CHAPTER 12
LIFE
INSURANCE
CONTRACTUAL
PROVISIONS
- FACT “Few policyholders ever read a life
insurance contract with any effort to
understand its provisions”
-Mehr and Gustavson
Life insurance: Theory and Practice
Ownership Clause
• The ownership clause states that the policy
owner possesses all contractual rights in the
policy while the insured is living.
• The owner of a life insurance policy can be the
insured, the beneficiary, a trust, or another
party.
• Rights can be naming and changing the
beneficiary, surrendering the policy for its cash
value, borrowing the cash value etc.
Entire-Contract Clause
• The entire-contract clause states that the life
insurance policy and attached application
constitute the entire contract between the
parties.
• All statements in the application are considered
to be representations rather than warranties.
• The insurer cannot change the policy terms
unless the policy owner consents to the change.
• It also protects the beneficiary from denying a
claim.
Incontestable Clause
• The incontestable clause states that the
insurer cannot contest the policy after it has
been in force two years during the insured’s
lifetime.
• The insurer cannot later contest a death claim
on the basis of a material misrepresentation,
concealment, or fraud.
• The insurer has two years to discover any
irregularities in the contract.
Suicide Clause
• The suicide clause states that if the insured
commits suicide within two years after policy
is issued, the face amount of insurance will not
be paid; there is only refund of the premiums
paid.
• If the insured commits suicide after the period
expires, the policy proceeds are paid just like
any other claim.
Grace Period
• A life insurance policy also contains a grace
period during which the policy owner has a
period of 31 days to pay an overdue premium.
• The purpose is to prevent the policy from
lapsing by giving the policy owner additional
time to pay an overdue premium.
• The policy owner may be temporarily short of
funds or may have forgotten to pay the
premium.
Reinstatement Clause
• The reinstatement provision permits the
owner to reinstate a lapsed policy.
• A policy may lapsed if the premium has not
been paid by the end of the grace period, or if
an automatic premium loan provision is not in
effect.
• There are some requirements must be fulfilled
to reinstate a lapsed policy;
Requirements of reinstatement
• Evidence of insurability.
• All overdue premiums plus interest must be
paid from their respective due dates.
• Any policy loan must be repaid or reinstated,
with interest from the due date of the
overdue premium.
• The policy must not have been surrendered
for its cash value.
• Etc.
Advantage and Disadvantage of
reinstatement
 Read 
Misstatement of Age or Sex Clause
• If the insured’s age or sex is misstated, the
amount payable is the amount that the
premiums paid would have purchased at the
correct age or sex.
 See example 
Beneficiary Designation
• The beneficiary is the party named in the
policy to receive the policy proceeds.
– Primary and contingent
– Revocable and irrevocable
– Specific and class
Primary and Contingent Beneficiary
• A primary beneficiary is the beneficiary who is
first to receive the policy proceeds on the
insured’s death.
• A contingent beneficiary is entitled to the
proceeds if the primary beneficiary
dies before the insured.
……read further ……
Revocable and Irrevocable Beneficiary
• A revocable beneficiary means that the policy
owner reserves the right to change the
beneficiary designation without the
beneficiary’s consent.
• An irrevocable beneficiary is one that cannot
be changed without the beneficiary’s consent.
Specific and Class Beneficiary
• A specific beneficiary means the beneficiary is
specifically named and identified.
• Under a class beneficiary, a specific person is
not named but is a member of a group
designated as beneficiary, such as
“children of the insured.”
Change of Plan Provision
• It allows policy owners exchange their present
policies for different contracts.
• It provides flexibility to the policy owner.
• Changing from an ordinary life to a limited
payment policy will require higher premium.
• A lower premium policy is allowed for
changing from a limited-payment policy to an
ordinary life policy.
Exclusions and Restrictions
• A life insurance policy contains remarkably
few exclusions and restrictions, such as;
– Suicide
– War clause
– Aviation exclusions
– Certain undesirable activities or hobbies
Payment of Premiums
• Life insurance premiums can be paid annually,
semiannually, quarterly, or monthly.
• If the policy is paid other than annually, the
policy owner must pay a carrying charge,
which can be relatively expensive when the
true rate of interest is calculated.
 Check the example 
Assignment Clause
• Absolute assignment transfers all ownership
rights in the policy to a new owner.
• Under a collateral assignment, the policy
owner temporarily assigns a life insurance
policy to a creditor as collateral for a loan.
– Only certain rights are transferred to the creditor
to protect its interest, and the policy owners retain
the remaining rights.
Policy Loan Provision
• Cash-value life insurance contains a policy
loan provision that allows the policy owner to
borrow the cash value.
• The interest rate is stated in the policy.
• Interest on a policy loan must either be paid
annually or added to the outstanding loan if
not paid.
Advantage of Policy Loans
• Relatively low rate of interest
• Substantially lower than credit cards rates.
• No credit checks on the policy owner’s ability
to repay the loan.
• No fixed repayment schedule.
• Policy owner has complete financial flexibility
to determine the amount and frequency of
loan repayments.
Disadvantage of Policy Loans
 This is for you to read 
Automatic Premium Loan
• An overdue premium is automatically
borrowed from cash value after the grace
period expires, provided the policy has a loan
value sufficient to pay the premium.
• It prevents policy from lapsing because of
nonpayment of premiums.
• The policy owner may be temporarily short of
funds or may forget to pay the premiums.
DIVIDEND OPTIONS
• If the policy pays dividends, it’s known as a
participatory policy.
• The dividend represents largely a refund of
part of the gross premium if the insurer has
favorable experiences with respect to
mortality, interest, and expenses.
Sources of Dividends
1. The differences between expected and actual
mortality experience;
2. Excess interest earnings on the assets
required to maintain legal services;
3. The difference between expected and actual
operating expenses.
– But dividends cannot be guaranteed.
Types of Dividends
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Cash
Reduction of premiums
Dividend accumulations
Paid-up additions
Term insurance (5th dividend option)
Cash
• A dividend is usually payable after the policy
has been in force for a stated period, typically
one or two years.
• The policy owner receives a check equal to the
dividend, usually on the anniversary date of
the policy.
Reduction of Premiums
• The dividend can be used to reduce the next
premium coming due.
• This option is appropriate whenever premium
payments become financially burdensome.
• It can also be used if the policy owner has a
substantial reduction in income and expenses
must be reduced.
Dividend Accumulation
• The dividend can be retained by the insurer
and accumulated at interest.
• The accumulated dividends generally can be
withdrawn at any time.
• If not withdrawn, they are added to the
amount paid when policy matures as a death
claim.
• The dividend generally is not taxable for
income tax purposes.
Paid-up Additions
• The dividend is used to purchase a small
amount of paid-up whole life insurance.
• Advantages are;
– The paid-up additions are purchased at net rates,
not gross rates; there are no loading for expenses.
– Evidence of insurability is not required.
• Disadvantages;
– Paid-up additions are a form of single premium
whole life insurance
Term Insurance (5th Dividend Option)
• The dividend can be used to purchase oneyear term insurance equal to the cash value of
the basic policy, and the remainder of the
dividend is then used to buy paid-up additions
or is accumulated at interest.
• A second form of this option to use the
dividend to purchase yearly renewable term
insurance.
NONFORFEITURE OPTIONS
• The payment to a withdrawing policy owner is
known as a NONFORFEITURE value or cashsurrender value.
• If a cash-value policy is purchased, the policy
owner pays more than is actuarially necessary
for the life insurance protection.
• Thus the policy owner should get something
back if the policy is surrendered.
NONFORFEITURE options
• Cash value
• Reduced paid-up insurance
• Extended term insurance
Cash Value
• The policy can be surrendered for its cash
value, at which time all benefits under the
policy cease.
• The cash-surrender option can be used if the
insured no longer needs life insurance.
• If an insured is retired and no longer has any
dependents to support, the need for
substantial amounts of life insurance may be
reduced.
Reduced Paid-up Insurance
• The reduced-up policy is the same as the
original policy, but the face amount of
insurance is reduced.
• The cash-surrender value is applied as a net
single premium to purchase a reduced paid-up
policy.
• This option is appropriate if life insurance is
still needed but the policy owner does not
wish to pay premium.
Extended Term Insurance.
• The net cash-surrender value is used as a net
single premium to extend the full face amount
of the policy into the future as term insurance
for a certain number of years and days.
• That means, the cash value is used to
purchase a paid-up term insurance policy
equal to the original face amount for a limited
period extended..
SETTLEMENT OPTION
• Settlement options refer to the various ways
that the policy proceeds can be paid.
• The policy owner can elect the settlement
option prior to the insured’s death, or the
beneficiary may be granted the that right.
SETTLEMENT OPTION….
• The most common settlement options are as
follows;
• Cash
• Interest option
• Fixed-period option
• Fixed-amount option
• Life income options
Cash
• When insureds die, cash may be needed
immediately for funeral expenses and other
expenses.
• The policy proceeds can be paid in a lump sum to
a designated beneficiary.
• Interest is paid on the policy proceeds from the
date of death to the date of payment.
• Interest is especially important in those cases
where the proceeds are large, and the proceeds
are paid several weeks or months after the
insured’s death.
Interest Option
• Under the interest option, the policy proceeds are
retained by the insurer, and interest is periodically
paid to the beneficiary.
• The interest can be paid monthly, quarterly,
semiannually, or annually.
• The beneficiary can be given withdrawal rights,
by which part or all of the proceeds can be
withdrawn.
• It can be effectively used if the funds will not be
needed until some later date.
Fixed-Period Option
• The policy proceeds are paid to a beneficiary
over some fixed period of time.
• The fixed-period option can be used in those
situations where income is needed for a
definite time period, such as;
– During the readjustment,
– Dependency, and
– Blackout periods.
Fixed-Amount Option
• A fixed amount is periodically paid to the
beneficiary.
• The payments are made until both the
principal and interest are exhausted.
– E.g., assume that the death benefit is $50,000, the
credit interest rate is 4 percent annually, and the
desired monthly benefit is $3,020.
– In this case, the beneficiary would receive $3,020
monthly for 17 months.
Life Income Options
• Death benefits can also be paid to the
beneficiary under a life income option.
• The major life income options are as follows;
– Life Income
– Life Income with Guaranteed Period
– Life Income with Guaranteed Total Amount
– Joint-and-Survivor Income
Life Income
• Installment payments are paid only while the
beneficiary is alive and cease on the
beneficiary’s death.
• There is no refund feature or guarantee of
payments.
• The options provides a highest amount of
installment income.
Life Income with Guaranteed Period
• The beneficiary receives a life income with a
guaranteed period of payments.
• If the primary beneficiary dies before receiving
the guaranteed number of years of payments, the
remaining payments are paid to a contingent
beneficiary.
– E.g., assume that Megan is receiving $2,000 monthly
under a life income option, and the guaranteed period
is 10 years. If Megan dies after receiving only one year
of payments, the remaining 9 years of payments will
be paid to a contingent beneficiary.
Life Income with Guaranteed Total
Amount
• Under the option, the beneficiary receives a
lifetime income, and the total amount paid is
guaranteed.
• If the beneficiary dies before receiving
installment payments equal to the total
amount of insurance placed under the option,
the payments continue until the total amount
paid equals the total amount of insurance.
Joint-and-Survivor Income
• Under this option, income payments are paid
to two persons during their lifetimes, such as a
husband and wife. 
– E.g., Richard and Margo may be receiving $1,200
monthly under a joint-and-survivor income
annuity.
– If Richard dies, Margo continues to receive $1,200
monthly during her life time.
Advantage of Settlement Options
• Periodic income is paid to the family;
– Settlement options can restore part or all of the family’s share
of the deceased earnings.
• Principal and interest are guaranteed;
– The insurer guarantees both principal and interest.
• Settlement options can be used in life insurance planning;
– Life insurance can be programmed to meet the policy owner’s
needs and objectives.
• An insurance windfall can create problems for the
beneficiary;
– Insurers now offer money market accounts for investment of
the death proceeds so that beneficiaries are not forced to make
immediate decisions concerning deposition of the funds.
Disadvantages of Settlement Options
• Higher yields often can be obtained elsewhere;
– Interest rates are offered by other financial
institutions may be considerably higher.
• The settlement agreement may be inflexible and
restricted;
– The beneficiary may not have the withdrawal rights in
an emergency may rise.
• Life income options have limited usefulness at the
younger ages;
– life income option is useful for older people rather
than younger people.
Use of Trust
• The policy proceeds can also be paid to a
trustee, such as the trust department of a
commercial bank.
• Under certain circumstances, it may be
desirable to have the policy proceeds paid to a
trustee rather than disbursed under the
settlement options.
ADDITIONAL LIFE INSURANCE
BENEFITS
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Waiver-of-Premium Provision
Guaranteed Purchase Option
Accidental Death Benefit Rider
Cost-of-Living Rider
Accelerated Death Benefits Rider
Vertical Settlement
Waiver-of-Premium Provision
• If the insured becomes totally disabled from
bodily injury or disease before some stated
age, all premiums coming due during the
period of disability are waived.
• During the period of disability, death benefits,
cash values, and dividends continue as if the
premiums had been paid.
Waiver-of-Premium Provision….
• Before any premiums are waived, the insured
must meet the following requirements;
– Become disabled before some stated age, such as
before age 60 or 65.
– Be continuously disabled for six months or may be
less.
– Satisfy the definition of total disability.
– Furnish proof of disability satisfactory to the
insurer.
Waiver-of-Premium Provision….
 Read the examples 
Guaranteed Purchase Option
• The guaranteed purchase option permits the
policy owner to purchase additional amounts
of life insurance at specified times in the
future without evidence of insurability.
• The insured may need additional life insurance
in the future but unable to afford to buy
today.
Guaranteed Purchase Option….
• Amount of Insurance;
– The typical option allows the policy owner to
purchase additional amounts of life insurance
every three years up to some maximum age
without evidence of insurability.
– E.g., the guaranteed purchase option of one
insurer allows additional purchase of life
insurance when the insured attains ages 25, 28,
31, 34, 37, 40, 43, and 46.
Guaranteed Purchase Option….
•
•
Assume that Heather, age 22, purchase a $25,000 ordinary life insurance policy
with a guaranteed purchase option and becomes uninsurable after the policy is
issued.
Assuming that she elects to exercise each options, she would have the following
amounts of insurance;
Age 22
$
25,000 (basic policy)
+
Age 25
$
25,000
Age 28
25,000
Age 31
25,000
Age 34
25,000
Age 37
25,000
Age 40
25,000
Age 43
25,000
Age 46
25,000
Total Insurance at age 46
$
225,000
Although uninsurable, Heather has increased her insurance coverage from $25,000 to
$225,000.
Advance Purchase Privilege
• Most insurers have some type of advance
purchase privilege by which an option can be
immediately exercised on the occurrence of some
event.
• If the insured
– marries,
– has a birth in the family, or
– legally adopts a child,
• an option can be immediately exercised prior to
the next option due date.
Other Consideration
• An important consideration is whether the
waiver-of-premium rider can be added to the
new insurance without furnishing evidence of
insurability.
• The most liberal provision permits the waiverof-premium rider to be added to the new
insurance if the original policy contains such a
provision.
Accidental Death Benefit Rider
• The accidental death benefit rider doubles the
face amount of life insurance if death occurs
as a result of an accident.
• In some policies, the face amount is tripled.
– E.g., at one insurer, the rider costs $69 annually
when added to a $100,00, policy issued to a male
age 35. Thus, if the insured dies as a result of an
accident, $200,000 will be paid.
Rider = see page 198 for explanation
Accidental Death Benefit Rider ….
• Requirements for Collecting Benefits;
• several requirements must be satisfied before
a double indemnity benefit is paid.
– Death must be caused directly, and apart from
other cause, by accidental bodily injury.
– Death must occur within 90 days of the accident.
– Death must occur before some specified age, such
as age 60, 65, or 70.
Accidental Injury Must Be The Direct
Cause Of Death.
• E.g., assume that Sam is painting his two-story
house.
• If the scaffold collapses and Sam is killed, a
double indemnity benefit would be paid because
the direct cause of death is an accidental bodily
injury.
• However, if Sam died from a heart attack and fell
from the scaffold, the double payment would not
be made.
– In this case, heart disease is the direct cause of death,
not accidental bodily injury.
Death Must Occur Within 90 Days Of
The Accident
• The purpose of this requirement is to establish
the fact the accidental bodily injury is the
proximate cause of death.
• However, because modern medical technology
can prolong life for extended periods, many
insurers are using longer time periods, such as
120. 180, or 365 days.
The Accidental Death Must Occur
Before Some Specified Death
• Insurers usually impose some age limitations
to limit their liabilities.
• Coverage usually terminates on the policy
anniversary date just after the insured reaches
a certain age, such as 70.
Limitations/Objections Of The Rider
• First, the economic value of a human life is not
doubled or tripled if death results from an
accident.
• Second, most person will die as a result of a
disease and not from an accident.
• Finally, the insured may be deceived and
believe that he or she has more insurance than
is actually the case.
Cost-of-Living Rider
• The cost-of-living rider allows the policy
owner to purchase one-year term insurance
equal to the percentage change in the
consumer price index (CPI) with no evidence of
insurability.
• the amount of term insurance changes each
year and reflects the cumulative change in the
consumer price index.
Cost-of-Living Rider….
• E.g., assume that Luis, age 28, buys a $100,000
ordinary life insurance policy and that the CPI
increases 5 percent during the first year.
• He would be allowed to purchase $5,000 of oneyear term insurance, and the total amount of
insurance in force would be $105,000.
• The term insurance can be converted to a cashvalue policy with no evidence of insurability.
Accelerated Death Benefits Rider
• The accelerated death benefit rider allowed
insureds who are terminally ill or who suffers
from certain catastrophic disease to collect part
or all of their life insurance benefits before they
die, primarily to pay for the medical care they
require.
• They generally can be classified as follows;
– Terminal illness rider
– Catastrophic illness rider
– Long-term-care rider