KEYWORDS: LIFE INSURANCE POLICY PROVISIONS, OPTIONS, AND RIDERS

Please review the following keywords prior to beginning this chapter. The understanding of their basic definition will improve comprehension of the chapter content.

Absolute Assignment:  This is a policy assignment under which the assignee (person to whom the policy is assigned) receives full control over the policy and also full rights to its benefits. Generally, when a policy is assigned to secure a debt, the owner retains all of the rights in the policy in excess of the debt, despite the fact that the assignment is absolute in form.

Accidental Death Benefit (Multiple Indemnity) Rider:  This rider pays an additional sum to the beneficiary if the insured dies due to a covered accident. The amount paid is a multiple of the policy face amount, such as double or triple the original benefit. Accident death life insurance provides the cheapest way to add a significant amount of coverage for a limited period.

Accelerated Benefits Rider:  This rider allows the insured to receive a portion of the death benefit before death if the insured has a terminal illness and is expected to die within one-to-two years. Regardless of the amount that’s withdrawn in an accelerated death benefit, it will decrease the death benefit when death occurs.

Accumulate Interest Option:  The “accumulate interest” dividend option allows the policy owner to leave dividends with the insurer to accumulate interest. In turn, the policy owner is required to pay taxes on any interest (profit) that’s generated by the dividend.

Assignment Clause:  This clause allows for the right to transfer policy rights to another person or entity.

Automatic Premium Loan Provision (or Rider):  This provision allows the insurance company to deduct the overdue premium from an insured’s cash value by the end of the grace period if a payment is missed on a life policy. The insurance company can AUTOMATICALLY take out a LOAN for the insured against her CASH VALUE to cover her PREMIUM if it doesn’t receive payment when due. This automatic premium loan can continue until the policy owner resumes making payments, or the policy runs out of cash value. Once all of a policy owner’s cash value is gone, if she doesn’t start paying, her policy will lapse.

Cash Option:  The “cash” dividend option allows policy owners to cash out the dividends they receive.

Cash Surrender Option:  The “cash surrender” non-forfeiture option allows the policy owner to receive the policy’s cash value. If this option is exercised, at this point, the policy owner no longer has coverage. Typically, the maximum period that a life insurance company may legally defer paying the cash value of a surrendered policy is six months (Delayed Payment provision).

Collateral Assignment:  This is an assignment of a policy to a creditor as security for a debt. The creditor is entitled to be reimbursed out of policy proceeds for the amount that’s owed. Any proceeds above the amount that’s due at the insured’s time of death will be paid to a beneficiary who’s designated by the policy owner.

Consideration Clause:  This clause states a policy owner must pay a premium in exchange for the insurer’s promise to pay benefits. A policy owner’s consideration consists of completing the application and paying the initial premium. The amount and frequency of premium payments are contained in the consideration clause. An example of the clause is, “Please CONSIDER me for insurance. Here is my COMPLETED APPLICATION, INITIAL PREMIUM, including how much and how often I agree to pay. Please consider me.”

Dependent Riders (Other Insureds Rider):  Dependents may be added as additional (other) insureds through the use of a dependent rider. Other insured riders are typically used for spouses and children.

Dividend Options:  These are the options that a policy owner has when receiving dividend payments from an insurance policy.

Entire Contract Provision:  This provision (or clause) states the insurance policy itself, including any riders, endorsements/amendments, and the application comprises the entire contract between all parties.

Exclusions:  These are features of an insurance policy which states that the policy will not cover certain risks.

Extended Term Option:  This non-forfeiture option permits the policy owner to use the policy’s cash value to buy level, extended term insurance for a specified period. No further premium payments are made.

Free-Look Period:  This period states that the policy owner is permitted a certain number of days once the policy is delivered to examine the policy and return it for a refund of all premiums paid.

Grace Period:  This is a period after the due date of a premium during which the policy remains in force without penalty. If an insured dies during the grace period of a life insurance policy before paying the required annual premium, the beneficiary will receive the face amount of the policy minus any required premiums. For life insurance, the grace period is typically one month.

Guaranteed Insurability Rider (Future Increase Option):  This rider permits the policy owner to buy additional permanent life insurance coverage, at the insured’s attained age, at predetermined intervals without submitting proof of insurability. It also includes specific events, such as marriage and births, without requiring proof of insurability. Typically, the benefit is allowed every three years, up to the original face amount of the policy.

Incontestable Provision (Period):  This provision states that the insurance company cannot challenge the validity of the policy once the policy has been in force for a specific period (generally two years). Over the years, case law has established precedence that the incontestable clause applies to cases of fraud.

Insuring Clause (or Insuring Agreement):  This agreement is the insurer’s basic promise to pay specified benefits to a designated person in the event of a covered loss. The agreement stipulates the scope and limits of coverage, and states, “We ensure to INSURE you for...”

Misstatement of Age or Sex Provision:  This provision allows the insurer to adjust the policy benefits if the insured’s age or sex is misstated on the policy application. The misstatement of age provision allows the insurer to adjust the benefits payable if the age of the insured was misstated when the application for the policy was made. At the time of application, if the insured was older than what’s shown in the policy, benefits would be reduced accordingly. The reverse is true if the insured was younger than listed in the application.

Non-Forfeiture Options:  These are the options an insured has for her cash value if she terminates a policy that has a cash value. For example, “you are closing your account (surrendering your policy); what do you want us to do with your cash (so you don’t forfeit it)?” When a policy owner decides she doesn’t want her insurance policy any longer, she has the option to surrender her policy.

One-Year Term Option:  This dividend option allows the policy owner to exchange the dividend for additional coverage in the form of a one-year term policy.

Paid-Up Additions Option:  This dividend option allows the policy owner to exchange the dividend for an additional single payment whole life policy.

Payor Provision (Rider or Clause):  This provision waives future premiums for a juvenile life insurance policy if the person who’s responsible for paying the premiums dies or becomes disabled.

Policy Loan (Cash Withdrawal) Provisions:  These provisions apply to policies that have cash value, as well as policy loan and withdrawal provisions. These policies must begin to build cash value after a certain number of years which, in most states, is three years. These loans, with interest, cannot exceed the guaranteed cash value. If the loan exceeds the guaranteed cash value, the policy is no longer in force. The policy owner has the right to the policy’s cash value.

Reduced Paid-Up Option:  This non-forfeiture option allows the policy owner to reduce the policy’s benefit amount and, in turn, cease making premium payments.

Reduced Premiums Option:  This dividend option allows the policy owner to return the dividend payment to the insurer in exchange for a reduction in the following year’s premium payments.

Reinstatement Provision:  This provision allows an insured to put a lapsed policy back in force by producing satisfactory evidence of insurability and paying any required past-due premiums. It permits the policy owner to reinstate a policy that has lapsed as long as the policy owner can provide proof of insurability and pays all back premiums, outstanding loans, and interest.

Return of Premium Rider:  This rider pays the total amount of premiums paid into the policy in addition to the face value, as long as the insured dies within a specific period that’s identified in the policy. It may also return premiums to the policy owner at the end of a specified period, if the insured is still alive.

Suicide Clause:  This clause states that the policy will be voided, and no benefit will be paid, if the insured commits suicide within two years from policy issuance. The primary purpose of a suicide provision is to protect the insurer from applicants who are contemplating suicide.

Waiver of Premium Rider: This rider allows the policy owner to waive premium payments during a disability and keeps the policy in force. The waiver of premium rider is not a loan and doesn’t provide cash payments to the policy owner. The insurance company is “waiving” the premiums.” In other words, it’s just as if the policy owner made the premiums every month.

INTRODUCTION

Unlike other lines of insurance, there’s not a standard Life Insurance Policy form that all insurance companies use. Despite efforts by insurance companies to offer products that are different from their competitors, insurance policies are more notable for their many similarities than their differences. The foundation of the uniformity is rooted in the state-level regulation of the industry and the adoption of NAIC guidelines.

Regulators in each state protect consumers by establishing strict guidelines as to what must and must not be included in an insurance policy. Furthermore, in an effort to promote state-by-state uniformity of insurance industry regulation, most states have adopted the standard wording of NAIC Model Regulations. As such, this standard wording is similar among the many different life insurance contracts that are available to consumers.

This chapter will begin with a discussion of the standard provisions that appear in most life insurance contracts. Thereafter, we’ll examine some of the standard exclusions and additional policy options. This chapter will introduce life insurance policy provisions, riders, and exclusions. Overall, this chapter will consider the rights and obligations of insurance contracts and how insurers can modify already existing provisions to increase or decrease policy benefits and premiums to meet an individual’s specific needs.

The chapter is broken into the following sections:

• General Life Insurance Policy Provisions

• Provisions and Options Related to Cash Value

• Provisions and Options Related to Policy Proceeds

• Options Related to Dividends

• Life Insurance Policy Riders

• Life Insurance Policy Exclusions

The state-specific portion of this course (located at the end) will detail the specific insurance definitions, rules, regulations, and statutes for your state. If a conflict exists, state law will supersede the general content.

Review of this chapter will enable a person to:

• Identify the standard provisions that are included in all life insurance contracts

• Understand the structure of a policy loan

• Identify the provisions and options that impact policy cash values

• Understand the taxation structure for insurance policy loans

• Understand provisions and options that impact policy proceeds

• Distinguish between revocable and irrevocable beneficiary designations

• Understand the concept of dividends and their taxation structure

• Distinguish between the different types of life insurance policy riders

• Distinguish between the different types of dividend options

• Distinguish between the principal sum and the capital sum

• Distinguish between level, decreasing, and increasing term riders

• Identify the common exclusions of life insurance contracts

GENERAL LIFE INSURANCE POLICY PROVISIONS 

Most states require the same set of provisions to be included in all life insurance contracts. These standard or usual provisions are almost identical in verbiage regardless of the insurance company or the locale in which the policy is issued.

These “standard provisions” that are found in all life insurance policies identify the duties, obligations, and rights of the parties to the contract. A provision may also be referred to as a policy clause. In general, provisions are intended to protect the owner of the policy.

ENTIRE CONTRACT PROVISION

he entire contract clause or provision is found at the beginning of the policy and states that the entire contract consists of all included policy documents, the attached photocopy of the original application, and any attached riders or endorsements. Nothing may be incorporated by reference, meaning that the policy cannot refer to any outside documents as being part of the contract. Therefore, the insurer cannot deny a claim in the future by stating that it did not provide the policy owner with the entire contract.

Additionally, the entire contract provision prohibits the insurer (including the agent) from making any changes to the policy, either through policy revisions or changes in the company’s bylaws, after the policy has been issued. Naturally, the policy owner or insured is also prohibited from making any changes to the policy.

The following is an example of an actual “entire contract” provision that may appear in a life insurance policy:

“The insurer has issued the policy in consideration of the application and payment of the premium. A copy of the application is attached and is part of the policy. The policy with the application makes up the entire contract. All statements made by or for the insured will be considered representations and not warranties. This insurer will not use any statements in defense of a claim unless it is made in the application, and a copy of the application is attached to the policy when issued.”

This clause doesn’t prevent a mutually agreeable change from being made to the policy if the policy expressly provides a means for modifying the contract after it has been issued. Changes or additions to a life insurance contract are referred to as endorsements, riders, or amendments. Only authorized company officers are permitted to modify or amend an insurance contract and, again, the changes must be agreed upon by the policy owners before taking effect.

Examples of mutually agreeable changes may include the policy owner changing the face amount of an adjustable life policy or adding additional coverage through a rider.

EXECUTION CLAUSE

The execution clause states that the insurance contract will be executed when both parties (the insurer and the policy owner) have satisfied the conditions of the contract. In other words, when both parties have fulfilled their responsibilities, the contract will be executed.

MODIFICATION PROVISION

This provision may be listed separately from the entire contract provisions and states that any changes made to the contract must be in writing and endorsed or attached to the policy. It also states that only an executive officer of the insurer or authorized home office personnel possess the authority to make any changes or modifications or waive a policy provision. A producer or agent is not required to countersign any such modification.

PRIVILEGE OF CHANGE CLAUSE (POLICY CHANGE PROVISION)

The privilege of change clause—also referred to as the policy change provision or conversion option—outlines the conditions under which the company will allow the policy owner to change the policy’s coverage. If the premium is increasing, but the face value remains the same, the insured will not be required to prove insurability. However, the insured is required to prove insurability if the premiums are decreasing or the face value is increasing, since it could result in adverse selection.

For example, this clause may allow you to exchange a higher-premium whole life policy for a cheaper term life policy with the same face amount. This option may seem attractive to an insured who recently found out they have a terminal illness. However, the insured will have to prove their insurability (i.e., that they don’t have a terminal illness) to ensure the insurer isn’t taking on greater risk for lower premium.

INSURING CLAUSE PROVISION

The insuring clause or agreement sets forth the company’s fundamental promise to pay benefits upon the insured’s death. This provision appears on the first page of the policy, which is also referred to as the policy face or cover page. This provision identifies the insurer’s promise, as well as the scope and limits of coverage provided by the policy. In other words, it specifies the death benefit or face amount. Additionally, the insuring clause identifies the amount of the annual premium, the frequency with which the premium is paid, and the name of the beneficiary.

An insuring clause may state that the promise to pay is subject to a policy’s provisions, exclusions, and conditions. Typically, the insuring clause is undersigned by the president and secretary of the insurance company.

One company’s insuring clause reads:

“This agreement has been made between the policy owner and the insurer. It provides a coverage limit of $100,000 payable to the primary or other beneficiaries in the event of the insured’s death. The annual premium is $400 to be paid in the method or mode selected by the policy owner. Further, the Company agrees to pay the surrender value to the policy owner if the insured is alive on the maturity date.”

CONSIDERATION CLAUSE

As previously described, there must be an exchange of value between the two parties for the contract to be legally enforceable. Consideration is the value that’s given in exchange for a contractual promise. In an insurance policy, the consideration clause states that the policy owner’s consideration consists of completing the application and paying the initial premium. The consideration clause or provision in an insurance policy also specifies the amount and frequency of premium payments that the policy owner must make to keep the insurance in force. The material statements of the applicant must be true. Therefore, the policy owner’s consideration in a life insurance contract is the premium paid and his representations regarding health history which appear in the application. Again, the insurer’s consideration in this life insurance agreement is its promise to pay a legitimate death claim once it receives a completed proof of loss (i.e., claim form) accompanied by a notarized death certificate.

If, for some reason, the consideration is not complete on the part of the policy owner, the contract will be void. Void means that there was never a valid contract and coverage was never in effect.

For example, if the policy owner’s check bounces or is returned for insufficient funds, there’s no coverage because there’s no consideration. If the check clears the bank, but the insurer later finds that the applicant engaged in material misrepresentations concerning his health, again, there will be no coverage since there’s no valid consideration. In this latter instance, the insurer will void or cancel the policy and return the premiums to the policy owner.

INCONTESTABLE CLAUSE

The incontestable clause or provision specifies that, after a certain period of time has elapsed (usually two years from the issue date), the insurer no longer has the right to contest the validity of the insurance policy as long as the contract continues in force. Therefore, after the policy has been in force for the specified term, the company cannot contest a death claim or refuse payment of the proceeds even on the basis of fraud, a material misstatement, or concealment.

The incontestable clause applies to the policy face amount plus any additional riders that are payable at death. Although the incontestable clause applies to death benefits, it generally doesn’t apply to accidental death benefits or disability provisions if they’re part of the policy. Because conditions relating to accidents vary and are often uncertain, the right to investigate them is typically reserved by the company.

The insurance company may only challenge (contest) a claim during the policy’s contestable period. Therefore, claims outside of the contestable period are generally incontestable. It should be noted that there are three situations to which the incontestable clause doesn’t apply. A policy that’s issued under any of the following circumstances will not be considered a valid contract and the insurer will therefore have the right to contest and possibly void the policy at any time:

• Impersonation or Identity    For example, if the insurer discovers that one person completed the insurance application, but a different person signed the application or completed the medical exam, the insurer can contest the policy and its claim.

• Lack of Insurable Interest at the Time of Application    If no insurable interest existed between the applicant and the insured at the inception of the policy, the contract is not valid. As such, the insurer can contest the policy at any time.

• Intent to Murder    If it’s proven that the applicant applied for the policy with the intent of murdering the insured for the proceeds, the insurance company can contest the policy and its claim. Since the policy did not have a legal purpose from the start, the insurance company may simply deny coverage. The policy owner is powerless to fight such a claim since no court of law will force an insurer to provide coverage under these circumstances.

A company can always void or cancel a policy for non-payment of premiums. Additionally, statements related to age, sex, or gender can be contested at any time.

MISSTATEMENT OF AGE OR SEX (GENDER) PROVISION

This provision states that if the age of the insured is “misstated” on the application, the policy will not be void or canceled. However, the amount of insurance will be adjusted to be that which would have been purchased by the premium had the correct age been known. In other words, the amount of death proceeds will be adjusted (up or down) to reflect the appropriate benefit that the premium paid would have purchased at the correct age.

A death benefit adjustment is involved whether the age was misstated higher or lower. This means that, even if the applicant lied intentionally about his age to save premium dollars, the insurer will not cancel or void the policy and will not deny a death claim when it discovers the incorrect age. Instead, it will simply adjust the death benefit or the death claim amount. Therefore, if the age of the insured is understated on the application, the insurer will pay a lower death benefit amount at death, and if the age of the insured is overstated, the insurer will pay a higher or additional face amount at death. If the sex of the insured is misstated, the insurer will take the same action of adjusting the face amount. Again, the insurer will not cancel the policy due to these inaccuracies but will adjust the policy benefit.

For instance, let’s assume that a 35-year-old insured purchased a $10,000 policy for $100 and, at his death, it’s determined that the actual age of the insured at the time of application was 40. The premium should have been $125. Therefore, since his age was misstated, the insurer will adjust the death benefit or pay 100/125 or 4/5ths of the original death benefit (i.e., $8,000).

SUICIDE CLAUSE OR PROVISION

For many years, insurers did not cover death as a result of suicide. Today, an insurer continues to protect itself against this contingency of a person taking his own life. Therefore, a suicide provision is inserted in most life insurance contracts. The provision or clause stipulates that death which is caused by suicide is excluded during an initial period after the policy becomes effective. The provision or clause stipulates that death which is caused by suicide is excluded during the initial two years after the policy becomes effective. Therefore, if the insured dies as a result of suicide during the first two years of the policy’s existence, the insurer will deny the claim and refund all premiums paid up to that point to the beneficiary. After the initial two-year period, if the insured dies as the result of suicide, coverage is provided, and the coverage limit will be paid to the beneficiary.

For example, John is covered by a life insurance policy and, six months after he purchases the policy, he commits suicide. Will the insurer pay the death benefit amount to the beneficiary? No, it will not because suicide is not a covered cause of death in the initial two years. If John commits suicide in the first two years, will anything be paid to the beneficiary? Yes, a return of the premium paid will be provided to the beneficiary.

OWNER’S PROVISION (RIGHTS OF POLICY OWNERSHIP)

This provision states that the policy owner possesses all of the rights contained in the policy. In any insurance policy or contract, the policy owner may name or change the beneficiary, borrow against the cash value (if applicable), and select the frequency with which premiums are paid (i.e., the premium mode, such as annual, monthly, etc.). The owner may also choose to transfer one, some, or all of these rights to another party. The transfer of policy ownership rights is referred to as “policy assignment.” Additionally, if the contract is participating, the policy owner possesses the right to receive any dividends (also referred to as excess interest credits) that are payable and vote to elect the company’s board of directors.

More often than not, the policy owner, the policy payor, the applicant, and the insured are all the same person. However, as described previously, this is not always the case.

For example, in the case of a juvenile policy, the parent or guardian is the owner, the payor, and the applicant, whereas the child is the insured. The child doesn’t possess any ownership rights until ownership is transferred to her.

An additional example could involve a divorce where, as part of an alimony judgment, a spouse is required to be the insured and payor of an insurance policy with the other (ex)spouse being listed as the policy owner.

Again, the primary rights of a policy owner include:

▪    The right to assign and change the policy’s beneficiaries

▪    The right to determine how proceeds will be paid (i.e., settlement options)

▪    The right to terminate the policy and select a non-forfeiture option

▪    The right to determine and change the premium payment schedule (not necessarily the amount of the premium, but whether the premium is paid monthly, quarterly, annually, etc.)

▪    The right to assign ownership of the policy to another person

▪    The right to decide what happens with dividends that are paid out from a participating policy

▪    The right to convert or renew a term policy if such option exists within the contract

▪    The right to exercise any other applicable policy options (i.e., guaranteed insurability option, policy loans, etc.)

APPLICANT CONTROL OR OWNERSHIP CLAUSE

If a proposed insured is under the age of majority (i.e., a minor), a parent or guardian is typically the applicant and the policy owner. When this occurs, the parent may have a provision inserted into the contract that provides him with full control of the policy until the minor reaches a specific age. Since the applicant is designated as the person in control of the policy, the provision is most often named, “the applicant control clause.”

ASSIGNMENT PROVISION

Individuals who purchase life insurance policies are commonly referred to as policy owners, rather than policy holders because they own their insurance policies and may do with them as they wish. The assignment provision reiterates one of the policy owner’s rights, as stated in the contract. It enables the policy owner to transfer any or all of their policy rights to another person. This transfer of rights or ownership is referred to as policy assignment. The previous owner is considered the assignor, and the new owner is considered the assignee.

Although the policy owner doesn’t need the insurer’s permission to assign a policy, the assignment provision will lay out the procedure required for the policy owner to transfer or assign his ownership rights. Generally, the policy owner must provide the insurance company with written notification of any assignment. The company will then accept the validity of the transfer without question. Additionally, insurable interest is not required to exist between the insured and the assignee.

The following is a description from the assignment provision of an actual policy: “The policy owner may assign this policy. The insurer will not be responsible for the validity of an assignment. The insurer will not be liable for any payments it makes or any actions it takes before notice of the assignment is provided to it from the policy owner.”

Absolute versus Conditional or Collateral Assignment

An absolute or complete assignment occurs when the policy owner transfers all of her policy (ownership) rights. In this case, the entire contract has been transferred to another party. An absolute assignment involves a complete transfer of the policy to another person. The assignor (original policy owner) is typically not able to recover an absolute assignment. An absolute assignment may also be referred to as a voluntary or complete assignment.

Collateral or conditional assignment occurs when the policy owner assigns one or some of the ownership rights to another party but doesn’t assign all of the policy ownership rights. As such, a collateral (or conditional) assignment is a partial and temporary transfer of policy rights to another person.

In a conditional assignment, the policy owner or assignor transfers a policy right to an assignee. Most conditional assignments involve the use by the assignor of a whole life policy’s cash value as collateral to secure a loan from a financial institution. When the cash value or a portion of it is “assigned” to a bank or “assignee,” the assignee becomes the primary beneficiary with regard to its interest (the amount of money owed). The assignee is only entitled to be reimbursed out of the policy proceeds for the amount of the outstanding loan (i.e., credit) balance. If the insured dies before the assignee is repaid, the death benefit is divided between the assignee and the stated primary beneficiary according to each person’s interest in the policy proceeds. In other words, under a conditional assignment, policy proceeds in excess of the “collateral” amount (i.e., the amount owed to the lender), pass to the insured’s primary beneficiary. Therefore, pledging the cash value of a whole life policy as security for a loan involves a “collateral” assignment.

Policy Assignment and Beneficiaries

Although a more detailed review of beneficiaries will be provided in a later chapter, let’s now focus on examining the provisions that are related to this topic.

The inclusion of the revocable beneficiary provision means that the policy owner may modify, alter, or change the beneficiary at any time and at her discretion. This is one of the owner rights as provided by the policy. If the owner wants to change the beneficiary, she may simply request a “change of beneficiary form,” complete it, and return it to the insurer.

With an irrevocable beneficiary provision, the policy owner or a court of law may designate an irrevocable beneficiary. In this case, the beneficiary designation cannot be changed or modified without the permission or consent of the named beneficiary. If a policy owner names an irrevocable beneficiary, the policy owner must obtain the irrevocable beneficiary’s agreement prior to any assignment. Furthermore, an assignee typically doesn’t have the ability to change an irrevocable beneficiary designation. However, the assignee could change a revocable beneficiary.

An irrevocable beneficiary may be able to assign a portion (or all) of the proceeds in a similar fashion as the policy owner. However, in general, if the beneficiary dies prior to the insured, any assignments that are made by that beneficiary are no longer valid unless the policy owner also agreed to the assignment in writing.

FREE-LOOK PROVISION

When a policy is delivered, this provision allows the new owner to review the contract for a specified number of days. If the new policy owner decides not to keep the policy, she may return it to the insurer as long as this is accomplished within a specified number of days from the delivery date. If the new policy owner decides to take this course of action and return the policy to the insurer, she will receive a full return of premium. The free-look provision may also be referred to as the “right to examine” provision. This provision allows the policy owner to return the policy for a full premium refund without giving the insurer a reason. A free-look provision must be included in all forms of life insurance, with the exception of flight or aviation insurance.

Mandatory free-look periods vary in each state, but they’re generally within 10 days of the delivery date. Depending on the state, there may be additional requirements for variable policies or senior applicants. The free-look period begins when the policy owner receives the policy. Most insurers require their policy owners to sign a dated delivery receipt when they receive their policy, and this receipt triggers the start of the free-look period. For the applicant to receive a premium refund, the policy must be returned within the specified number of days from the date she received it.

For example, if a policy is delivered to the new owner on January 25, the 10-day free look period begins on January 25 and will end 10 days later. In this case, the free-look period will end on February 4. To arrive at the correct answer, the day after the policy is delivered (January 26) should be counted as day one.

MODE OF PREMIUM (PREMIUM PAYMENT) PROVISION

The “mode of premium” provision states that premiums must be paid to an insurer or its representative in order for coverage to be provided and allows the policy owner to select the mode of premium. Insurers vary with regard to the payment modes that are made available. Some policy owners may choose to pay on an annual basis. The policy owner will save the most money (i.e., have lower premiums) if she pays annually, since annual premium payments result in lower administrative and maintenance costs for the insurer. This savings is typically passed to the policy owner. The other methods that are available for the payment of premiums include quarterly, semiannually, or monthly. Since insurers experience substantially higher administrative and maintenance costs when the premium is paid monthly, it’s considered the most costly method.

GRACE PERIOD PROVISION

Grace periods are standard in many other financial products, such as consumer loans, mortgages, credit card payments, etc. In a life insurance policy, the grace period is meant to protect the policy owner against the unintentional lapse of the policy. Grace period describes the period of time following the premium due date, that coverage doesn’t lapse despite the fact that the premium has not been paid. This period is generally 31 days (for some states, it’s 30 days) and coverage remains in effect during the days following the due date. Although it’s no longer a common practice, industrial policies have been known to define their grace period as four weeks. Additionally, some states may have specific laws for grace periods when the policy owner is a senior.

The insurer offers this grace period because it wants to keep business “on the books.” If the insured dies during the grace period and before a premium has been paid, the death benefit will be paid less a pro-rata share of the owed premium. A primary purpose of the grace period, as well as the reinstatement and automatic premium loan provision, is to keep a life insurance policy in force even when a premium payment is late. Keeping the policy in force prevents the life insurance company from requiring the insured to prove their insurability again and prevents the insurer from charging a higher rate for the insured’s increased age.

REINSTATEMENT PROVISION

If a policy lapses because premiums are not paid, many life contracts allow reinstatement as long as it’s requested within three years (for some states, it’s five or seven years) after the policy lapses. However, the request is not the predominant factor. The insurer will require proof of insurability or good health and all back premiums (plus interest) that are owed must be paid to the insurer before reinstatement is granted. Once a reinstatement application (along with proof of insurability and owed premiums) is sent to the insurer, coverage will automatically be reinstated within 45 days unless the insurer rejects the request.

A principal reason for a policy being reinstated is that the contract owner wants to “reinstate” the initial premium rate as well as the coverage limit. Other than an insured’s coverage being reinstated, the most crucial advantage to the reinstatement of an insurance policy is that the premium of the policy will continue to be based on the insured’s age at the time of the initial application (i.e., the applicant’s original age).

Whenever a policy is reinstated, a new two-year contestable period goes into effect for the statements that are made on the reinstatement application. However, there’s no new suicide exclusion. A policy cannot be reinstated if it was surrendered (i.e., given up by the policy owner).

PROVISIONS AND OPTIONS RELATED TO CASH VALUE

The following provisions are associated with the cash value of a whole life insurance policy. There are two primary types of cash value provisions—those involving policy loans and those involving policy surrender. Provisions involving a policy loan give a policy holder the ability to utilize the cash value of a life insurance policy without surrendering it. Provisions involving policy surrender give the policy owner the ability to surrender the policy without losing all of its equity.

EXCESS INTEREST PROVISION

The excess interest provision in life insurance means that the cash value will increase faster than the guaranteed rate if the insurer earns a return that’s greater than the guaranteed rate. Therefore, the excess interest provision allows interest that’s more than the policy’s guaranteed rate of interest to be credited to the cash value account. The following two methods are used for the excess interest provision:

1. Index-linked Method:  The index-linked method credits the excess interest from earnings tied to an economic indicator (e.g., the Consumer Price Index).

2. Portfolio Method:  The portfolio method credits the excess interest in direct relation to the insurance company’s earnings on its investments.

NON-FORFEITURE CASH VALUES

There was a point in time in the life insurance industry that, if a person did not pay her premium and failed to pay it by the end of the grace period, the policy would lapse, and she would forfeit any equity held in the policy. In response to this problem, many states adopted the standard non-forfeiture law. This law requires the policy owner to be given access to any cash value accumulation if she stops paying the policy. In simple terms, this means that a person is allowed to stop paying premiums and not forfeit any of the equity in the policy. The amount of cash value and rate of accumulation will vary by both policy type and company. Additionally, prior to the execution of any non-forfeiture option, the cash value is reduced by any loans that have been taken out.

Insurers are typically required to make cash surrender values available for ordinary whole life insurance after the first three policy years. However, most policies begin to generate cash values in as little as one year.

There are three non-forfeiture options that are available to a policy owner who decides to surrender a whole life policy—surrender for cash, reduced paid-up permanent insurance, and extended term insurance. If this scenario arises, the policy owner can stop paying premiums, and she will not “forfeit” the cash value or equity that has been built up in the policy.

In other words, when a policy owner decides to terminate the policy, she has the “option” of using the cash surrender value in one of three ways. However, none of these options is available if there’s no cash value present. These non-forfeiture options prevent the loss of cash value or equity if the policy owner surrenders the policy. Generally, an option will be selected by the owner; however, in one instance, an option will go into effect automatically.

Furthermore, once a policy is surrendered, it cannot be reinstated. Non-forfeiture options may also be referred to as non-forfeiture benefits or non-forfeiture values since they provide guaranteed values. Generally speaking, a policy cannot lapse as long as there’s cash value present. Non-forfeiture options recognize the equity build up in a whole life policy.

Cash Surrender Option    

Policy owners may request an immediate cash payment of their cash values when their policies are surrendered. Any outstanding policy loans or debts reduce the amount of cash value that the policy owner will receive.

The cost recovery rule states that when a life policy is surrendered for its cash value, the cost basis (total premiums paid) is exempt from taxation. If the amount received in a cash surrender is greater than the total of premiums paid (minus dividends paid), the excess is taxable as ordinary income. A partial surrender will allow the policy owner to withdraw the policy’s cash value on an interest-free basis.

Reduced Paid-Up Option    

A second non-forfeiture option is to accept a paid-up policy for a reduced face amount of insurance. By doing this, the policy owner uses the policy’s cash value as the premium for a single-premium whole life policy at a lesser face amount than the original policy. When this option is exercised, the paid-up policy is the same kind as the original, but for a lesser amount of coverage. This means that if the original policy was a participating policy, the new policy will also be a participating policy. Once the paid-up policy has been issued, the new face value remains the same for the life of the policy. Additionally, as with all whole life policies, the new policy will also build cash value.

The insured’s current attained age is used for premium calculation, but proof of insurability is not required since the benefit is being reduced. Additionally, riders and accidental death benefits from the original policy are excluded from the premium calculation and are dropped from the new policy.

When an insured selects this option, she has recognized the need for some type of permanent life insurance, but no longer wants to continue premium payments. Therefore, this is the option that provides the policy holder/insured with life insurance coverage for the greatest period (i.e., permanent whole life protection).

Extended Term Option    

The extended term option permits the policy owner to surrender the policy and exchange the cash value for a paid-up level term insurance policy. Unless a policy loan is present at the time of surrender, the coverage amount of the new paid-up extended-term life policy will be identical to the face amount of the surrendered whole life policy. Again, since all of the elements in a traditional whole life policy is predetermined, the policy holder will know precisely what the cash value will be in subsequent years. When this option is exercised, the non-forfeiture table will inform the policy owner of the period during which coverage is provided (i.e., 11 years and 165 days). Generally, when a policy lapse occurs with cash value present and the insurer is unable to contact the policy owner, this non-forfeiture option is activated automatically. This fact is also stated in the policy.

If there’s an outstanding policy loan when the policy is surrendered, the balance of the loan is deducted from the cash value amount and the policy’s face value amount. In this situation, loans are deducted from both the face value and the cash value to prevent terminally ill policy owners from taking out large loans before changing to a policy that they know they will not outlive.

The extended term option is typically the default non-forfeiture option for a standard risk insured. If a whole life policy lapses because the policy owner fails to pay the premium and there’s still an amount of cash value present, the extended term option will routinely or automatically be activated if the insurer is unable to make contact with the policy owner.

The extended term insurance option provides the insured with the most life insurance protection (i.e., greatest face amount) in the event of a voluntary policy surrender or non-payment of premium. It also provides an insured with the greatest amount of coverage in the event of non-payment of premium (i.e., as long as the cash value is present).

POLICY LOAN PROVISION

Permanent or whole life insurance is characterized by a buildup of cash value. The policy loan provision, which is required in all whole life policies, outlines that the policy owner has the right to access this equity at his discretion. This provision, which is supported by the previously reviewed owner’s rights provision, permits the owner to receive an advance against the cash value build-up of the whole life policy.

 Structure of a Policy Loan

This advance against the cash value should be considered more of an advance of policy proceeds as opposed to an actual bank loan. A policy “loan” cannot be “called” by the insurance company and is able to be repaid at any time by the policy owner. Additionally, policy loans don’t require credit checks, proof of income, or other things that are commonly associated with taking out a loan. Remember, the policy owner is essentially getting the policy proceeds advanced and using the cash value as collateral. Typically, the only qualification for a policy owner to be able to take out a policy loan is that the policy must have accumulated cash value which is available to secure the loan (i.e., act as collateral). However, if the policy contains an irrevocable beneficiary, the policy owner must secure permission from the irrevocable beneficiary in order to borrow against the cash value.

The maximum loan value of a whole life policy is generally its cash value, less any projected interest. Therefore, policy owners may make withdrawals or partial surrenders in amounts that don’t exceed the cash value, less the interest. Although the loan doesn’t need to be repaid, any outstanding policy loans or interest at the time of the insured’s death will reduce the policy’s face amount. Additionally, if the policy owner later chooses to surrender the policy for cash, the cash value available to the policy owner is reduced by the amount of any outstanding loan, plus interest. Other surrender options (i.e., extended term or reduced paid-up) would also take any outstanding policy loans into account when determining the term period or reduced face value. Taking a loan permits the person to keep the whole life policy in force and use the borrowed funds when cash is needed.

Policy Loan Interest

Keep in mind, while a policy owner may be borrowing “his money,” the insurance company planned on using that money as an investment to return an estimated amount of interest. This estimated interest is a crucial component for an insurance company to fulfill its obligations.

Policy loans reduce the amount of funds that an insurer has to invest and, accordingly, reduce the interest that the insurance company can accumulate. Policy owners are required to pay interest on these loans to offset the interest that the insurance company is missing by not having the funds invested.

Interest rates on policy loans can vary by company. The method for calculating the rate and any rate minimums or maximums must be specified in the policy when it’s issued. Most states stipulate that the maximum allowable fixed rate can be no more than 8%, but some states charge between 5 and10%, or a variable interest rate that’s tied to the Moody’s Corporate Bond Index. If the interest rate is variable, the company may set a new rate each policy year.

The policy owner may pay off the interest each year on the anniversary date of the policy (not the anniversary date of the loan). If the policy owner doesn’t make a scheduled interest payment on a policy loan, the amount of interest due will be added to the loan balance. If policy loan balance (plus interest) ever exceeds the life insurance policy’s cash value, the policy will lapse (no longer be in force).

Uses of a Policy Loan

Individual Uses    The primary advantage of a policy loan is that it provides ready cash for the policy owner without needing to apply or qualify for the loan. Whether it’s to pay debts, pay for emergencies, pay for education expenses, or to be used for a business purpose, a policy owner may use the cash value for any reason when he needs cash. The cash value may also be used as collateral in order to secure another type of loan with a lending institution.

Business Uses    Businesses may take out life insurance to safeguard a number of different risks. As the policy’s cash value grows, the company has the option of taking a policy loan for any reason that it deems necessary. Business policy loans encounter the same rules as loans on individual policies with regard to structure, interest, and repayment. The original purpose for the company taking out the policy may be significantly impacted if the policy proceeds are reduced due to an outstanding loan.

 Taxation

In general, policy loans may be taken out of an individual whole life policy without any tax implications as long as the policy remains active. However, this changes if the policy lapses or is surrendered and there’s an outstanding loan that’s greater than the total premiums paid. When a policy with an outstanding loan is lapsed or surrendered (before the insured’s death), any gains (i.e., the amount received via policy loan that exceeds the premiums paid) will be immediately taxed as ordinary income. Additionally, interest that’s paid to the insurer on a policy loan is not tax-deductible. Tax implications for policy loans that are taken on business-owned life insurance are beyond the scope of this course.

Right to Defer Loan

While not often utilized, insurers typically have the right to defer a policy loan or the payment of the cash value (in most states, this can be for up to six months after its request). This right to defer is designed to protect an insurer if a large number of policy holders decide to make withdrawals at the same time. However, this right to defer doesn’t apply to death benefit claims or automatic premium loan payments.

Even if the policy doesn’t contain an automatic premium loan provision, if the policy owner informs the insurer that he wants to borrow against his policy’s available cash value to pay his premium, the company cannot defer the loan.

AUTOMATIC PREMIUM (OR POLICY) LOAN PROVISION

The automatic premium loan provision offers another way for the policy owner to avoid or guard against the unintentional lapse of his policy, as long as there’s sufficient cash value present in the policy. The automatic premium loan provision allows the insurance company to automatically take a loan against the policy’s cash value to pay the premium due if the required premium is not paid by the end of the grace period.

For example, if the policy owner’s premium due date is the first of the month and he forgets to pay the premium, coverage could lapse following the grace period. However, if this provision has been inserted in the policy and if there’s enough cash value present, once the grace period elapses, the insurer “automatically” withdraws an amount from the cash value in order to pay the premium.

If elected, this provision provides a means by which the policy will pay for itself if the owner inadvertently forgets to pay the premium within the grace period. In other words, if included in a whole life policy, this provision will ensure that coverage continues beyond the grace period by preventing a premium default.

The automatic premium loan provision is NOT automatically included in a policy and must be elected by the policy owner, typically at the time of application. However, there’s generally no charge to add this provision. This provision is only available on policies that offer cash value (i.e., permanent, whole life) and cannot be added to any type of temporary or term insurance. Since the provision is elected (either at the time of application or after policy issue), it may also be referred to as a rider (i.e., the automatic premium loan rider).

The funds that are taken from the cash value constitute a loan and are used to pay the premium. For this provision to work, there must be sufficient cash value present in the policy. In other words, the automatic premium loan provision prevents a policy from lapsing due to the non-payment of premium as long as there’s enough equity in the policy to pay the overdue premium. However, the cash value will eventually reduce to zero and cause the policy to lapse if the policy owner allows the automatic premium loan provision to pay the premiums for an extended period.

Automatic premium loans are added to, and treated the same as, any other policy loans from the standpoint of the maximum loan amount, the interest charged, and the impact to proceeds and surrender values. Although this option is typically elected at the time of application, some insurers may allow for it to be added after the policy is issued. Additionally, insurers may place a limit on the number of consecutive premium payments it will make under the automatic premium loan provision.

PROVISIONS AND OPTIONS RELATED TO POLICY PROCEEDS

When applying for life insurance, the policy owner must understand the purpose of the policy she wants to purchase. Who’s the policy designed to protect (i.e., a child, a spouse, a charity)? What’s the policy’s intended purpose (i.e., income replacement, debt reduction, estate creation)?

One of the important elements that a policy owner should consider when she purchases life insurance is the settlement options or the manner in which death proceeds are paid at the time of the insured’s death. In most cases, the selection is made by the beneficiary at the time of the insured’s death. However, a settlement option may be selected by the policy owner at the time of application. Failure to arrange for the proper payment of proceeds may defeat the very purpose for which the insurance was intended.

Living benefits allow a policy owner to receive a portion of the policy proceeds while the insured is still alive. The insurer will typically require the policy owner to have a physician certify that the insured has a qualifying condition (i.e., terminal illness) before providing access to living benefits.

BENEFICIARY DESIGNATION PROVISIONS

The policy owner has the option to designate who will receive any policy proceeds at the time of the insured’s death (i.e., the beneficiary). The beneficiary designation is part of the entire contract. Later in this course, there will be a closer examination of the types of beneficiary designations and unique circumstances that can arise. Beneficiaries are not required to sign the application or be notified of their designation. The policy owner may change the beneficiary at any time as long as the beneficiary is not irrevocable.

SETTLEMENT OPTIONS PROVISION

The settlement options provision outlines the various ways that the policy’s death benefit may be paid to the beneficiary, as well as who has the authority to decide how the funds will be distributed.

All life insurance policies include a variety of settlement options that are available to a beneficiary when an insured dies. The settlement options provide the beneficiary with more flexibility with which to receive proceeds. The principal method used to pay death proceeds is a lump-sum. In this manner, the beneficiary receives policy proceeds income tax-free in one payment.

Following the death of the insured, if any settlement option other than the lump-sum option is used, the proceeds will remain with the insurer to be paid out in installments. The insurance company must pay interest on the proceeds that remain with them. The interest that’s credited to or paid to the beneficiary is taxable as ordinary income.

The various settlement options available and when they may be used will be examined later in the course.

The spendthrift clause stipulates that the policy owner may select a settlement option at the time of application. However, in most cases, the settlement selection is made by the beneficiary following the insured’s death.

WITHDRAWAL PROVISION

The withdrawal provision is often used when the policy proceeds are held by the insurer and earn interest. This provision outlines the any steps and requirements for withdrawing any funds left on deposit with the insurer. The beneficiary may have the option to withdraw all of the funds or only a limited amount each year.

ACCELERATED (DEATH) BENEFITS PROVISION (RIDER)

The accelerated benefits provision allows an insured to “accelerate” the death benefit of a life insurance policy while still living as long as a physician diagnoses and verifies that the insured is suffering from a terminal illness and is likely to die within 12 to 24 months or less. The accelerated benefits provision is typically added to a policy through an accelerated benefits rider or terminal illness rider. Specific conditions for payment must be satisfied in order for a benefit to be paid. The insured may receive up to a specific percentage (which varies by company) of the death benefit. Any amount that’s paid out under the accelerated benefits provisions will be subtracted from the face value at the time of the insured’s death. This is referred to as the effect on the death benefit.

For example, a $100,000 policy that provides for a 75% accelerated benefit will pay up to $75,000 to the terminally ill insured. The remaining $25,000 is payable as a death benefit to the beneficiary when the insured dies.

Accelerated payment can be made in a lump-sum or through monthly installments over a particular period (e.g., one year), and are received tax-free as long as the insured is terminally ill.

This provision or rider is typically given without an increase in premium. However, companies may deduct an interest charge from the proceeds that are paid out to make up for what the company would have made had the funds not been withdrawn.

Disclosures

When applying for a policy that includes an accelerated benefits provision, the customer must receive a summary of coverage which includes a brief summary of the accelerated benefit, the conditions or occurrences that trigger payment of the benefit, and an explanation of the effect exercising payment under the provisions may have on the cash value, accumulation account, death benefit, premium payments, and policy loans.

If the accelerated benefit option is exercised, the insurer must provide the policy holder and any irrevocable beneficiary with an illustration that:

▪    Demonstrates any effect the payment of the benefit will have on the cash value, accumulation account, death benefit, premium payments, policy loans

▪    Includes a statement that receipt of accelerated benefit payments may adversely affect the recipient’s eligibility for Medicaid or other government benefits or entitlements

▪    Includes a statement that benefits may be taxable, and

▪    Includes a statement that assistance should be sought from a personal tax advisor.

Variations

Another type of accelerated benefit is the catastrophic, chronic, or critical illness coverage rider (i.e., dread disease coverage). The terms of this coverage are similar to the terminal illness rider except that the covered disease must be identified or listed in the policy (e.g., cancer, heart disease, renal failure, stroke, cancer, AIDS, etc.).

Additionally, the rider may provide benefits for those who are unable to perform at least two activities of daily living (e.g., eating, bathing, toileting, dressing, transferring, and continence).

Long-Term Care Rider

Some accelerated benefits are available by adding a long-term care rider to a life insurance policy. If an insured is permanently confined to a nursing home and requires long term care, the policy rider will pay a benefit. A long-term care rider can help safeguard against the financial burden of long-term care. These riders may be added to individual or group policies. For the insured to qualify for an accelerated benefit under a long-term care rider, the (long-term) confinement must be covered by the rider, or additional requirements must be satisfied.

The long-term care rider, similar to an individual long-term care policy, will generally pay benefits when the insured is unable to perform at least two activities of daily living (ADLs). Activities of daily living include eating, dressing, bathing, toileting/continence, walking/ambulation, transferring, or taking medication. As with the accelerated benefits rider, the long-term care benefits that are received will typically be paid out income tax-free.

There are two different ways that a long-term care rider may be designed. When designed using the generalized or independent approach, the long-term care rider is recognized as independent from the base life insurance policy. As such, the base policy’s face amount or cash value is not impacted by any benefits that are paid out. When designed using the integrated approach, the base policy’s death benefit and/or cash value amounts will be reduced by any long-term care benefits that are paid out.

For example, if the life insurance policy has a death benefit of $100,000 and the long-term care rider pays out $20,000 before the death of the insured, the final death benefit paid will be $80,000.

OPTIONS RELATED TO POLICY DIVIDENDS

POLICY DIVIDENDS

As described previously, mutual insurers issue participating or par insurance policies and, as such, provide their policy owners with the opportunity to receive dividends. Although stock companies typically only issue non-participating or non-par policies, in rare cases, they may also issue participating policies, which include the potential for policy owner dividends. A stock insurance company that offers both par and non-par policies is operating on a mixed plan. Mutual companies can issue only participating policies.

An insurance dividend is not considered taxable income since it’s actually a return of an overpayment of premium. Therefore, insurance dividends are tax-exempt. During the sale of insurance, producers cannot inform an applicant that dividends are guaranteed. In fact, most states require a policy that provides a choice of dividend options to include a statement that dividends are not guaranteed. A producer is allowed to provide illustrations or documentation to an applicant that verifies the payment of dividends in previous years by the insurer.

The source of funds from which policy dividends are paid includes mortality, interest, and expenses. At the end of each year, the insurance company will review the money it received (premium payments), the gain (interest) generated by that money, the annual operating costs (loading expenses), and the claim expenses paid out (mortality). The mutual insurer that experiences excess surplus after paying claims and other operating expenses pays dividends to its policy holders.

Dividends typically become payable after the first or second policy year and are generally paid on policy anniversary dates. The policy holder may inform the insurer as to what dividend option she selects. This option will remain the same until the policy holder requests another option.

DIVIDEND OPTIONS

If a policy owner is entitled to a dividend, she can choose how to receive it in any of the five ways identified below. An easy way to remember these options is by using the acronym CRAPO.

1. Cash:  If the policy owner is entitled to a $50 dividend, she may request for the insurer to send payment directly to her. Again, insurance dividends that are received are tax-exempt.

2. Reduced, Reduction, or Suspension of Premiums:  If the policy owner’s annual premium is $250 and he discovers that he’s entitled to a $50 dividend, he may choose to direct the insurer to retain the dividend and subtract that amount from the upcoming premium. The policy owner then pays $200 for the year’s premium. This dividend option assists the policy owner whose primary objective is to conserve cash since the policy owner is not required to remit the entire annual premium. The premium reduction option is the dividend option that’s utilized by the policy owner when the policy owner wants to minimize his current outlay of funds.

3. Accumulate At Interest:  Under this option, the policy owner directs the insurer to retain the $50 dividend in a designated account. When this occurs, the insurer must pay interest on the dividend(s) it holds. Although the dividend is tax-exempt (not taxable), any interest earned on dividends that are left with the insurer is taxable as ordinary income in the year in which the interest is credited, regardless of whether the policy owner actually receives it. As related to life insurance, if death occurs, the face amount is paid plus any dividend accumulations. In the event of a policy surrender, the cash value and dividend accumulations will be paid to the policy owner.

Although it’s not common, a policy dividend may be utilized to pay up a policy earlier than expected by suspending or terminating premium payments. If the situation arises in which the policy’s cash surrender value plus dividends payable or accumulated (if previously left with the insurance company) equals or exceeds what the single premium at the attained age of the insured would be for a coverage amount that’s equal to the current face amount of the policy, the policy will be “paid-up” for life.

[EXAM TIP:  Don’t confuse paying a policy up using dividends with the reduced paid-up non-forfeiture option. Using dividends, the policy (including the original face value) remains fully intact. With a reduced paid-up option, the face value is REDUCED to the amount that the policy’s present cash value could afford if it’s used to purchase a single-premium policy.]

4.       Paid-Up Permanent Additions:  Often referred to simply as paid-up additions (PUA), the policy owner may elect to use the $50 dividend to purchase additional permanent whole life insurance. The amount that can be purchased will be based on two criteria:

• The current age of the insured, and

• The amount of the dividend

The insured is not required to prove insurability. Since there’s no investigation conducted to determine the insured’s health and there’s no agent to whom commissions are paid, the operating expenses or load charge that’s associated with issuing paid-up additions is substantially lower than that which is associated with issuing other insurance coverages. The dividend amount is the premium that will be used to purchase a small amount of permanent paid-up life insurance. In other words, the dividend is being spent on purchasing a small face amount of single premium life insurance. This paid-up addition has its own cash value. Therefore, this option provides for an increase in cash value for the policy owner. If this option is used, it increases the total death coverage to its greatest amount possible.

5.       One-Year Term Insurance:   The $50 dividend can be used to simply purchase any type of term insurance that the insurer offers. The one-year term option is the dividend option that provides the policy owner with a different type of life insurance (i.e., term life insurance) than that which is provided by the primary policy (i.e., whole life) paying the dividend.

This option may be used to purchase as much term insurance as possible up to the base policy’s cash value. Any excess dividend portions may be applied to any of the other dividend options. It may also be used to provide a face amount of life insurance that’s equal to the amount of a policy loan taken against the cash value of the whole life policy.

For example, the policy owner who has an outstanding loan can use this option to buy more life insurance just in case the insured dies before the loan is repaid.

The one-year term insurance dividend option requires a specific application and the issuance of a separate rider. If this option had been selected since the policy’s inception, proof of insurability is typically not required. However, if the policy has been in force for several years with a different dividend option, the insurer may require evidence of insurability.

LIFE INSURANCE POLICY RIDERS

One of the unique features of a life insurance contract is the ability for the policy owner (typically the applicant and insured) to customize the policy to meet his specific needs through policy add-ons (also referred to as riders or endorsements). Riders are special policy provisions that provide benefits that are not found in the original contract, or that make adjustments to the policy.

Since many of these riders provide an additional benefit for the policy owner, their inclusion will typically result in an increase in the cost of the policy (i.e., an added premium).

Policy options and riders are a similar concept to customizing a new vehicle, such as adding leather seats, a sunroof, or even an extended warranty. All of these customizations cost additional money.

Riders are generally added at the time of application; however, in some circumstances, the policy owner may add a rider after the policy is issued. If the policy owner allows their policy to lapse, any additional riders that have been added to the policy will cease, even if the lapsed policy is automatically converted to another type of coverage as provided in the original policy.

WAIVER OF PREMIUM RIDER

When added to an insurance policy, the waiver of premium rider prevents the policy from lapsing if the insured becomes totally disabled. If an insured becomes totally disabled for six consecutive months, the insurer promises to waive any future premium payments until she returns to work. When this rider is in use, the insurer is technically making the premium payments for the insured. Therefore, in a whole life policy, the cash value accumulates as it normally would, and the policy owner can still borrow against the cash value. Also, if the policy is participating, the policy owner will continue to receive any owed dividend payments while the premiums are being waived. The policy owner resumes premium payments if the insured recovers and can return to work. However, the premiums that were paid by the insurer are NOT required to be repaid.

This rider is not automatically included in a life insurance policy and, although it requires an extra premium, it’s actually quite inexpensive. This is considered an additional rider that must be requested by the applicant. This rider may be added to both term and permanent life insurance. Adding the waiver of premium rider to a policy requires an additional charge added to the policy’s premium since the rider provides additional protection to the policy owner and additional risk to the insurance company.

The additional fee required for this rider only covers the protection that’s provided by the rider; it doesn’t have any impact on the cost of insurance or cash values. The rider typically “falls off” once the insured reaches a specified age—which most often ranges from age 60 to 65. Once the rider falls off, the premiums for the policy will be reduced by the additional amount that was required for the rider.

If the insured becomes disabled after the rider falls off, the premiums will not be waived since the coverage is no longer in force. However, the premiums will continue to be waived beyond the limiting age as long as the disability occurred prior to the rider falling off the policy. This benefit applies even if the waiting period (generally six months after the disability occurs) extends past the cutoff age (age 60 to 65).

In addition to making the full premium payments during the waiting period, for the premiums to be waived under this rider, the insured typically must be under the care of a physician and be totally disabled as defined by the policy. Some insurers may also describe the disability requirement as “total and permanent.” Note, there’s not a universal definition of totally and permanently disabled. Depending on the policy, totally disabled may mean that the insured is not able to perform her normal job (own occupation) or is unable to engage in any gainful employment (any occupation). Some policies will even use a combination which applies the “own occupation” definition for a specific period (e.g., the first two years of the disability) and then applying the broader “any occupation” definition if the insured is still disabled. The insured doesn’t need to be hospitalized or collecting Social Security benefits to receive the waiver of premium benefits.

Any premiums that are paid within the initial six months of the disability will be refunded to the policy owner from the first day of disability. The waiver of premium rider waives the required premium payments to keep the policy in force; however, it doesn’t provide any income or modify the coverage provided under the policy in any way. This rider typically excludes disabilities which are the result of acts of war, self-inflicted injuries, or injuries sustained while committing a crime.

WAIVER OF COST OF INSURANCE RIDER

The waiver of cost of insurance rider—also referred to as the waiver of monthly deductions—is typically reserved for universal life policies. Premiums for a universal life policy can fluctuate. For this reason, insurers generally only offer to waive the monthly cost of the insurance, not the total premium that was being paid by the insured. In this case, the cash value will remain level and continue to collect interest, but it will not grow to the extent that it would have had the full premiums been paid.

In some cases, a company may write the rider to waive the guaranteed minimum annual premium instead of the monthly cost of insurance. In this case, the policy’s cash value will grow by the amount of the additional premium payment minus the actual cost of insurance. The cash value will also continue to collect interest. 

DISABILITY INCOME BENEFIT RIDER

The disability income benefit rider provides an income benefit if the insured is totally and permanently disabled as defined by the policy. Most disability income benefit riders provide for a small, stated benefit, such as 1% of the face amount of the policy, that is payable if the insured is totally disabled. The monthly income paid is generally limited to no more than $1,000 per month. Income benefits begin after the six-month waiting period as previously described.

For example, if Jim owns a $20,000 life insurance policy with this rider included and becomes totally disabled, he will be paid $200 per month (1% of $20,000).

As a whole, the disability income benefit rider contains the same type of qualifications and structure as the waiver of premium rider. In fact, most disability income benefit riders waive the premium in addition to including a disability income benefit.

In the event of an insured’s total and permanent disability:

▪    The waiver of premium rider states that the company will pay the premiums. Therefore, the amount paid depends on the amount of the policy’s premium.

▪    The disability income rider states that the company will pay the insured policy owner a monthly income. Therefore, the amount paid is based on the face amount of the policy.

ACCIDENTAL DEATH BENEFIT (ADB) RIDER (DOUBLE INDEMNITY)

This type of rider may also be attached to a life insurance policy for an additional premium. This benefit provides a multiple indemnity and an additional death benefit if the cause of death on a death certificate is listed as “accidental.” Policies that pay a multiple of two times the policy face amount are referred to as double indemnity, while those that pay three times the death benefit for death due to accidents are referred to as triple indemnity, and so forth.

This rider often includes a restriction that the insured must die within 90 days of the accident in order for the additional death benefit to be paid. Therefore, the rider typically doesn’t provide any coverage if the insured dies more than 90 days after the accident. Statistically, in such cases, the cause of death is not accidental, but more likely due to heart failure, kidney or liver failure, pneumonia, or some other type of “non-accidental” cause.

Remember, the cause of death that appears on the death certificate will indicate whether the insurer pays the claim.

For example, if the insured suffers a fatal heart attack or stroke while driving a car and the car crashes into a tree, the policy will not pay the rider benefit.

Additionally, the definition of “accidental death” doesn’t include accidents resulting, directly or indirectly, from an ailment or physical disability relating to the insured. Accidental deaths resulting from self-inflicted injury, war, riot, insurrection, or private aviation activities are also excluded.

This rider provides the least expensive form of life insurance available today. The primary reason that accidental death insurance is cheaper than other life insurance is that it’s limited in scope since it only covers death due to an accident and stipulates that death must occur within 90 days of the accident. Therefore, under this rider, coverage is less expensive than whole life insurance or any type of individual term life insurance, regardless of whether it’s characterized by a level or decreasing face amount.

An accidental death rider provides an additional death benefit for a limited period of time at the lowest possible cost. Typically, the insured must be under the age of 55 or 60 to add the rider, and the extra protection generally expires after the insured reaches the age of 60 or 65. As with the other riders that have age limits, the premium for this benefit is not payable beyond the date on which the additional benefit expires. The benefit also drops off if the policy owner surrenders the policy and selects one of the non-forfeiture options.

The addition of an accidental death benefit rider to a whole life policy doesn’t impact the policy’s cash value. Any policy loans are subtracted from the policy’s face amount and not from the accidental death riders. Additionally, the benefit doesn’t apply to paid up additions or extended term that is purchased with policy dividends.

ACCIDENTAL DEATH AND DISMEMBERMENT (AD&D) RIDER

Some accidental death benefit riders may include dismemberment benefits as well. The death benefit that’s paid under accidental death coverage is referred to as the principal sum. The severance (dismemberment) benefit that’s paid under accidental dismemberment is referred to as the capital sum and is most often one-half of the principal sum.

A dismemberment involves the loss of a limb as a result of an accident. The loss of use of a limb (i.e., paralysis) may also qualify as a dismemberment loss under some policies. However, the loss of a toe or finger doesn’t qualify. Most policies also pay dismemberment benefits for presumptive types of disability, such as the loss of sight or hearing. The principal sum may be paid when an insured loses any combination of limbs, such as a hand and a foot, an arm and a foot, or both eyes.

For example, if an accidental death benefit of $20,000 was purchased and the insured suffers a loss of hearing, the policy will pay (a capital) sum of $10,000 (i.e., 50% of the principal sum).

GUARANTEED INSURABILITY OPTION

This rider allows a policy owner to purchase additional life insurance coverage at specified dates without providing evidence of insurability (i.e., no medical exam required). Since this rider provides specific dates on which additional life insurance policies can be bought, the policy owner can only transact purchases using this option on these days, or within a short window (generally 90 days). Typically, the older the insured gets, the fewer dates the policy owner has to purchase more life insurance. The rider may also allow the policy owner to purchase additional coverage at various milestones (e.g., marriage or the birth of a child). For the birth of a child, it’s often referred to as the stork provision.

The option amount is the maximum life insurance that a policy owner can buy on the specified date (option date). The policy owner can buy the option amount or less on the option date, or none at all. However, the option amounts cannot be added from one option to another if the earlier option date was not exercised. Premium costs for new coverages being purchased under this rider are calculated using the standard premium rates for the insured’s attained age.

Although the concept is the same from company to company, the official name may vary. Other names used to refer to the same type of rider include the insurance protection rider (IPR) or future increase option (FIO).

COST OF LIVING (ADJUSTMENT) RIDER

This rider automatically increases the face amount of the policy at specified intervals based on increases in the Consumer Price Index (CPI). The CPI measures the inflation rate each year. For example, if there’s a 2% rise in this index, the policy owner’s face amount will increase by 2% for the next year. However, a decrease in the index will not result in the lowering of the policy’s death benefit.

The cost of living (COL) rider or cost of living adjustment (COLA) rider can provide increases in the amount of insurance protection without requiring the insured to provide evidence of insurability. Of course, an increase in the death benefit will mean that there’s an increase in premiums. Additionally, a policy owner is not required to add the increased benefit; instead, she may simply request to keep the existing premium and benefit amounts.

These riders can take many different forms depending on the type of policy to which it’s attached. With adjustable life policies, the COL is more of an agreement than a rider. The policy owner already has limited freedom to change the policy’s face value amount. A COL agreement simply waives the need for the insured to prove insurability if the face amount increase is intended to match the increases in the CPI. With whole and term life insurance, a COL typically takes the form of an increasing term rider that’s attached to the base policy. Since universal life insurance policies already have such a high degree of flexibility, the addition of a COL is not sensible.

PAYOR RIDER

The payor rider—also referred to as the payor benefit provision or payor clause—is only added to a policy that an adult purchases to cover the life of a child or juvenile. This rider provides that premiums will be waived until the child reaches age 21 (some policies use the age of 18 or 25) if the premium payor (i.e., parent or guardian) dies or becomes totally disabled. The rider solely covers the premium payments for the policy; it doesn’t provide any income or death benefit to the child.

[EXAM TIP:  Don’t confuse the payor rider with the guaranteed insurability rider. The guaranteed insurability rider may be added to a policy that covers an adult or child and allows the insured to buy more insurance without a medical exam. The payor rider waives premiums or the cost of a policy that covers a child.]

EXCHANGE PRIVILEGE RIDER (SUBSTITUTE OR CHANGE OF INSURED RIDER)

The exchange privilege rider—also referred to as the substitute or change of insured rider—outlines the conditions and processes for changing the insured of an insurance policy. This rider is typically limited to a business policy that covers a key employee or executive. The goal is to simplify updating the insurance policy when such an insured is no longer employed with the business. Although the exchange privilege rider allows for the policy to continue with the same face amount, the premiums are recalculated based on the new insured’s age, sex, insurability, etc.

TERM INSURANCE RIDERS

Many people like the peace of mind that comes with permanent insurance policies and the large, inexpensive face values that are typically associated with term insurance. Term insurance riders were created to give insureds an inexpensive option to add additional temporary coverage to a permanent policy. These riders allow for an additional death benefit (above the permanent face value) if the insured dies during a specified term. Although there’s an additional expense for the extra protection, it’s nominal compared to the cost for the permanent protection and less than if the insured were to take out a separate term policy.

Additionally, if the insured is still alive at the end of the term, the rider will fall off the policy (i.e., the extra coverage terminates) and the cost associated with the rider will fall off of future premium costs. However, the premium and face value that are associated with the permanent protection for which the rider was attached will remain intact.

This additional insurance doesn’t have any impact on cash values or dividends and is typically dropped if the insured exercises a non-forfeiture option or allows the policy to lapse. In addition to only being attached to a permanent policy (a term rider cannot be added to a term policy), the coverage period for a term rider cannot extend past the premium paying period for the permanent policy to which it’s attached.

For example, if a 35-year-old individual is applying for a 20-pay whole life policy, he could also add a $100,000 10-year or even 20-year term rider for a small additional fee. However, he cannot add a 30-year term rider because the policy to which he’s attaching it will be paid-up in 20 years.

As with a standard term life insurance contract, term riders are a common way for an insured to have excess coverage during a specific phase of life (e.g., while raising children). There are many different term riders from which a policy owner may choose, most of which resemble the term life policies described earlier.

Level Term Rider

A level term rider adds an additional fixed, level death benefit for a predetermined period at a predetermined cost to the existing face value of a permanent policy.

For example, an individual has been issued a $50,000 whole life insurance policy with a $100,000 10-year term rider. If she dies in five years (or at any point in the next 10 years), her beneficiary will receive $150,000 ($50,000 for the whole life + $100,000 for the term rider). If the individual dies in 15 years (or at any point after the 10-year term), her beneficiary will only receive the $50,000 face value of the whole life insurance.

Decreasing Term Rider

A decreasing term rider adds an additional decreasing death benefit to the existing face value of a permanent policy for a predetermined period and at a predetermined cost. The cost of a decreasing term rider is lower than the cost of a level term rider because the benefit amount decreases each year. To discourage policy owners from canceling the rider later in the term (when the benefit is scheduled to decrease to a low amount), some insurers may design the premium schedule to end earlier than the protection period. Other insurers may design the benefit to only decrease for a portion of the protection period.

For example, Mary wants to add a 20-year decreasing term policy to her whole life insurance to cover the $100,000 balance of her mortgage. The insurance company may design the rider to start with a face value of $100,000 and decrease by $5,000 per year for a fixed additional premium of $20/month, which is in addition to the premium for the permanent whole life policy.

However, to discourage Mary from canceling the rider as the coverage decreases, the insurer may design the premiums so that they’re complete after 15 of the 20 years. Or the insurer may design the policy so that the face value stops decreasing after 15 years and remains at a fixed $25,000 for the final five years.

Increasing Term Rider

An increasing term rider will allow for an increasing amount of coverage each year. Increasing term riders provide an additional term insurance face amount at death that’s equal to either all premiums paid or the amount of cash value. Increasing term riders may also be referred to as increasing benefit riders and they always increase the cost of the insurance policy.

Return of Premium Rider

The return of premium rider is a type of increasing term insurance that’s added to a whole life policy. When the insured dies, the beneficiary receives the face amount plus an additional (term insurance) death benefit that’s equal to the cumulative total of all premiums paid during the life of the policy. Therefore, under this rider, the amount of coverage increases each year based on the cumulative total of all premiums paid. The policy owner is simply purchasing term insurance that increases as the total amount of premiums paid increases.

Insurers may also offer a return of premium (ROP) term life insurance policy, which returns 100% of the premiums paid over the life of the policy to the policy owner if the insured is still alive at the end of the policy term. Any return of premium is received tax-free. Some policies may allow for premiums to be returned on a sliding scale if the return of premium term life policy is surrendered. If the insured dies during the term, the beneficiary will receive the policy’s face value only, without any premium return.

For example, at the age of 70, an insurer may return all premiums paid over the life of the policy back to a living insured if he carries such a rider.

Return of Cash Value Rider

The return of cash value rider is another type of increasing term rider that provides an increasing amount of term insurance that equals the cash value as it accumulates in a whole life policy. This rider allows the cash value to be paid in addition to the face amount. Again, the rider provides an additional term insurance benefit that’s equal to the cash value amount at the time of death.

RIDERS COVERING ADDITIONAL INSUREDS

At this point, the riders described are added to the insured’s policy and provide the insured (or policy owner) with additional benefits. Riders may also be added to a life insurance policy that provides term insurance coverage for a spouse, children, or entire family. The actual name of the rider may or may not include the word “term.” Whenever the insured adds a rider to their individual policy that covers the life of another person, the insurance provided by the rider will always be term insurance..

As a whole, these riders are referred to as other insured or dependent (term) riders.

▪    The family (term) rider – When added to an insured’s individual policy, this rider covers the rest of the family, but not the primary insured who’s protected by the individual policy.

▪    The spousal (term) rider – This rider may be added to a primary policy to cover a spouse.

▪    The child or children’s (term) rider – This rider may be added to an insured’s policy to cover children or adopted children.

For example, a potential client of an agent or producer wants to purchase a life insurance policy covering her life, but also wants to cover her husband by adding a rider to her policy if he dies in an accident. To meet her policy needs, what type of rider should be suggested? The reference “if he dies in an accident” gives the impression that the accidental death rider should be added to the policy to satisfy this need. However, this is a dependent rider that would be added to cover the spouse. The accidental death rider is added to the primary insured’s policy to cover the primary insured; it doesn’t cover her spouse.

LIFE INSURANCE POLICY EXCLUSIONS

Insurance policies may contain an exclusion provision which provides the insurer with the right to deny a death claim if death is caused by any of the listed exclusions. Exclusions may be listed in the policy itself or attached as riders and referred to as optional provisions or clauses. Today, many exclusions (with the exception of suicide) are being replaced with additional premium requirements (also referred to as a rate-up). Listed below are the most common types of exclusions.

WAR (MILITARY SERVICE)

The war or military service exclusion prevents an insurer’s financial catastrophe and typically applies to declared and undeclared wars. Most life insurance policies will contain one of two common war exclusions clauses. The status war clause is a restrictive type of clause which states that the insured will not possess coverage under an individual life insurance policy while he’s in the military even if he’s killed while away on furlough. The results clause states that an individual policy doesn’t provide coverage if the insured dies while participating in military activities or during military maneuvers of some sort. If the insured was killed while on furlough, he would be covered under an individual policy

[EXAM TIP:  It’s safe to assume that an exam question is referring to the “results clause” unless the exam question explicitly uses the “status war clause.”]

AVIATION

Although it was common years ago, current life insurance policies are unlikely to exclude death for passengers, crew members, or pilots aboard commercial aircraft. However, most life insurance policies will exclude deaths resulting from certain types of high-risk aviation activities.

For example, the activities of a stunt, test, or student pilot, a flight instructor, and aircraft used for agricultural purposes (i.e., crop dusting) are typically excluded.

COMMISSION OF A FELONY (ILLEGAL ACTIVITY)

Some insurance contracts exclude death or injury when it results from the insured committing a felony or doing something illegal. If included in the policy, the exclusion only applies to persons committing the crime since victims or innocent bystanders are always covered.

ILLEGAL OCCUPATION

The illegal occupation provision specifies that the insurer is not liable for losses which are attributed to the insured being connected with a felony or participating in any illegal occupation.

INTOXICANTS AND NARCOTICS

The insurer will typically deny a claim if the insured is intoxicated or under the influence of narcotics at the time of the loss.

SUICIDE

As previously described, all policies exclude the payment of the benefit if the insured commits suicide during the specified period. Again, in the case of suicide during that period, the beneficiary will only receive the premiums paid for the policy up to the time of death, minus any outstanding loans. The suicide exclusion is the only exclusion that “falls off” after a specified period. Any other policy exclusions remain for the life of the policy unless the policy is amended.

HAZARDOUS OCCUPATIONS, HOBBIES, OR AVOCATIONS

Insurers can choose to exclude coverage for deaths resulting from an individual’s dangerous occupation, hobbies, or avocations. In the past, excluding occupations (e.g., a high-rise window washer), hobbies (e.g., scuba diving), and avocations (e.g., a doctor who’s traveling to a third world country to provide care) was a common practice. However, today, most insurers forgo the exclusion and instead offer the coverage if an extra premium is collected (rate-up). If a specific cause of loss is excluded in the policy, it’s excluded forever. If a cause of loss is not excluded in the policy, the cause of loss is covered forever. Hazardous hobbies or occupations may result in the exclusion of certain causes of death by endorsement, resulting in a refund of premiums paid.

For example, let’s assume that Robert has been scuba diving for 10 years when he applies for life insurance. The insurance company may tell Robert that, due to the risky nature of scuba diving, death resulting from a scuba-related accident is excluded from his policy (i.e., it’s not covered). As such, his policy will contain a scuba diving exclusion form, which becomes part of his entire contract. While on vacation, Robert convinces Carol to go scuba diving. Carol obtained life insurance five years ago, but since she has never been scuba diving, the insurer did not include a scuba diving exclusion in her life insurance policy. Unfortunately, Robert and Carol suffer a tragic accident during their scuba excursion and, as a result, both die. Robert’s beneficiary will not receive his policy’s death benefit since scuba-related deaths were excluded. However, Carol’s beneficiary will receive her policy’s death benefit (minus any outstanding policy loans) because scuba-related deaths were not excluded. The insurer cannot change her policy and exclude Carol’s death after the fact (post-claim underwriting) since the exclusion form is not a part of the entire contract.

What if Robert failed to tell his insurer that he frequently scuba dives and, as such, the scuba exclusion form was not included in his entire contract? Would his death then be covered? In reality, it depends. If the policy was inside the contestable period, the insurer could do more research on Robert’s scuba diving history. After finding out that Robert was an avid scuba diver, the insurer may determine that had Robert been untruthful on the application and will exclude the loss. However, if the policy is not inside the contestable period, the incontestable clause forces the insurance company to cover the loss.

The change of occupation provision allows the insurer to reduce the maximum benefit payable under the policy if the insured switches to a more hazardous occupation or to reduce the premium rate charged if the insured changes to a less hazardous occupation.

CHAPTER SUMMARY – LIFE INSURANCE POLICY PROVISIONS, OPTIONS, AND RIDERS

Standard Life Insurance Provisions

Key points to remember from this chapter include:

▪    The entire contract clause or provision is found at the beginning of the policy.

▪    The privilege of change clause (or policy change provision) outlines the conditions under which the company will allow the policy owner to change the policy’s coverage.

▪    The insuring clause or agreement sets forth the company’s basic promise to pay benefits upon the insured’s death and specifies the amount and frequency of premium payments.

▪    The execution clause or provision specifies that, after a certain period has elapsed (typically two years from the issue date), the insurer no longer has the right to contest the validity of the insurance policy so long as the contract continues in force.

▪    The incontestable clause allows an insurer to contest a claim during the contestable period. However, statements related to age, sex, or gender can be contested at any time. The company reserves the right to adjust the premium if the age of the insured is misstated.

▪    Death caused by suicide is excluded during the initial period after the policy becomes effective.

▪    Owner’s Provision or Rights of Policy Ownership states that the policy owner possesses all of the rights contained in the policy. The primary rights of a policy owner include:

‒      The right to assign and change the policy’s beneficiaries

‒      The right to determine how proceeds will be paid (settlement options)

‒      The right to terminate the policy and select a non-forfeiture option

‒      The right to determine and change the premium payment schedule (not necessarily the amount of the premium, but whether the premium is paid monthly, quarterly, annually, etc.)

‒      The right to assign ownership of the policy to another person

‒      The right to decide what happens with dividends that are paid out from a participating policy

‒      The right to convert or renew a term policy if such option exists within the contract

▪    Absolute assignment of an insurance policy involves a complete transfer of the policy to another.

▪    Beneficiaries and assignees are entitled to the proceeds upon the death of the insured before any claims of the insured’s creditors.

▪    Irrevocable beneficiary means that the beneficiary cannot be changed.

▪    The two types of assignments are absolute and collateral.

▪    Mode of Premium states that premiums must be paid to an insurer or its representative in order for coverage to be provided and allows the policy owner to select the mode of premium.

▪    Free-look Provision allows the policy owner to return the policy for a full premium refund without providing the issuer with a reason.

▪    The grace period in a life insurance policy is meant to protect the policy owner against the unintentional lapse of the policy.

▪    The reinstatement period allows an insured to reinstate a lapsed insurance policy. Typically, this must be done within three years of the policy lapse. However, in some states, reinstatement may be allowed for as long as seven years. If the insurer doesn’t accept or reject the reinstatement within 45 days, coverage will be automatically reinstated as if it had never lapsed.

▪    Non-forfeiture options prevent the policy owner from forfeiting a policy’s cash value if he decides to terminate the policy. The three non-forfeiture options are:

1. Cash Surrender

2. Reduced Paid-Up Option

3. Extended Term Option

▪    The cost recovery rule states that, when a life policy is surrendered for its cash value, the cost basis (total premiums paid) is exempt from taxation.

▪    The extended term insurance option provides the insured with the most life insurance protection in the event of a voluntary policy surrender or non-payment of premium.

▪    The primary advantage of a policy loan is that it provides ready cash for the policy owner without needing to apply or qualify for the loan.

▪    The automatic premium loan provision allows the insurance company to automatically take a loan against the policy’s cash value to pay the premium due if the required premium is not paid by the end of the grace period.

▪    The spendthrift clause stipulates that a settlement option may be selected by the policy owner at the time of application. Additionally, it protects the monies, left on account with the insurer to the named beneficiary from creditors.

▪    The accelerated benefits provisions, also referred to as the living benefits or terminal illness rider, allows a policy owner to “accelerate” the death benefit of a life insurance policy if certain conditions are met.

▪    Catastrophic illness coverage covers only identified or listed diseases in the policy, such as cancer, heart disease, renal failure, stroke, etc.

▪    The long-term care rider will generally pay benefits when the insured cannot perform at least two activities of daily living (ADLs).

▪    Activities of daily living (ADLs) include:

‒      Eating

‒      Dressing

‒      Bathing

‒      Toileting/continence

‒      Walking/ambulation

‒      Transferring or

‒      Taking medication

▪    There are two different ways that a long-term care rider can be designed:

‒      Generalized or independent approach

‒      Integrated approach

▪    An insurance dividend is not considered taxable income.

▪    A policy that provides a choice of dividend options must include the statement that dividends are not guaranteed.

▪    Dividend options include:

‒      Cash

‒      Reduced, reduction, or suspension of premiums

‒      Paid-up permanent additions

‒      One-year term insurance

‒      Accumulate at interest

▪    One of the unique features of a life insurance contract is the ability for the applicant (typically the policy owner) to customize the policy to meet her specific needs through policy add-ons, which are referred to as riders.

▪    The waiver of cost of insurance rider, also referred to as the waiver of monthly deductions, is typically reserved for universal whole life policies.

▪    The disability income benefit rider provides an income benefit if the insured is totally and permanently disabled as defined by the policy.

▪    Policies that pay a multiple of two times the policy face amount are referred to as double indemnity, while those that pay three times the death benefit for death due to accidents are referred to as triple indemnity, and so forth.

▪    The death benefit that’s paid under accidental death coverage is referred to as the principal sum.

▪    The severance (dismemberment) benefit that’s paid under accidental dismemberment is referred to as the capital sum and is generally one-half of the principal sum.

▪    The guaranteed insurability option allows a policy owner to purchase additional life insurance coverage at specified dates without providing evidence of insurability.

▪    The payor rider—also referred to as the payor benefit provision or payor clause—is only added to a policy that an adult purchases to cover the life of a child.

▪    Term insurance riders were created to give an insured an inexpensive option to add additional temporary coverage to a permanent policy.

▪    A level term rider adds an additional fixed, level death benefit to the existing face value of a permanent policy for a predetermined period and at a predetermined cost.

▪    A decreasing term rider adds an additional decreasing death benefit to the existing face value of a permanent policy for a predetermined period and at a predetermined cost.

▪    An increasing term rider will allow for a greater amount of coverage each year. Increasing term riders provide an additional term insurance face amount at death that’s equal to either all of the premiums paid or the amount of cash value.

▪    The cost of living rider automatically increases the face amount of the policy at specified intervals based on increases in the Consumer Price Index (CPI).

▪    Additional insured riders can be added to a life insurance policy to provide term insurance coverage for a spouse, children, or an entire family.

▪    The exchange privilege rider—also referred to as the substitute or change of insured rider—outlines the conditions and processes for changing the insured of an insurance policy.

▪    The war exclusion prevents an insurer’s financial catastrophe and typically applies to declared and undeclared wars.

▪    The status war clause is a restrictive-type clause which states that the insured will not possess coverage under an individual life insurance policy while he’s in the military even if he’s killed while away on furlough.

▪    The results clause states that an individual policy doesn’t provide coverage if the insured dies while participating in military activities or during military maneuvers of some sort.

▪    Most life insurance policies will exclude deaths that result from certain types of high-risk aviation activities.