Trieschmann, Hoyt & Sommer
Loss of Life
Chapter 16
©2005, Thomson/South-Western
Chapter Objectives
• To distinguish among the insurer, the beneficiary, the
insured, and the policyowner of the life insurance policy
• Describe the major characteristics of term life, whole life,
universal life, variable life, and other forms of life
insurance and give examples of appropriate uses for
each
• List three general premium payment arrangements for
whole life insurance and discuss the effects of each
arrangement on the buildup of the policy’s cash value
• Explain how life insurance premiums, death benefits,
and cash values are treated for federal income tax
purposes
2
Chapter Objectives
• Explain the intent of the following contract provisions
– Incontestability clause, suicide clause, misstatement-of-age
clause, misstatement-of-sex clause, entire contract clause,
provisions related to policy assignment clause, war hazard
exclusion, aviation hazard exclusion, spendthrift trust clause,
and grace period and reinstatement provisions
• Explain the nature of policyowner dividends,
nonforfeiture options, and settlement options and
describe the choices available for each of these terms
• Give examples of important considerations in wording
the beneficiary designation in a life insurance policy
• Explain the intent of the waiver of premium benefit, the
accidental death benefit, and living benefit options
3
Introduction
• For many people, the risk management tool most
appropriate for dealing with the exposure of premature
death is life insurance
• The standard arrangement is a contract specifying that
upon the death of a person whose life is insured
– A stated sum of money (the policy’s face amount) is paid to the
person or organization designated in the policy as the
beneficiary
• Many life insurance contracts also have benefits that
may be payable due to circumstances other than death
– One example is the savings element (called the cash value) that
accumulates under some policies
– The cash value can be refunded to the owner of the policy if the
contract is terminated prior to death
4
Types of Life Insurance
• In 2002 the face amount of new life insurance
sold in the U.S. was $2.9 trillion
• Total life insurance in force by the end of 2002
was $16.3 trillion
• Three major types of life insurance
– Term
– Whole life
– Universal life
• Other types of life insurance exist
– Some were more prevalent in past years but
decreased in popularity as newer forms of life
insurance were developed and marketed
5
Term Insurance
• Designed to provide protection if the insured
person dies during a specified period of time
• Accounts for a substantial portion of the face
amount of all life insurance purchased by
individuals in the U.S. each year
• In most cases it has no cash value and cannot
be used to meet savings needs
• Its exclusive focus on death protection means
that, for a given amount of premium dollars
– A person can usually buy a larger face amount of
term insurance coverage than can be purchased with
any other type of life insurance
6
Duration of Term Coverage
• Term insurance contracts are issued for a specific period
of time
– Such as 1 year, 5 years, or 20 years
• At the end of the period, the insurance protection ceases
unless the coverage is renewed
• Some term insurance is sold with the expectation that
the coverage will be renewed several times
• Straight term insurance is generally not renewable
• Another way of stating the policy’s duration of coverage,
instead of specifying an exact number of years
– The contract remains in effect up to a particular age
7
Coverage Options and Guarantees
• A legitimate concern regarding the purchase of term
insurance would arise if there were no guarantees
allowing insureds to renew their term insurance
protection
• A person’s health might deteriorate while the coverage
was in effect
– The individual could be considered uninsurable in the future
– Thus, when the term period ended, the insurance protection
would expire
• And the former insured would be unable to obtain new coverage
• Because many insureds want to protect their right to buy
coverage in the future regardless of their health
– Most insurance companies issue what is known as renewable
term insurance
8
Coverage Options and Guarantees
• Renewable term policies are written for a
specified number of years
– Are renewable for similar periods of time, regardless
of the insured’s health
• Each time the policy is renewed
– The premium increases to reflect the insured’s current
age
• Changes in health status that may have taken
place since the policy was issued are not
reflected in future premiums
9
Coverage Options and Guarantees
• Term insurance renewal rights usually are not completely
unlimited
– Due to insurers’ concerns about adverse selection
• Without some limitation on the right to renew
– Overall mortality rates among insureds would be higher due to
these types of behaviors
– Insurance premiums would have to be greater
• Previously this concern about adverse selection caused
many insurers to offer the renewability option only until
about age 60 or 65
– However, with greater experience and in response to competitive
pressures
• It is now common for insurers to issue policies that can be renewed
until more advanced ages
10
Coverage Options and Guarantees
• Most term policies are convertible into a different form of
life insurance
• Standard conversion provision gives the insured the option
to change the term policy into some form of permanent
coverage to remain in effect for the person’s entire lifetime
– Rather than expiring on a specified date
• When term insurance is convertible, the right to change to
permanent coverage is provided
– Regardless of the insured’s health at the time of conversion
• Some policies can be converted at any time before they
expire
– However, term insurance contracts that can be renewed up to very
advanced ages often are more restrictive regarding conversion
rights
• It is not unusual for conversion rights to end after age 65 for 70
– Even though right to renew policy as term insurance extends to age 90 or
beyond
11
Face Amount Variability
• The majority of term policies have a face amount that
does not change over time
– Referred to as level term contracts
• Term insurance can also be arranged so that the face
amount either
– Decreases over time (decreasing term insurance)
• Usually purchased for specific purpose
– Such as providing cash to pay off a mortgage or other debt if
the insured dies with some of the loan still outstanding
– Increases over time (increasing term insurance)
– Face amount increases periodically on a predetermined basis
– A more common approach for meeting an increasing need is
through a cost-of-living rider or a guaranteed insurability rider
» Both of these are endorsements to a basic level term or
permanent insurance policy
12
Face Amount Variability
• Cost-of-living rider
– Automatically increases the amount of protection by
the same percentage that the Consumer Price Index
has increased since the basic policy was issued
– As long as the insured accepts and pays for the
additional amount of coverage each time it is offered,
no evidence of insurability is required
• Guaranteed insurability rider
– Provides that the insured will be able to purchase
additional amounts of insurance protection in the
future
• Regardless of health
• Subject to stated maximums
13
Whole Life Insurance
• May be kept in force for the insured’s entire
lifetime
• Has accounted for more than half of all life
insurance policies sold in the U.S. in recent
years
– Lags behind term insurance with respect to the total
face amount of coverage issued
• Contains the savings elements called cash
values
– If the owner of the whole life policy decides to
terminate it before the insured’s death, the cash value
can be refunded
14
Whole Life Insurance
• A straight life contract is arranged so that the
premiums are payable as long as the insured
lives
• A limited-pay life policy requires that the
premiums are payable for only a specified period
of time
– Such as 20 years or until age 65
– After that time, no further premiums are necessary,
but the coverage remains in effect until the insured’s
death
• Is also possible to pay for a whole life policy with
only one premium
– Called a single-premium life
15
Whole Life Insurance
• When a premium for whole life insurance is paid to the
insurer
– Part of that premium is used to help pay the policy’s fair share of
death benefits for insureds who die that year
– Part of the premium not needed to pay that year’s death benefits
is used to pay current expenses of the insurer
– Any remaining amounts are invested to earn interest
• Life insurance premiums are calculated such that, when
they are combined over time with the premiums and
investment earnings from other similar policies
– All mortality and expense costs can be paid as incurred until all
insureds are dead
16
Whole Life Insurance
• If insureds terminate their whole life contracts before
death
– They are entitled to refunds of the excess premiums that have
accumulated for their policies to date
– Called the policy’s cash value
• The more premium dollars that are paid earlier in the life
of the contract
– The greater the cash value available on policy termination
• Life insurers make various assumptions about mortality
costs, interest earnings, and expenses
– On the basis of these assumptions, it is possible to guarantee
within the contract the cash values that will be generated by
policy termination at various times
17
Universal Life Insurance
• First introduced in the U.S. in 1979
• Offers more flexible premium payment options
than do most other forms of life insurance
• The minimum initial premium required to activate
the policy is specified by the insurer
– But the policyowner usually decides the timing and
size of subsequent premiums
• Policyowners can also periodically adjust the
size of the death benefit in most universal life
contracts
– Although insurers may require proof of insurability if a
request is made to increase the death benefit
18
Universal Life Insurance
• The cash value of the universal life policy is
established deliberately and varies regularly
– Depending on such factors as
• The insurer’s investment savings, mortality experience, and
expenses
• The amount and timing of premiums paid by the insured
• Basic versions of life insurance contracts–differ
only with respect to how the death benefit is
designated
– Type A universal life
– Type B universal life
19
Universal Life Insurance
• Type A universal life
– The death benefit is an amount that remains the same while the
policy is in force
– The death benefit is the cash value plus whatever amount is
necessary to bring the total to the specified amount
• Type B universal life
– Has fluctuating death benefits that are made up of a specified
amount of death protection plus the policy’s cash value
• Table 16-1 provides an illustration of the structure of the Type B
universal life policy
– As the cash value grows over time so does the death benefit
– The actual rates credited correspond closely to money market
rates
» The interest rate credited is an especially crucial item in
determining the size of the cash value and the death
benefit for Type B contracts
20
Table 16-1: Illustration of Type B Universal Life
Insurance Policy Structure (Male, age 25)
21
Universal Life Insurance
• In the first several years following their introduction
– Universal life cash values were credited with interest that
substantially exceeded the minimum guarantees
– Illustrations for selling policies were often based on the
assumption that interest rates of 10 or 11% would continue
throughout the life of the policy
– However, in the early 1990s interest rates dipped to their lowest
levels in decades
– Insurers were forced to credit universal life cash values with
much lower interest rates
• Leading to dissatisfaction among many policyowners
• For the policy illustrated in Table 16-1, a wide range of
potential cash values may result at various ages
– Depending on the interest rate assumption
• Table 16-2 shows some of the possible results
22
Table 16-2: Interest Rate Sensitivity of Type B Universal
Life Policy Cash Values (Initial Death Benefit of $100,000)
23
Variable Life
• The death benefit and cash value fluctuate with the
investment performance of one or more portfolios of
securities
• Policyholders can designate the types of investments
that they want supporting their policies
• If the selected investments increase in value
– Both the face amount and the cash value of the variable life
contract will also increase
• Poor investment performance will result in decreasing
coverage and cash values
– Although a minimal face amount is usually guaranteed
• Originally designed to provide an inflation hedge for both
the death protection and savings elements of the policy
24
Variable Universal Life
• Combines some of the features of both universal life and
variable life insurance
– Referred to as flexible premium variable life
• Contract usually is designed similarly to a universal life
policy with respect to death benefits and flexible
premium arrangements
– A primary difference is that policyowners are given a choice of
investments to be used to support the contract
• Rather than using only high-grade, short-term money market
investments as in the standard universal life policy
• Usually only the cash value of a variable universal policy
varies with the performance of the underlying securities
25
Modified Life
• Can describe many different policy structures
• Usually the contract is a form of whole life insurance with
premiums that are lower than usual for an initial period of
time
– After that time, the premiums are somewhat higher than they
otherwise would be
• Can be especially appropriate for insureds with limited
incomes who want to own permanent life insurance they
cannot currently afforded
• Convertible term insurance can meet the same need
– But many persons who plan to convert their term insurance do
not actually do so because of the substantial premium increase
• An advantage of modified life is that the policyowner
does not have to initiate any type of positive action to
obtain the permanent insurance
26
Endowment
• The amount of endowment insurance sold in the U.S. is
now negligible
• Provides death benefits for a specified period time
– Has a cash value, and the policyowners pay the contract’s face
amount at the end of the protection period if the insured is still
alive
• While the policy does provide death protection
– On a relative basis it emphasizes savings to a much greater
degree than any policy discussed so far
• Most insureds now seek other alternatives because of
the adverse tax treatment now accorded to endowment
policies
27
Industrial Life
• Known variously as industrial life, home service
life, or debit insurance
• Type of cash value life insurance that is sold in
very small amounts
– Primarily to meet burial needs of low income insureds
• The face amount is only a few thousand dollars
• Premiums are only a few dollars each week and
are usually collected personally at the insureds’
homes
28
Industrial Life
• More expensive on a relative basis than other forms of
life insurance because
– Of the high cost of its premium collection method
– Mortality rates tend to be higher for persons who purchase this
form of coverage
• Because the face amount is so small, underwriting
standards are often fairly liberal
– Medical exams are rarely required
• Those who purchase industrial life insurance would be
better served by regular term or whole life insurance
– The low-income status of most of these insureds makes it
unlikely that they will be approached by traditional life agents
29
Credit Life
• Offered in connection with installment sales of consumer
durables, such as automobiles
• Decreasing term insurance issued without a medical
examination
• Will expire when the installment sales contract is paid off
• Cost of protection is incorporated into the regular
payment made by the purchaser
• If the insured dies before the loan is repaid
– Sufficient coverage exists to repay the balance of the debt
– Protects the insured’s dependents as well as the lender
30
Income Tax Treatment of Life
Insurance
• Premiums
– In most cases, individuals cannot deduct the premiums they pay
for individual life insurance
– The primary exception is for someone who is paying premiums
on a life insurance policy owned by a charitable organization
• Death benefits
– As a general rule, when an insured dies and a death benefit is
paid
• The beneficiary does not have to report the death benefit as taxable
income if the proceeds are paid in a lump sum
• When settlement is made through a series of periodic payments
from the insurer
– The beneficiary generally can exclude only part of each
payment from taxable income
– The amount of each payment that represents a distribution of
the original death benefit is not taxed
» While the portion that is due to interest earnings is subject
to taxation
31
Income Tax Treatment of Life
Insurance
• Cash values
– If a life insurance policy with a cash value is
terminated before death and the contract is
surrendered for cash
• It is likely that there will be taxable income that must be
reported in the year of the surrender
• The amount of taxable income is the difference between the
cash received at termination and premiums that were paid
during life of the contract
– While a cash value policy is in force, the annual
increments to the cash value (inside buildup) often
escape immediate taxation
• In many policies these increments are not taxed until the
policy is surrendered for its cash value
32
Income Tax Treatment of Life
Insurance
• Cash Values
– In some policies however, taxation of part of the inside buildup
occurs every year
– The determining factor depends on whether the policy meets the
statutory definition of life insurance as specified in the IRC
• Policies that meet this definition are not subject to immediate
taxation of their inside buildup
• Cash values of policies that cannot meet the requirements will be
partially taxed each year
– According to the IRC, a policy is considered to be life insurance
for tax purposes of it meets at least one of two tests
• The intent of both tests is to assure that the cash value in a
particular policy is not excessive in relationship to the policy’s death
benefit
– Contracts that are primarily savings vehicles and have a only a
nominal death benefit will be unable to pass these tests
» Therefore, these contracts will not be granted an income
tax advantage for the inside buildup
33
Life Insurance Contract Provisions
• The contractual provisions of the life
insurance policy are of special significance
to the insured
• Because it is through the wise use of
these rights that some of the most
valuable benefits of protection can be
obtained
34
Incontestability Clause
• If the policy has been in force for a given period and if the insured
has not died during that time
– The insurer may not afterward refuse to pay the proceeds, nor may it
cancel or contest the contract, even due to fraud
• Thus, if an insured is found to have lied about his or her physical
condition at the time the application was made for life insurance
– And this misrepresentation is not discovered until after the expiration of
the incontestability clause
• The insurer may neither cancel the policy nor refuse to pay the face amount
if the insured has died from a cause not excluded under the basic terms of
the policy
• Serves as a time limit within which the insurer must discover any
fraud or misrepresentation in the application or be barred thereafter
from asserting what would otherwise be its legal right
• The legal justification for this clause is protection of beneficiaries
from doubtful claims by an insurer
– That the deceased had made misrepresentations after it becomes
impossible for the deceased to defend against or to deny the allegation
35
Suicide Clause
• Partially protects the beneficiary from the
financial consequences of suicide
• States that if the insured does not commit
suicide for at least a stated period (usually two
years after issuance of the contract)
– The insurer may not deny liability under the policy for
subsequent suicide
• If the suicide occurs within two years of the
issuance of the policy
– The insurer’s only obligation is to return without
interest the premiums that have been paid
36
Misstatement of Age or Sex
• Misrepresenting one’s age in life insurance is material to accepting
the risk and normally would become a defense against payment of
the proceeds
– If it were not for the incontestability clause
• Without some control over this possibility
– It would become possible for people to understate their ages to obtain
lower life insurance premiums
• Proof of age is therefore required before proceeds are paid
• Under the misstatement-of-age clause
– If it is determined that the policyholder’s age has been misrepresented
• The insurer adjusts the amount of proceeds payable rather than canceling
the agreement altogether
• Proceeds will be adjusted in a similar manner through the
misstatement-of-sex clause
– It is common for females to pay lower premiums than males of the same
age when purchasing life insurance
37
Entire Contract Clause
• Provides that the policy, together with the
application, constitutes the entire contract
between the parties
• Desirable for the protection of the insured
and the beneficiary because
– Without the clause it might be possible to
affect the rights of the respective parties
through changes in the bylaws or in the
charter of the insurer
38
Assignments
• An insured may wish to assign the benefits of a
life insurance policy
– Often as collateral for a loan
• Permission of the insurer is not necessary
– But the insurer must be properly notified in writing of
an assignment or else is not bound by it
• If the insured dies, the insurer pays the holder of
the assignment that part of the proceeds equal
to the outstanding debt
– Then pays the remainder to the named beneficiaries
39
Dividend Options
• Some life insurance policies are participating
– They pay the policyowner dividends
• The dividend is not a distribution of profit but a
partial return of the premium payment
– Reflects the insurer’s experience with respect to
mortality, investment income, and expenses
• Dividends are not taxable to the recipient
• Insurers are not required to pay dividends
• However, dividends may be substantial
40
Cash or Payment of Premium
• A policyowner may specify that all
dividends are either to be paid to the
policyowner in cash
– Or be applied toward the payment of the next
premium due
41
Accumulation at Interest
• The insurer may retain the dividends and pay interest on the
accumulated amount
• A minimum guaranteed interest rate is stated in the policy
– Although insurers often pay more than the guaranteed minimum
• The dividends themselves are not taxable
– But interest paid on them through this option is taxable to the
policyowner in the year in which it is credited
• When dividends are paid and are not withdrawn prior to the
insured’s death
– The accumulated dividends are added to the policy face amount and
are paid to the beneficiary as part of the death benefit
• Accumulated dividends distributed as part of the death benefit are not
considered taxable income
42
Paid-Up Additions
• Policyowners of whole life policies usually are
offered the paid-up additions option
– Each dividend is used to purchase as much single
premium whole life insurance as possible
• An economical way to buy additional life
insurance
– No commission or other acquisition expenses must
be paid
• No medical examination or other evidence of
insurability is required
• The insurance purchased under this option
provides additional death protection and has a
cash value
43
One-Year Term Option
• Uses each year’s dividend to purchase as much
one-year term insurance as possible
• Insureds can increase their death protection to
the maximum extent without additional premium
payment
• Sometimes the amount of term insurance may
be limited to the size of the policy’s accumulated
cash value or its face amount
• Any remaining dividend can be taken under
another dividend option
44
Nonforfeiture Options
• Guarantee that the savings element in a policy
will not be forfeited to the insurer under any
circumstances
– But will always accrue to the benefit of the insured
• Required by law in all states
– Prior to this requirement there were cases in which
aged persons agreed to sell their policies to
speculators when they could no longer afford to pay
the premiums
– The insured seldom fared well in these transactions
45
Cash Value Option
• The policy may be surrendered for cash
• A schedule of guaranteed minimum cash values
is included in the policy
– Although the actual cash value in policies may vary
considerably from the minimums guaranteed
• Before payment is made, any outstanding
indebtedness is subtracted
• The cash is usually paid immediately
– Although the insurer has the right to delay payment
for as long as six months
– After 30 days the insurer is entitled to interest on the
amount due
46
Paid-Up Insurance Option
• The insurer uses the cash value to buy as much
single-premium insurance as possible on the life
of the insured
– Given the size of the cash value
• The same type of insurance is purchased as
existed for the original policy
– The only difference is that the new death benefit will
be for lower now than before
– And no more premiums will be required after the
option is exercised
47
Extended-Term Option
• If the insured does not select a nonforfeiture option and
has not implemented the automatic premium loan
provision
– Most insurers automatically place a cash value policy on the
extended-term option
• If premiums remain unpaid after expiration of the grace period
• The policy’s cash value is used to purchase term
insurance for as many years and months as are allowed
by the rates in effect for the insured’s age when the
lapse occurs
• Minimum guarantees regarding this option are included
in the policy
48
Policy Loans
• Sometimes the policyowner may need access to funds
that are only available through the cash value of his or
her life insurance policy
– And it may not be desirable to terminate the policy
• The cash value may be borrowed from the insurer with
the insurance coverage remaining intact
• If the insured dies with an outstanding policy loan
– The amount of the loan is subtracted from the policy proceeds
before payment is made to the beneficiary
– Otherwise, there is no obligation to repay policy loans
• However, because the insurer calculates premiums on
the assumption that interest will be earned on the funds
supporting the policy
– Interest is charged to anyone--including the policyowner—who
borrows some of these funds
– Unpaid interest accumulates and is added to the total loan
outstanding
49
Policy Loans
• If the policyowner takes a policy loan but still wants to
maintain the full amount of death protection
– The one-year term dividend option can be helpful, assuming that
the contract is participating
• Because policies without flexible premium arrangements
will lapse after expiration of the grace period if premiums
are not paid when due
– Many insurers encourage the use of an automatic premium loan
provision
• Automatically authorizes the insured to use cash values to pay
unpaid premiums that are due
• Policy loans from cash value life insurance contracts
generally are not taxable as income
50
Beneficiary Designation
• The beneficiary of a life insurance policy
generally must have an insurable interest in the
insured’s life at the time the policy is issued
• Attention should be given to the way the
beneficiary designation is worded
– So that the death benefit will be paid to the intended
person
– If children are listed by name, then any subsequent
children born to the insured will be excluded
• Thus, is better to say “children of the insured” if the policy is
intended to benefit all children at the time of the insured’s
death
51
Beneficiary Designation
• Policyowners have the right to change beneficiaries
without notice to those affected
– Provided that a beneficiary was not named irrevocably
• A revocable beneficiary has no control over the policy
– But an irrevocable beneficiary can be changed only if the
beneficiary gives written consent
• Contingent beneficiaries
– Will receive the policy proceeds if the primary beneficiary is not
alive at the time of the insured’s death
– If both the insured and the primary beneficiary die under
circumstances such that it cannot be determined who died first
• The general rule is that the proceeds will be paid to the contingent
beneficiaries
52
Beneficiary Designation
• If the primary beneficiary clearly survives the insured and
then dies
– The death benefit is payable to the primary beneficiary’s estate
• A common disaster clause may be used in the
beneficiary designation
– Specifies that upon an insured’s death, the insurance proceeds
are to be held by the insurer for a period of time
– After that time, if the primary beneficiary is alive
• The proceeds are distributed to that person
– Otherwise, the death benefit is paid to the contingent
beneficiaries
• In situations where no primary or contingent
beneficiaries are alive when the insured dies
– The death benefit is paid to the insured’s estate
53
Excluded Causes of Death
• Uncommon for life insurers to exclude coverage for
death arising out of specific causes
• One occasionally used exclusion is the war hazard
exclusion
– During periods when there is a serious threat of war or other
hostilities involving military forces of at least two countries
• Insurers may insert a war hazard exclusion in policies issued to
insureds who are either in the military or of an age that may cause
them to become subject to military duty
– Eliminates insurance coverage for death that is a direct result of
war or other hostile actions between countries
• The aviation hazard exclusion limits coverage for death
from aviation activities other than as a fare-paying
passenger on a commercial aircraft
– Rarely found in policies currently being issued
54
Settlement Options
• The different ways in which the policyowner or
beneficiary may elect to have the benefits of a policy
paid
• Lump-sum option
– Proceeds of the life insurance are paid in a lump sum
– Vast majority of benefits are paid in this manner
– Insurer’s obligations are over
• Fixed-period option
– The insurer pays the proceeds in equal installments over a
specific time frame
– The size of each installment varies with the
• Desired frequency of payment
• Length of the total time period during which payments are to be
made
• Interest rate paid by the insurer on proceeds not yet distributed
55
Settlement Options
• Fixed-amount option
– Used when a specified amount of income is desired
– The length of time the payments are made is a
function of the size and frequency of each payment
and the interest rate paid by the insurer on the
proceeds
– Interest earned in excess of the guaranteed level
increases the length of time during which payments
are made
56
Settlement Options
• Interest option
– The insurer holds the proceeds of the policy and pays
the beneficiary an income consisting of interest only
– A guaranteed minimum rate is stated in the policy
• With excess interest often used to increase the amount of
each payment
– The beneficiary usually has the right to withdraw
some or all of the principal amount
57
Settlement Options
• Life income options
– Several variations guarantee a beneficiary an income
for his or her remaining lifetime
– Additional guarantees may be made concerning the
number of payments that will be made or the
guaranteed total dollars to be paid
• Regardless of how long the beneficiary lives
58
Waiver of Premium Benefit
• Provides that insureds who become disabled before a
specified age will be excused from paying premiums for
as long as the disability continues
• The life insurance policy will have the same cash values,
death benefits, and dividends as it would have had if all
premiums had been paid
• Policies vary as to how they define disability for this
purpose
– Many contracts also require a six-month waiting period after the
onset of the disability before premiums are waived
• This is not expensive and is generally recommended as
a way of assuring that the life insurance policy will
remain intact regardless of the insured’s health
59
Accidental Death Benefit
• Makes it possible for the beneficiary to receive an
accidental death benefit if the insured dies from an
accident
• The size of the accidental death benefit is often equal to
the face amount of the underlying policy
• Numerous restrictions exist in this benefit
– Common exclusions include death from suicide, death that occur
more than 120 days following an accident, death from illness,
death due to war or aviation
• May lead naive insureds to believe that their total death
protection has doubled for only an small extra premium
• However, accidents are far from being the leading cause
of death
– And accidents that satisfy the definitions of the accidental death
benefit are even less common
60
Accelerated Death Benefit
• Also known as a living benefit option
• Under specified circumstances, a percentage of the
policy’s face amount, discounted for interest, can be paid
to the insured before death
• Some insurers consider such payments to terminate all
future contractual rights to benefits
• Others allow some or all of any remaining face amount
to be paid to the beneficiary when the insured dies
• Accelerated death benefits can be an important income
source for persons with terminal illnesses
• Some insurers also offer this option to help pay for an
insured’s long-term care needs
– An additional agreement known as a long-term care rider may be
attached to a permanent form of coverage
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Accelerated Death Benefit
• Variations exist among insurers regarding
– The percentage of the death benefit that can be paid
on an accelerated basis
– Whether an additional premium is charged
– The types of policies for which the main benefit
options are available
– Whether the accelerated death benefit can be
payable in a lump sum or only via installments
– Whether complete surrender of all future policyowner
rights accompanies the payment of accelerated
benefits
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Accelerated Death Benefit
• One of the factors impeding the growth of living benefit
options is a concern that the payment erodes the death
benefit protection provided for beneficiaries
– Often one of the major reasons for purchasing a life insurance
policy in the first place
• Until recently another problem had been the unclear tax
status
– Should living benefits be exempt from income taxes in the same
way that death benefits are?
• The Health Insurance Portability and Accountability Act of 1996 states
that
– From December 31, 1996 forward accelerated death benefits are excluded
from taxable income
» If a physician certifies that the insured has a terminal illness that is
expected to result in death within 24 months or less
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Spendthrift Trust Clause
• One of the legal rights granted to the life
insurance owner in most states is the exemption
of death proceeds in cash values from claims of
creditors
• Creditors cannot attach the cash value of life
insurance for the payment of the insured’s debts
– Unless the insured has wrongfully bought or paid up a
life insurance policy with money rightfully subject to
creditors’ claims
• Neither may the insured’s creditors attach the
death proceeds of life insurance
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Spendthrift Trust Clause
• May the beneficiary incur large debts using as security
the right to receive income from life insurance proceeds?
– Technically this is possible unless the state law has a provision
to the contrary or unless the law has permitted the attachment of
the spendthrift trust clause
• If this clause is attached to a life insurance policy, the beneficiary’s
right to that promised income cannot be attached by creditors in any
court in the state of residence
• Without such a clause there might be a temptation for an
unscrupulous creditor to persuade a beneficiary to
purchase goods beyond the ability to pay
– Secure in the knowledge that the life insurance could be
attached
• Once the proceeds have been paid to the beneficiary
– The protection is lost since the money lose its identity as life
insurance proceeds
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Grace Period and Reinstatement
Clauses
• Always gives the insured an extra 30 days in which to
pay any premium that is due before lapse takes place
• Can forestall policy lapses as long as sufficient cash
values exist to cover the premium due
• Once the policy actually lapses, special application must
be made under the reinstatement clause to restore
coverage
– Contracts may be reinstated within a certain period after lapse,
usually three or five years, with evidence of insurability
– Sometimes a new medical exam must be taken
• But in most cases the insured is required only to make a statement
of personal good health at the time of reinstatement
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Grace Period and Reinstatement
Clauses
• All premiums in arrears must be paid plus interest
• Reinstatement reopens the incontestability clause for
another two years
– But generally the suicide clause is held not to be reopened
• It is sometimes desirable to reinstate an old policy rather
than to take out a new one because the old policy may
have certain provisions
– Such as more favorable settlement options, immediate eligibility
for dividends, or higher interest assumptions
• Also, no new acquisition costs have to be paid in the
reinstated policy, as they would on a new contract
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