policy for another type of policy form permitted by the company. If the exchange is to a policy with a higher premium, the insured merely has to pay the higher premium and no proof of insurability would be required. If the exchange is to a policy form with a lower premium, proof of insurability may be required as this could result in adverse selection against the insurer.
If Charlie discovers that he has only six months to live, he might decide to exchange his higher-premium 20-pay life for one-year term insurance with the same face amount. The insurer's risk has increased while its premium income has decreased. Thus, Charlie will have to prove insurability.
An assignment of a life insurance contract involves the transfer of some or all of the policyowner's legal rights under the contract to another party. The policy provisions concerning assignment do not usually grant the owner/ insured any rights to assign, but do set out the procedures by which assignments may be made. When assignments are effected, the insurer must be notified. The party receiving the assigned rights is known as the assignee. The person transferring these rights is known as the assignor. There are several types of assignments utilized, including the following.
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An inter vivos trust is one that takes effect during the lifetime of the grantor. A testamentary trust is a trust created after the grantor's death, according to the provisions of the grantor's will.
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Beneficiaries' Assignment Rights In some cases, the policy's beneficiary can assign a portion of the proceeds. However, unless the beneficiary has been named irrevocably, there is actually little to assign. A revocable beneficiary expects to receive the proceeds, unless the policyowner changes the designation to another person. A lending institution is unlikely to advance money based on such an expectancy. An irrevocable beneficiary is more likely to receive the death benefit. An irrevocable beneficiary, then, is more likely to find a lending institution willing to lend money.
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Classes as beneficiaries Rather than specifying one or more beneficiaries by name, the policyowner can designate a class or group of beneficiaries. For example, "children of the insured" and "my children" are class designations.
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Free Look This policy provision permits the policyowner to take a specified number of days to examine the life insurance contract. If the new policyowner decides that the purchase was unnecessary or unwise, the contract may be cancelled with the entire premium refunded by the insurer. The free look laws vary in each state and range from 10- to 20-day periods (longer for senior insurance products). The free look period begins when the policyowner receives the policy. For the applicant to receive a premium refund, the policy must be returned within 10 or 20 days from the date the policy is delivered.
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Modifications or changes in the policy, or any agreement in connection with the policy, such as changes in the beneficiary, face amount, or additional coverage, must be endorsed on or attached to the policy in writing over the signature of a specified officer or officers of the company. Only an executive officer of the insurer can change the contract, not the agent.
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Naming Beneficiaries There are two methods for naming and changing beneficiaries: the filing method and the endorsement method. 9. 3. 18. 2. 1 Filing Method This method of effecting a beneficiary change is also known as the recording method. The request must be filed in writing to the insurer and is made effective by the insurance company recording the change in its records. 9. 3. 18. 2. 2 Endorsement Method This method requires that the beneficiary change be typed or affixed directly to the policy. The insured must make a written request and mail the request along with the policy to the insurance company.
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Some states require life insurance policies to include a provision that gives the insurer the right, at its own expense, to examine an insured while a claim is pending, and in the event of death to perform an autopsy, at its own expense, and where not prohibited by law.
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Uniform Simultaneous Death Act This law stipulates that if the insured and the primary beneficiary are killed in the same accident and there is insufficient evidence to show who died first, the policy proceeds are to be distributed as if the insured died last. This law allows the insurance company to pay the proceeds to a secondary or other contingent beneficiary. If no contingent beneficiary has been named, the insured's estate will receive the proceeds.
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The insured's estate can be named as beneficiary. The insured may direct that the policy proceeds be payable to his executors, administrators, or assignees to pay estate taxes, expenses of past illness, funeral expenses, and any other outstanding debts before the settlement of the estate. However, in general it is not desirable to name the estate as beneficiary. When money enters an estate and there is no will, the court handling the disposition of that estate is required to distribute the assets according to state law, which may or may not be the way the deceased would have wished. In addition, estate costs usually are determined by the size of the probate estate. This means that adding life insurance policy proceeds to the probate estate increases the costs of settling the estate. Finally, when a policyowner leaves policy proceeds to a named beneficiary, there are ways to protect these funds from the beneficiary's creditors. When the proceeds go into the estate, the heirs receive the proceeds in cash, which is more vulnerable to creditors.
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The insuring agreement or insuring clause states that the insurer agrees to provide life insurance protection for the named insured which will be paid to a designated beneficiary when proof of death is received by the insurer.
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This provision or clause in a life insurance policy provides that the insurance coverage is granted in consideration of the application and the payment of the initial premium. The payment of the initial premium is required to place the insurance coverage in effect.
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When this clause is inserted in a life insurance contract, death by suicide is not covered during the policy's first two years. If suicide occurs during this initial two-year period, premiums are refunded but no face amount (death benefit) is paid. Following the two-year period, coverage is provided for suicide.
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A Minor as Beneficiary Naming a minor as the beneficiary of a life insurance policy presents problems. The most immediate of these problems is that a minor would not be competent legally to receive payment of and provide receipt for the policy proceeds if the insured dies before the minor comes of age. An insurance company may hold on to the proceeds, paying interest on them until the beneficiary reaches legal age, or the company may insist that a trustee or guardian be appointed for the minor, someone who is legally entitled to receive and manage the policy proceeds. Some parents anticipate this problem by establishing a trust to administer the life insurance proceeds and all other property in the estate of the parents in the event that both parents die leaving minor children.
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A policyowner has the right to borrow from the cash value, and there is no legal obligation to repay the loan. Interest is assessed by the insurer for these borrowed funds, and the interest rates are determined by each state. Currently, most life insurance contracts charge approximately 8% on some contracts and a variable interest rate on others. Partial surrenders are allowed with a Universal Life or a Variable Universal Life Policy. In a whole life policy, the policyowner can usually borrow up to 90% of the policy's cash value. After a variable life policy has been in force for three years, the minimum percentage of the cash value that must be made available for a loan is 75%. The insurer is not required to loan 100% of the cash value, and if the loan exceeds the policy cash value due to poor separate account performance, the policyowner has 31 days to deposit enough into their account to make it positive. If the policyowner fails to do so, the insurer may terminate the contract.
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Absolute, Voluntary, Complete Assignment Sometimes the policyowner decides to sell or make a gift of a life insurance policy by assigning all rights in the policy to the assignee. This type of assignment is made voluntarily, so it's sometimes called a voluntary assignment. A voluntary assignment usually involves turning all rights—including the right to use the cash value—over to the assignee. For this reason, it can be called an absolute or complete assignment. When an absolute assignment is made, the original policyowner usually has no means of recovering surrendered rights. This type of assignment is usually permanent.
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Collateral, Partial, Conditional Assignment This involves the assignment of some but not all policy rights to an assignee. A lender may wish that a life contract be collaterally assigned so that it may draw upon the cash savings value if loan payments are not paid promptly. Collateral assignment transfers a portion of the ownership right temporarily. Rights are returned to the policyowner when the debt is repaid. In addition, the amount of the assignment cannot exceed the amount of the debt.
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Common disaster clause This clause states that in case of death in a common accident (disaster), the insured will be presumed to have survived the beneficiary. This prevents the payment of the insurance proceeds to the estate of the beneficiary and thus permits the proceeds to be distributed to any contingent beneficiaries or wherever else provided for by the policy. The common disaster clause only goes into effect if the insured and primary beneficiary are involved in the same accident. Most policies specify that the death of the primary beneficiary must occur within 30 to 90 days of the accident. If the primary beneficiary lives past the minimum time period, then the death benefit would be paid to the estate of the primary beneficiary.
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Every life insurance contract contains a grace period. This is the period of time following the date that each premium is due during which the insurance policy remains in force and coverage is provided, even though the premium has not yet been paid. Generally 31 days.
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Exclusions and Limitations Most life insurance contracts contain exclusions, or defined circumstances, that would not be covered if death occurs. Some of the more common exclusions are as follows. 9. 3. 19. 1 Aviation Exclusion This exclusion restricts coverage in the event of death from aviation activities, except when the insured is a fare-paying passenger. This exclusion is generally found in double indemnity (accidental death) provisions as well. This exclusion generally restricts coverage for military pilots and crew members. Aviation-related deaths of test pilots, stunt pilots, student pilots, or crop dusting pilots are not covered (but may be covered for an additional premium). Commercial airline pilots and crew members are usually covered at standard rates. For example, a person who applies for life insurance coverage and is a private pilot, for example, may be issued a policy, but an aviation rider or exclusion (excluding coverage for aviation activities) will be added to it.
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Facility of Payment Provision This provision allows the insurer to select a beneficiary if the named beneficiary is a minor, is deceased, or cannot be found. This provision is found most commonly in group life insurance contracts and industrial life policies. Nor mally, the insurer would select an immediate family member.
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Generally, only universal life and variable universal life policies, with their inherent policy flexibility, permit withdrawals. Because cash value withdrawals (versus loans) are taxable income to the extent they exceed the policyowner's cost basis in the contract, most sizeable withdrawals are technically regarded as "withdrawals" up to the owner's basis. Withdrawn amounts above basis are regarded as "loans," which are not taxable.
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Hazardous Occupation or Hobby Exclusion Few applicants are declined life insurance because of their occupations. Firefighters and police personnel generally can purchase life insurance at standard rates. Instead, underwriters focus on the applicant's avocations or hobbies. If an applicant participates in a hazardous hobby such as auto racing, sky diving, or scuba diving, the amount of insurance that may be purchased may be limited or an extra premium may be charged because of the additional risk. Also, the death benefit may be excluded if death occurred as a result of the hazardous avocation.
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Irrevocable beneficiary The policyowner may also designate an individual to be an irrevocable beneficiary. In this case, the beneficiary designation cannot be changed without the consent and signature of that named beneficiary. The policyowner is responsible for paying the premium but needs consent and a signature from the irrevocable beneficiary in order to exercise ownership rights such as borrowing from the cash value, assigning, or cancelling the policy. An irrevocable designation might be used when a court orders a husband in a divorce settlement or annulment to continue payment on an insurance policy on his own life, with an irrevocable beneficiary designa tion on behalf of his wife (the primary beneficiary) and his children (the contingent beneficiaries).
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Per Capita and Per Stirpes When life insurance proceeds are to be distributed to a person's descendants, a per stirpes or a per capita approach generally is used. Per stirpes means by the root or by way of branches. A per stirpes distribution means that a beneficiary's share of a policy's proceeds will be passed down to the beneficiary's living child or children in equal shares should they (the named beneficiaries) predecease the insured. Therefore, per stirpes means the proceeds go to the descendents of the named beneficiary. The per stirpes beneficiary does not have to be named because it goes through the bloodline. Per capita means per person or by the head. A per capita distribution means a policy's proceeds are paid only to the named beneficiaries who are living. Therefore, per capita means the proceeds go to the named beneficiary. In short, the per capita beneficiary claims the policy's proceeds in his own right, while the per stirpes beneficiary receives the proceeds through the rights of another.
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Prohibited Provisions By law in most states, life insurance policies are not permitted to contain the following provisions: A provision that limits the time for bringing any lawsuit against the insurance company to less than one year after the reason for the lawsuit occurs A provision that allows a settlement at maturity of less than the face amount plus any dividend additions, less any indebtedness to the company and any premium deductible under the policy A provision that allows forfeiture of the policy because of the failure to repay any policy loan or interest on the loan if the total owed is less than the loan value of the policy A provision making the soliciting agent the agent of the person insured under the policy or making the acts or representations of the agent binding on the insured (agent must only be an agent of the company, not the insured) Backdating An insurer may not backdate a policy for more than six months before the original application was made to preserve age and reduce premium. Premium must be collected for each month the policy is backdated.
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Reinstatement If a life insurance contract was not surrendered for the cash savings value, many contracts permit reinstatement of the policy if it is effected within three years of the policy lapse. Proof of insurability may be requested by the insurer. In addition, all owed premiums (back premiums) as well as any outstanding loans must be paid. Many insurers request that a reinstatement application be completed. This means that statements made by the policyowner/applicant are again contestable for two years. The advantage of reinstating a lapsed policy instead of purchasing a new one is the insured original issue age is used when reinstated; therefore, the premium is lower.
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Spendthrift Clause A person who spends money extravagantly is known as a spendthrift. The insured can protect the proceeds of an insurance policy from the actions of a spendthrift beneficiary through the use of a spendthrift clause. This clause in a life insurance policy provides the following features. The proceeds will be paid in some way other than a lump sum. The proceeds or payments to be made to the beneficiary are protected from the beneficiary's creditors while they are still held by the insur ance company. The spendthrift clause also prevents the beneficiary from: transferring the proceeds—assigning payments to a creditor; commuting the proceeds—taking the present value of future payments in a lump sum; and encumbering the proceeds—borrowing money on the strength of the proceeds of the policy. The insured normally elects the spendthrift clause at the time of the application for insurance.
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The automatic premium loan (APL) provision may be added to a cash value life insurance contract and protects the policyowner against the inadvertent lapsing of the contract. If the cash value is sufficient, a loan in the amount equal to the premium due is subtracted from the cash value to pay the premium. In most instances, this provision must be requested by the policyowner at the time of application. Many companies do not allow it to be added once the policy is issued. If the policyowner allows the automatic premium loan to always pay the premium, the policy will lapse when the cash value is reduced to zero. If this happens, the policyowner will not be able to reinstate the policy. All outstanding loan amounts will be deducted from the death benefit upon the death of the insured.
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The entire contract provision is also referred to as the entire contract clause. This provision states that the policy and a copy of the application constitutes the entire contract between the insurer and the insured. A copy of the life insurance application is attached to the policy. The basic purpose of the clause is to provide assurance to the policyowner that he has in his possession all necessary documents with regard to his life insurance coverage. The clause also prevents the policyowner and the producer from unilaterally amending the policy. (Only an executive officer of the insurance company can amend the policy.)
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The incontestable clause of a life insurance policy states that after a specified period of time (two years), the insurer may not dispute or contest the validity of the contract or the statements. After the contract has been in effect for a specific length of time, the insurance company agrees not to challenge any statements made by the applicant on the application.
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This provision specifies when, where, and how premiums are to be paid. Usually premiums are to be paid in advance either at the company's home office or to the agent. The various modes of paying the premium also are identified, such as monthly, quarterly, semiannually, and annually. The least expensive way to pay the premium is annually. The other premium modes require the payment of a service charge added to the basic premium. For example, an annual policy premium may be $300. The monthly premium may be $25.50, which would total $306 of premium in a year.
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Under this provision, the policy provides for an adjustment of benefits payable if it is discovered that, after an insured's death, or at the time of claim, the insured's age was misstated on an insurance policy application. Specifically, the benefit payable will be adjusted to an amount that the premium would have purchased at the correct age. If the misstatement is discovered during the policy period, there may be an adjustment of the face amount or a refund of excess premiums paid. An adjustment is involved whether the age was misstated higher or lower than it actually was. Any inaccuracy regarding the applicant's sex would be treated in the same manner, since premiums for females may be less expensive than those for males.
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War or Military Service Exclusion This exclusion normally provides for the return of premium with interest in the event that death occurs under conditions excluded in the policy. This clause is generally included in a life insurance contract that is issued during wartime or in time of impending military action. The purpose of this clause is to control adverse selection against the company by those individuals entering military service. Especially during wartime, an individual entering the military may purchase more insurance than he normally would. There are two basic types of war clauses. Status-type clause If this clause is included in a life insurance contract, the policy will not pay in the event of death while the insured is in the military, regardless of the cause of death. This would hold true even if the insured were home on leave and the death had nothing to do with military action. Results-type clause This type of clause is much less restrictive than the status type clause. A contract that includes this clause would not provide coverage for a member of the military if the member was killed as a result of military exercises or service in general. However, if the individual was home on leave and fatally injured in an accident or died as a result of a nonservice related illness, the insurer would pay the face amount of the contract.
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When the proposed insured is a minor, the applicant can be the minor's parent or other relative or legal guardian. In such a situation, the applicant— let's say a parent who is applying for insurance on her son's life—will probably want to maintain control of the policy until the insured is of age. This can be accomplished by including a clause that designates the parent (the applicant) as the controller (or owner) of the policy. Because this clause designates the applicant as the person in control of the policy, it is called the applicant control clause or the ownership clause.
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