chp 4
Core Policy Provisions and Contractual Components
Entire Contract: A complete life insurance contract consists of the policy document itself, a copy of the original application, and any attached riders, endorsements, or amendments. To be legally valid, this entire contract must be in writing and physically attached to the policy. Material extrinsic to these documents, such as advertisements or sales representations, does not constitute part of the contract.
Modifications Clause: Any changes to the policy must be formalized in writing, signed by an executive officer of the insurance company, and approved by the policyowner. These modifications must be added to the entire contract. Insurance producers are strictly prohibited from making or authorizing policy changes.
Insuring Clause: Located on the first page of the policy, this clause identifies the specific parties involved in the contract. It contains the insurer’s explicit promise to pay the death benefit upon receipt of due proof of death, provided the policy remains in force at the time of the insured's passing.
Ownership Rights: The policyowner is the individual who enters into the contract and possesses all contractual rights. These include:
Naming and changing revocable beneficiaries.
Accessing the cash values of the policy.
Selecting dividend options.
Assigning the policy to other entities.
The sole responsibility for paying premiums.
Note: The policyowner and the insured person do not have to be the same individual.
Assignment: This is the legal transfer of ownership rights. All assignments must be in writing and submitted to the insurer’s home office. The insurer is not responsible for verifying the validity of an assignment. Assignment does not alter the identity of the insured or the amount of coverage.
Absolute Assignment: This represents a permanent and total transfer of all policy rights to another party (e.g., a parent transferring a policy to an adult child).
Collateral Assignment: This is a temporary transfer of specific rights to a creditor to serve as security for a debt. In the event of the insured’s death, the creditor is paid first from the death benefit to satisfy the outstanding debt.
Policy Maintenance, Lapses, and Reinstatements
Grace Period: The grace period is a window of or days following a premium due date during which coverage remains active despite non-payment. If the insured dies during this window, the death benefit is paid to the beneficiary, but the amount of the unpaid premium is deducted from the final payout. This provision is designed to prevent an unintentional policy lapse.
Policy Lapse: A lapse occurs when a premium is not paid by the end of the grace period. Once a policy lapses, it is no longer in force, and the insurer is not obligated to pay a death benefit.
Reinstatement: This provision allows a policyowner to restore a lapsed policy to active status, usually within a -year window following the lapse. Requirements for reinstatement include:
Submission of a written application.
Provision of evidence of insurability.
Payment of all past-due premiums plus interest.
Upon reinstatement, the policy is treated as though it never lapsed, though a new -year incontestability period commences.
Misstatement of Age or Gender: If the insured’s age or gender is recorded incorrectly on the application, the insurer will adjust the death benefit or the premium to reflect what should have been paid based on the correct information at the time of issue.
There is no time limit for correcting such errors.
A misstatement does not void the policy.
The incontestability clause is not applicable to misstatements of age or gender.
Policy Exclusions and the Suicide Clause
Exclusions: These are specific conditions or circumstances that the policy does not cover. These must be explicitly stated in the contract at the time of issue and cannot be added later. Common exclusions include:
Aviation: Specifically for non-commercial pilots.
Military Service: Often managed through a Status Clause.
War: Managed through a Results Clause, which may limit the payout to a refund of premiums only.
Hazardous Occupations or Hobbies: Examples include skydiving or race car driving.
Suicide Clause: If an insured commits suicide within the first years of the policy, the insurer will not pay the death benefit but will refund the premiums paid. This applies regardless of whether the insured was sane or insane and is intended to discourage the purchase of insurance in contemplation of suicide. After the initial -year period, suicide is covered in the same manner as any other cause of death.
Beneficiary Designations and Distribution Methods
Beneficiary: An individual, group, trust, or legal entity designated to receive the death benefit proceeds upon the death of the insured.
The Beneficiary Hierarchy:
Primary Beneficiary: The first person or group in line to receive the benefit.
Contingent (Secondary) Beneficiary: Receives the benefit only if the primary beneficiary is deceased at the time of the insured’s death.
Tertiary Beneficiary: Third in line, receiving benefits only if both primary and contingent beneficiaries are deceased.
Beneficiary Rights:
Revocable Beneficiary: The policyowner can change this designation at any time without obtaining the beneficiary’s consent.
Irrevocable Beneficiary: This beneficiary has a vested interest. The policyowner cannot change the beneficiary, cancel the policy, take a loan, or make major policy changes without the written consent of the irrevocable beneficiary.
Methods of Distribution:
Per Stirpes: Meaning "by the branch," this method ensures that if a named beneficiary is deceased, their share of the benefit passes to their heirs (usually their children).
Per Capita: Meaning "by the head," this method divides the death benefit equally among surviving named beneficiaries. The heirs of any deceased beneficiaries receive no portion of the benefit.
Types of Beneficiary Designations:
Individual (Named): A specifically identified person; best practice involves providing full legal name, date of birth, and Social Security Number.
Class Beneficiary: A designation for a group, such as ‘my children.’ This automatically includes future members of that group unless stated otherwise.
Estate: The default beneficiary if no others are named or living. These proceeds are subject to probate and potential taxes.
Trust: A legal entity that manages how and when the benefit is distributed. It is useful for managing funds for minors, avoiding probate, and giving the policyowner control via trustee instructions.
Special Beneficiary Clauses and Financial Protections
Minors as Beneficiary: If a minor is named directly without a trust or pre-named guardian, the court will appoint a guardian. This process may delay access to funds and may not align with the insured’s wishes. Using a trust is the recommended best practice.
Common Disaster Clause: This covers situations where the insured and the primary beneficiary die in the same accident. If the primary beneficiary does not survive the insured by a set duration (typically days), the law assumes the beneficiary died first. The benefit then passes to the contingent beneficiary.
Uniform Simultaneous Death Act (USDA): If the sequence of death cannot be determined, the law assumes the insured survived the beneficiary. This ensures the payout goes to the contingent beneficiary or the insured’s estate.
Spendthrift Clause: This clause protects the death benefit from the beneficiary’s creditors and prevents reckless spending. It requires the benefit to be paid in installments rather than a lump sum. While funds are held by the insurer, they cannot be encumbered (placed under claim or lien) or assigned by the beneficiary. Once the funds are disbursed to the beneficiary, they can be reached by creditors.
Facility of Payment Clause: This allows the insurer some flexibility to pay the death benefit to a party other than the named beneficiary, specifically those who are ‘equitably entitled,’ such as relatives who paid for medical or funeral expenses.
Disability-Related Riders
Waiver of Premium Rider: If the insured becomes totally disabled, all future premiums are waived. The policy remains in force, and cash values and dividends continue to accrue. A waiting period of to months is standard. The rider usually expires at age .
Waiver of Cost of Insurance Rider: Specifically for Universal Life policies, this waives monthly administrative fees and insurance costs during total disability but does not contribute to cash value growth.
Disability Income Rider: This provides the insured with a monthly income, typically calculated as of the policy’s face amount, during total disability. It begins after a -month waiting period, also waives premiums, and does not reduce the ultimate death benefit.
Payor Benefit Rider: Used in juvenile policies, this waives premiums if the payor (usually a parent) dies or becomes disabled. This remains in effect until the child reaches the age of majority. Evidence of insurability for the payor is required at the time the rider is added.
Riders for Additional Insureds
Spouse Rider: Provides level term coverage for a spouse, typically until age , and is convertible to a permanent policy.
Children’s Term Rider: Covers all children in the family under a single premium rate. Newborns are usually added days after birth with proper notice. This rider includes conversion rights.
Family Term Rider: This is a combination of spouse and child coverage. It is often sold in "protection units," for example: dollars for the insured, dollars for the spouse, and dollars per child.
Nonfamily Rider: This provides coverage for an individual with an insurable interest who is not a family member, such as a business partner.
Death Benefit and Supplemental Riders
Accidental Death Benefit (ADB): Known as Double or Triple Indemnity, this pays or the face amount if death results from accidental bodily injury. Death must occur within days of the accident. The rider expires at age .
Accidental Death and Dismemberment (AD&D): This rider pays a ‘principal sum’ for accidental death and a ‘capital sum’ (usually of the principal) for dismemberment. Loss of two limbs or total eyesight (double dismemberment) pays the full rider amount. Losses must occur within days of the accident, and the rider expires at age .
Return of Premium Rider: This is an increasing term benefit that refunds all paid premiums if the insured dies during the term. The total payout equals the face amount plus the total premiums paid.
Guaranteed Insurability Rider (GIR): This allows the insured to purchase additional coverage at specific ages () or after life events (marriage, birth) without providing proof of insurability. Premiums for the additional coverage are based on the attained age at the time of the increase, and the rider expires at age .
Cost of Living Rider: This automatically increases the death benefit annually to keep pace with inflation as measured by the Consumer Price Index (CPI). It uses increasing term insurance, and while proof of insurability is not required, premiums may increase as the coverage amount grows.
Accelerated Benefit (Living) Riders
Accelerated Benefit Riders: These allow the insured to access a portion of the death benefit while still alive due to qualifying medical conditions. These payouts are generally tax-free but reduce the final death benefit paid to beneficiaries.
Living Needs Rider: Pays between and of the death benefit if the insured is diagnosed with a terminal illness and has a life expectancy of to months. This rider is usually free and if health improves, no repayment is required.
Long-Term Care (LTC) Rider: Allows access to up to of the policy value if the insured is chronically ill or cannot perform out of Activities of Daily Living (ADLs): eating, bathing, dressing, toileting, transferring, and continence. Payouts are tax-free and reduce the final death benefit.
Accelerated Rider Restrictions: These riders cannot introduce new exclusions. Standard exclusions that still apply include suicide, intentional self-inflicted injury, war, and illegal activities.