Policy Ownership

The whole and universal life policies have similar ownership sections. OwnershipIn life insurance, refers to rights policyholders have over their policies such as the right to assign the policy to someone else, to designate the beneficiary, to make a policy loan, or to surrender the policy for its cash value. refers to rights. The owner of a life insurance policy has rights, such as the right to assign the policy to someone else, to designate the beneficiary, to make a policy loan, or to surrender the policy for its cash value. When filling out the initial policy application, the policyowner designates whether the rights should stay with the insured or be assigned to another person, such as a spouse or perhaps to a trust. The ownership provisionA provision filled out by the policyowner stating where the rights of the policy should be assigned (e.g., insured, spouse, or a trust)., sometimes simply labeled rights, shows this designation.

Death Benefits and Death Benefits Options Provisions

This section is unique to universal life policy, as would be expected from the lengthy explanation above regarding the two options of death benefits. In Chapter 27 "Appendix D", you can see the wording of these options, the amounts of coverage, and changes to the amounts.

The changes in basic amount provisionIn life insurance, specifies the conditions under which a policyowner can change the total face amount of the policy. specifies the conditions under which a policyowner can change the total face amount of the policy. Any requested decreases take place on a monthly anniversary date and reduce the most recent additions to coverage (if any) before affecting the initial face amount. Requests for increases in coverage must be made on a supplemental application and are subject to evidence of insurability.

Payment of Benefits Provisions

This section applies to both the sample whole life and the sample universal life policies and to other policies in general. The purpose of the payment of benefits provisionIn life insurance, enables the owner of the policy to designate to whom the proceeds shall be paid when the insured dies. is to enable the owner of the policy to designate to whom the proceeds shall be paid when the insured dies. If no beneficiary is named, the proceeds will go to the owner’s estate. A revocable beneficiaryLife insurance beneficiary that can be changed at will by the policyowner. can be changed at will by the policyowner. Most people prefer the revocable provision. Irrevocable beneficiaryLife insurance beneficiary that cannot be changed only with the consent of the beneficiary. designations, on the other hand, can be changed only with the consent of the beneficiary. For example, a divorced spouse, as part of a property settlement, may be given an irrevocable interest in life insurance on his or her former spouse. The former spouse, as the insured and policyowner, would be required to continue premium payments but could not make a policy loan or other changes that would diminish the rights of the irrevocable beneficiary.

A beneficiary must survive the insured in order to be entitled to the proceeds of the policy. It is customary, therefore, to name one or more beneficiaries who are entitled to the proceeds in the event that the primary (first-named) beneficiary does not survive the insured. These are known as secondary or tertiary contingent beneficiariesIn life insurance, beneficiaries who are entitled to the proceeds in the event that the primary (first-named) beneficiary does not survive the insured.. Such beneficiaries are named and listed in the order of their priority.

If the insured and the primary beneficiary die in the same accident and none of the evidence shows who died first, there is a question as to whether the proceeds shall be paid to the estate of the primary beneficiary or to a contingent beneficiary. In states where the Uniform Simultaneous Death Act has been enacted, the proceeds are distributed as if the insured had survived the beneficiary. Where this act is not in effect, the courts have usually reached the same conclusion. If no contingent beneficiary has been named, the proceeds go to the estate of the policyowner, thus subjecting the proceeds to estate taxes, probate costs, and the claims of creditors. Probate costs are levied by the court that certifies that an estate has been settled properly. Probate costs (but not estate taxes) are avoided when benefits go to a named beneficiary.

A similar problem arises when the primary beneficiary survives the insured by only a short period. In such a case, the proceeds may be depleted by taxes and costs associated with the beneficiary’s estate settlement or because an annuity-type settlement option had been selected. This problem can be solved by adding a common disaster provision (or survivorship clause)Provides that the beneficiary of a life insurance policy must survive the insured by a specified period of time or must be alive at the time of payment to be entitled to the proceeds., which provides that the beneficiary must survive the insured by a specified period of time (e.g., seven to thirty days) or must be alive at the time of payment to be entitled to the proceeds. If neither of these conditions is fulfilled, the proceeds go to a contingent beneficiary or to the estate of the policyowner if a contingent beneficiary has not been named.

Policyowners should designate the beneficiary clearly. No questions should exist about the identity of the beneficiary at the time of the insured’s death. In designating children as beneficiaries, one must keep in mind that a minor is not competent to receive payment. In the event of the death of the insured prior to the maturity of a beneficiary child, a guardian may have to be appointed to receive the proceeds on behalf of the child. As a general rule, policyowners should avoid naming minors as beneficiaries. Where the objective is a substantial estate to benefit a child or children, the preferable approach would be to name a trust as beneficiary. The child or children (the ones already born and those to be born or join the family unit after a divorce and remarriage) could be the beneficiary(ies) of the trust.

Payment Methods

Life insurance is designed to create a sum of money that can be used when the insured dies or the owner surrenders a cash value policy. In the early days of life insurance, the only form in which the death proceeds or cash value of a policy were paid was in a lump sum. Because a lump-sum payment is not desirable in all circumstances, several additional settlement options (or settlement plansAllows the policyholder or beneficiary of a life insurance contract to stipulate, from a variety of options, how the death benefit will be provided.; also called payment plans) have been developed and are now included in most policies. The owner may select an option in advance or leave the choice to the beneficiary. The owner may also change the option from time to time if the beneficiary designation is revocable. The payment plans have the following methods for death proceeds:

• Interest method—the beneficiary leaves the proceeds with the insurer and collects only the interest
• Fixed years method—even distribution of the proceeds over a certain number of years
• Life income method—even distribution of the proceeds over the life of the beneficiary
• Fixed amount method—even distribution of the proceeds until depleted
• Joint life income method—even distribution of the proceeds over the life of the beneficiary, with continued distribution to his or her beneficiary at the same or reduced level
• One-sum method—a lump-sum distribution
• Other method, as agreed upon

Premium Provisions

This section also applies to both the whole and the universal life policies. Premiums are payable on the due date on a monthly, quarterly, semiannual, or annual basis. The first premium must be paid in advance, while the insured is in good health and otherwise insurable. Subsequent premiums are due in advance of the period to which they apply. Insurance companies send a notice to the policyowner indicating when the premium is due. The time horizon over which premiums are payable depends on the type of policy (e.g., through age ninety-nine for a straight life policy), and it is stated on the cover page. Note in the sample universal life policy of Chapter 27 "Appendix D" that the premium limitations section allows the insurer to refund any overpayment of premiums. As you know, such possibility may occur because of the flexible premium allowed for universal life policies.

Dividend Options

Participating policies of mutual insurers, such as State Farm, share in the profits the insurer earns because of lower-than-anticipated expenses, lower-than-expected mortality, and greater-than-expected investment earnings. The amounts returned to policyowners are called dividends. Dividends also involve the return of any premium overpayment. Dividends are payable annually on the policy anniversary. They are not guaranteed, but they are a highly significant element in many policies.

When purchasing a participating life insurance policy, the policyowner can choose how the dividend money should be spent from one or more of the following dividend optionsWhen purchasing a participating life insurance policy, the policyowner can choose how the dividend money will be distributed from among several choices. (see Chapter 26 "Appendix C"):

• Applied toward the next premium
• Used to buy paid-up additional insurance
• Left with the insurer to accumulate interest
• Paid to the policyholder

The majority of companies offer these four options. The selection of the appropriate dividend option is an important decision.

Guaranteed Values Provisions

This section illustrates the major differences between the whole life and universal life policies. A whole life policy guarantees that a policyholder who decides to cancel the policy can either take cash for the surrender (cash) value or continue the policy in force as extended term insurance and paid-up insurance. These provisions are also called nonforfeiture optionsIn whole life insurance, guarantees that a policyholder who decides to cancel the policy can either take cash for the surrender (cash) value or continue the policy in force as extended term insurance and paid-up insurance. in other policies. The sample whole life policy lists these amounts in the Schedule of Insurance and Values in Chapter 26 "Appendix C".

As pointed out earlier, the cash value life plan results in the accumulation of a savings (or cash value element, from the insured’s perspective) that usually increases as each year passes. If the contract is terminated, the policyholder can receive the cash value, or the policy can be converted to extended term insuranceNonforfeiture option where the death benefit of a whole life policy continues at its previous level for as long as the cash value supports this amount of term insurance. or paid-up insuranceNonforfeiture option where death benefits are paid up completely without expiration date, as if a new policy providing a lower death benefit was in place.. Under the extended term insurance option, the death benefit continues at its previous level for as long as the cash value supports this amount of term insurance (like a single premium life). Under the paid-up insurance option, it is as if there is a new policy providing a lower lifetime death benefit than the old one did. The death benefits are paid up completely without an expiration date. Both extended term and paid-up options are nonforfeiture options.

With universal, current assumption, and variable universal life policies, the policyowner may discontinue premium payments at any time without lapsing the policy, as long as the surrender value is sufficient to cover the next deduction for the cost of insurance and expenses. In the universal life policy, there is a description of the account value at the end of the first month. It is 95 percent of the initial premium less the monthly deduction. Thereafter, adjustments take the interest rate into account. The following sections are covered in the sample universal life in Chapter 27 "Appendix D":

• Account value
• Monthly deduction
• Cost of insurance
• Monthly cost of insurance rates
• Interest (guaranteed at 4 percent in the sample policy)
• Cash surrender value
• Withdrawals
• Surrender charges
• Basis of computation, which includes the table of surrender charges

Policy Loan Provisions

Policy loan provisionsApply to whole life and the universal life policies and allow the owner to borrow an amount up to the cash value from the insurer at a rate of interest specified in the policy and up to the account value in universal life. apply to both the whole life and the universal life policies. The owner can borrow an amount up to the cash value from the insurer at a rate of interest specified in the policy, and up to the account value in universal life. In the sample universal life policy in Chapter 27 "Appendix D", the interest rate is set at 8 percent. In the whole life policy, the majority of insurers use a fixed rate of interest or a variable rate, as indicated in the sample whole life policy in Chapter 26 "Appendix C".

General Provisions

Both the whole life and the universal life sample policies conclude with general-provision sections that include the following:

• The contract
• Annual report (universal life only)
• Projection of benefits and values (universal life only)
• Annual dividend (universal life only)
• Dividend options (universal life only as part of this section; see dividends for whole life above as a separate section)
• Assignment
• Error in age or sex
• Incontestability
• Limited death benefits (suicide clause)

Waiver of Premium

The waiver of premium riderIn life insurance, provides that premiums due after commencement of an insured’s total disability shall be waived for a period of time. is offered by all life insurance companies and is included in about half of the policies sold. Some companies automatically provide it without charging an explicit amount of additional premium. The rider provides that premiums due after commencement of the insured’s total disability shall be waived for a period of time. A waiting period of six months must be satisfied first. In flexible premium contracts such as universal and variable universal life, the waiver of premium provision specifies that the target premium to keep the policy in force will be credited to the insured’s account during disability.An alternative to the waiver of premium rider for flexible premium contracts waives only the amount required to cover mortality cost and expense deductions. If a premium was paid after disability began and before the expiration of a waiting period, the premium is refunded. When disability begins before a certain age, usually age sixty, premiums are waived as long as the insured remains totally disabled.

Disability Income

The disability income riderIn life insurance, provides a typical income benefit of $10 per month per $1,000 of initial face amount of life insurance for as long as an insured’s total disability continues and after the first six months of such disability, provided it commences before age fifty-five or sixty. provides a typical income benefit of $10 per month per $1,000 of initial face amount of life insurance for as long as total disability continues and after the first six months of such disability, provided it commences before age fifty-five or 60. Disability payments are usually made for the balance of the insured’s life as long as total disability continues. Under some contracts, payments stop at age sixty-five and the policy matures as an endowment, but this is less favorable than continuation of income benefits.

The definitions of disability for these riders are like those for waiver of premium provisions. Most disability income insurance is now sold either through a group plan (e.g., see Chapter 22 "Employment and Individual Health Risk Management" and Case 2 of Chapter 23 "Cases in Holistic Risk Management") or as separate individual policies. Most life insurers do not offer this rider.

Accidental Death Benefit

The accidental death benefit (or double indemnity) riderIn life insurance, usually provides that double the face amount of the policy will be paid if the insured’s death is caused by accident, and, sometimes, triple the face amount if death occurs while the insured is riding as a paying passenger in a public conveyance. is sometimes called double indemnity. It usually provides that double the face amount of the policy will be paid if the insured’s death is caused by accident, and sometimes triple the face amount if death occurs while the insured is riding as a paying passenger in a public conveyance.Policies with flexible face amounts usually issue the accidental death rider for a fixed amount equal to the basic policy’s initial face amount. Figure 19.8 "Accidental Death Benefits Rider" illustrates the accidental death benefit rider.

A typical definition of accidental death is, “Death resulting from bodily injury independently and exclusively of all other causes and within ninety days after such injury.” Certain causes of death are typically excluded: suicide, violations of the law, gas or poison, war, and certain aviation activities other than as a passenger on a scheduled airline. This rider is usually in effect until the insured is age seventy.

Figure 19.8 Accidental Death Benefits Rider

Guaranteed Insurability Option

Many insurers will add a guaranteed insurability option (GIO)In life insurance, gives the policyowner the right to buy additional amounts of insurance, usually at three-year intervals up to a specified age, without new proof of insurability. to policies for an additional premium. This gives the policyowner the right to buy additional amounts of insurance, usually at three-year intervals up to a specified age, without new proof of insurability. The usual age of the last option is forty; a small number of insurers allow it up to age sixty-five. The amount of each additional purchase is usually equal to or less than the face amount of the original policy. If a $50,000 straight or interest-sensitive life policy with the GIO rider is purchased at age twenty-one, the policyowner can buy an additional $50,000 every three years thereafter to age forty, whether or not the insured is still insurable. By age forty, the total death benefit would equal $350,000. The new insurance is issued at standard rates on the basis of the insured’s attained age when the option is exercised. The GIO rider ensures one’s insurability. It becomes valuable if the insured becomes uninsurable or develops a condition that would prevent the purchase of new life insurance at standard rates.

Accelerated Death Benefits

Some medical conditions regularly result in high medical expenses for the insured and his or her family or other caregivers. The need for funds may significantly exceed benefits provided by medical and disability insurance because of deductibles, coinsurance, caps on benefits, and exclusions, and (perhaps primarily) because of having purchased inadequate coverage. Accelerated death benefitsTriggered by either the occurrence of a catastrophic (dread) illness or the diagnosis of a terminal illness, resulting in payment of a portion of a life insurance policy’s face amount prior to death. are triggered by either the occurrence of a catastrophic (dread) illness or the diagnosis of a terminal illness, resulting in payment of a portion of a life insurance policy’s face amount prior to death.

The accelerated benefits are also called living benefits, or terminal illness rider. Usually, the terminally ill insured can receive up to 50 percent of the death benefits to improve quality of life before death. Often, the coverage is provided without an additional premium. The benefit can usually be claimed when two doctors agree that the insured has six months or less to live. When the insured desires greater amounts, he or she may use a viatical settlement company to transfer the ownership of the policy to a third party in return for a higher percentage of the death benefits, perhaps 80 percent. A more detailed discussion of viaticals is provided in the box “Do Viatical and Life Settlements Have a Place in Today’s Market?”

Catastrophic Illness Coverage

When a catastrophic illness riderIn life insurance, provides that a portion (usually 25 to 50 percent) of the face amount of the policy is payable upon diagnosis of specified illnesses. is added to a life insurance policy (usually requiring an additional premium), a portion (usually 25 to 50 percent) of the face amount is payable upon diagnosis of specified illnesses. The named illnesses differ among insurers but typically include organ transplantation.

As benefits are paid under either a catastrophic or terminal illness rider, the face amount of the basic policy is reduced an equal amount, and an interest charge applies in some policies. Cash values are reduced either in proportion to the death benefit reduction or on a dollar-for-dollar basis.

Buy More Life Insurance

As long as you are insurable, you can buy more life insurance as your needs increase. What if you become uninsurable? You can protect yourself against that possibility by buying a policy with a guaranteed insurability option; however, this has drawbacks. First, the option is limited to a specified age, such as forty, and you may need more insurance after that age. Second, you must buy the same kind of insurance as the policy you have. Third, the premium will be higher due to your age.

Buy a Cost-of-Living Rider or Policy

Another alternative is the inflation rider (or cost-of-living)Automatically increases the amount of life insurance as the consumer price index rises., which automatically increases the amount of insurance as the consumer price index (CPI) rises. It provides term insurance in addition to the face amount of your permanent or term policy up to a point, such as age fifty-five for the insured. If, for example, you have a $100,000 whole life policy and the CPI goes up 5 percent this year, $5,000 of one-year term insurance is automatically written for next year at the premium rate for your age. You are billed for it along with the premium notice for your basic policy. Because your premium increases with each increase in coverage, you may conclude that you bear the risk of keeping your coverage up with inflation. Keep in mind that no evidence of insurability is required. You do not have to accept (and pay for) the additional insurance if you don’t want it. If you refuse to exercise the option, however, it is no longer available. In other words, you can’t say, “I’m short of funds this year, but I will exercise the option next year.” Table 19.4 "Inflation Rider Option (at 5 Percent Annual Inflation)" illustrates how the inflation rider option would affect your total amount of insurance if you had bought a $100,000 whole life policy in 1995 and the inflation rate was 5 percent every year.

Buy a Variable or Variable Universal Life Policy

The face amount of variable life and variable universal life (except for the level face amount type) policies fluctuates with the performance of one or more separate accounts. You have the option of directing most of your premiums into common stock accounts where long-run returns are expected to offset CPI increases.

If you buy a variable life policy, you assume the risk that the equity markets may be going down at the same time that the CPI is going up. Should you buy a variable life policy? The answer depends on you. How much investment risk are you willing to take in coping with inflation?