Chapter 4: Life Policy Provisions and Options

Question 1

Payment of Premium Provisions

Answer 1

• Mode of Premium
• Grace Period
• Automatic Premium Loans (APL)
• Reinstatement

Question 2

Mode of Premium

Answer 2

This provision addresses the FREQUENCY of premium payments (monthly, quarterly, semiannually, or annually), and to whom the premiums are payable. The more frequent the payment, the GREATER the cost will be. The policyowner has the right to change the premium mode.

Question 3

Grace Period

Answer 3

The time period provided after the premium due date before a policy lapses. If the insured dies during this period, the death benefit is payable MINUS any premiums due.

The typical grace period is a month (30 or 31 days) - 31 days for MD. Coverage continues during the grace period, but if the premium is not paid, the policy lapses at the end of the grace period.

Question 4

Automatic Premium Loan (APL)

Answer 4

This provision must be elected by the policyowner and can be cancelled at any time. It enables the insured to automatically borrow against the cash value to cover a premium payment and prevent the contract from lapsing unintentionally. APL is available on cash value policies only and does not require an additional premium.

It becomes effective at the end of a grace period. APL loan is treated as all other loans. If the APL is used to pay premiums, interest on the loan accumulates on an annual basis.

Question 5

Reinstatement

Answer 5

If a policy has lapsed unintentionally due to nonpayment, it can be reinstated by the owner. The reinstatement period is typically 3 years from lapse, but can be as long as 5 years, In order to reinstate, the insured must provide evidence of insurability and owner must pay late premiums from the date of lapse, PLUS interest. Reinstatements are designed to put a policy back in force as if the lapse never occurred. Upon reinstatement, a new incontestability period takes effect.

Question 6

Standard Provisions - Individual Policies ONLY

Answer 6

Contractual provisions explain what the contract consists of, what duties and responsibilities the parties to the contract have, how the policy works, and details the agreement between the policyowner and the insurance company. Provisions and clauses, unlike riders, and included in the contract for NO additional charge.

Question 7

Entire Contract Clause

Answer 7

This provisions describes the parts of the life insurance contract. The entire contract consists of the policy, riders (or endorsements), amendments, and a copy of the application. All statements made in the application are, in the absence of fraud. deemed to be representations and not warranties. All parts to the contract must be attached and in writing. Nothing can be incorporated by reference.

Question 8

Incontestability Clause

Answer 8

Within the first 2 years of a policy, the INSURER may contest a claim and void the contract upon proof of a material misstatement or fraud. Except for nonpayment of premiums, the policy will be incontestable after it has been in force, typically, 2 years from the policy issue date, even in cases of fraud.

Question 9

Insuring Clause (Proof of Death)

Answer 9

The insuring clause is found on the FIRST PAGE of the policy and is considered the most important clause in the policy. It identifies the parties to the contract and the perils or conditions under which it will pay. The insuring clause is the insurance company’s promise to pay the policy’s death benefit to the named beneficiary, after receiving due proof of death of the insured, as long as the policy is in force.

Question 10

Consideration Clause

Answer 10

Specifies the amount and frequency of premium that will be paid by the owner as something of value, in exchange for which the company promises to pay, as necessary, in the future. The particulars of the payments the insurer agrees to are found in the insuring clause.

Question 11

Changes (Modifications)

Answer 11

Changes or modifications must be in writing, signed by an executive officer of the insurer, approved bny the policyowner, and made part of the entire contract. A producer cannot alter, change, modify, or waive any policy provisions.

Question 12

Suicide Clause

Answer 12

If the insured commits suicide, while sane or insane, typically within 2 years from the policy’s issue date, the insurer’s liability is limited to a refund of premium. If the insured commits suicide after the clause has expired, the insurer must pay out the death benefit to the named beneficiary. The intent of this clause is to discourage individuals from purchasing an insurance policy while contemplating suicide.

Question 13

Owner’s Rights (Ownership Provision)

Answer 13

Policyowner retains all rights to the policy. Unless the insured is also the policyowner, the insured does not have rights. The policyowner has the right to name or change revocable beneficiaries, borrow against the cash values or access living values, receive dividends, select among dividend options made available, and to assign the policy on a collateral basis or an absolute basis. It is also the owner’s responsibility to make the premium payments. The beneficiary does not have rights in the policy.

Question 14

Assignment

Answer 14

The transfer of ownership. There are two types of assignments:

• Absolute Assignment
• Collateral Assignment

Question 15

Absolute Assignment

Answer 15

The original owner, the assignor, will name a new owner, the assignee, of the policy. Since a new owner is named, this is considered a permanent assignment. The full amount of the policy is assigned, and this is referred to as a transfer of ownership.

Question 16

Collateral Assignment

Answer 16

DOES NOT cause permanent change in ownership. However, the rights of the owner will be subject to the assignment. A collateral assignment is typically used when an insurance policy becomes collateral for a loan. This is a TEMPORARY assignment until the debt is paid in full. In this case, assignor is the original owner and the assignee is the creditor. The assignment takes place over the beneficiary designation.

Question 17

Misstatement of Age or Gender

Answer 17

If the age and/or gender of the insured have been misstated in the policy, all benefits under the policy will be provided based upon the insured’s correct age and/or gender according to the premium scale in effect at the time the policy was issued. An insurer can refund any overpaid premiums if the amount of premium paid was greater than it should have been. The insurer can reduce the face amount in cases where the amount of premium paid was less than that which should have been paid.

There is NO time limit for discovery, and this provision NEVER cancels or voids a policy. The incontestability clause DOES NOT apply. Age and/or gender are not considered material to the policy issuance.

Question 18

Free Look (Right to Examine Period)

Answer 18

The free look allows the policyowner a specified number of days following receipt of the policy to look it over. If dissatisfied for any reason, the owner has the right to return for a full refund of any premiums paid.

The free looks period is 10 DAYS, unless state law specifies otherwise. The free look period starts on the date when the policy is delivered to the owner. For this reason, it is important for a producer to collect a delivery receipt when delivering the policy.

Question 19

Exclusions

Answer 19

Conditions stipulated in the contract for which the insurer will not provide coverage. The insurer cannot add or alter any of the exclusions after the policy has been issued. Such exclusions are normally limited to the following:

• Aviation (Student Pilots, those with newly issued pilot’s license, or limited flying experience)
• Status Clause (Military Status)
• Results Clause (War Clause)
• Hazardous Clause (Hazardous Occupation)
• Hazardous Hobbies or Avocation
• Suicide (Within first 2 years)

Question 20

Provisions Specific to Cash Values (Policy Loans Provision)

Answer 20

A policy loan may be made from a cash value policy once there is sufficient cash value to borrow against. In most policies, cash value must be made available to borrow against after 3 YEARS.

A loan against the cash value does not immediately reduce the cash value in a policy. Rather, cash value is used as collateral against the loan. Interest will be charged annually, and if unpaid will be added to the balance of the unpaid loan. Interest charged may be fixed or variable.

The insurer may defer granting a loan for up to 6 months unless the loan was intended to repay any premium, such as automatic premium loan. Failing to repay a loan or interest will not void the policy until the total amount of the outstanding loan and unpaid interest equals or exceeds the policy’s total cash surrender value.

Any outstanding loans will be deducted from the face amount at the time of claim, or from cash values upon surrender, along with any interest due.

Question 21

Policy Loan Rate Provisions

Answer 21

Policy loans with fixed rates can have a maximum fixed interest rate of 8% or less as stated in the policy. For policy loans with an adjustable (variable) interest rate, the maximum rate is based upon Moody’s corporate bond yield average and is stated in the policy. The policy loan cannot exceed the available cash surrender value.

Question 22

Partial Withdrawals or Partial Surrenders

Answer 22

A partial withdrawal of cash value is permitted in a UNIVERSAL or VARIABLE UNIVERSAL life policy. A partial withdrawal is considered a partial surrender of the policy. A partial surrender is actually paid from the policy value and either reduces the amount of the death benefit or the amount of cash value in the policy. Since this is NOT considered a loan, annual interest is NOT charged. Taxation applies to any interest on the cash value paid out as a withdrawal. In other words, any amount paid in excess to the premium is subject to taxation.

When a partial withdrawal is made, the policy’s cash or account value will be reduced by the amount of the withdrawal. There may be a surrender or withdrawal charge associated. The insurer may limit the number of withdrawals that an be made annually or the amount of the withdrawal, specifying minimums and maximums.

Question 23

Surrenders

Answer 23

The owner of a cash value policy may surrender the ENTIRE policy. This action will cancel the insurance coverage. The policyowner is entitled to receive the cash surrender value in the policy Universal life and variable universal life policies may have a surrender charge schedule which lasts 10-20 years. A schedule must be given, which shows what percent of the cash value is subject to a surrender charge. The surrender charge schedule typically hows the percentage charged, reducing on an annual basis.

**The difference between the cash value and the cash surrender value is the surrender charge. This provides a means for the insurer to recapture the upfront expenses involved in issuing the policy.

Question 24

Policy Provisions Prohibited By LAw

Answer 24

It is prohibited in MOST states to have a contract with a provision:

• Limiting the time for any legal action to be taken against an insurer to less than 1 year after the act (or lack of an act) occurs. The statute of limitations cannot be less than 1 year.
• Allowing for the backdating of a policy for more than 6 months. If backdating is allowed, the insurer may only allow this for a maximum of 6 months.
• For any settlement at maturity of less value than the amount insured by the policy, plus dividend additions, less any outstanding policy loans, loan interest, and unpaid premiums.
• For forfeiture of the policy for failure to repay any loan on the policy or to pay interest on the loan while the total indebtedness on the policy is less than the cash value of the policy.

Question 25

Beneficiary Designations

Answer 25

Types of Beneficiaries include:

• Revocable
• Irrevocable

Question 26

Revocable Beneficiary

Answer 26

The policyowner may change a revocable beneficiary AT ANY TIME. This beneficiary does not have a vested interest in the policy. Most named beneficiaries are revocable and have no rights.

Question 27

Irrevocable Beneficiary

Answer 27

The policyowner may not change an irrevocable beneficiary unless the beneficiary dies or provides written consent for the change. If an irrevocable beneficiary is named, the owner may NOT make changes to the policy that affect the coverage or benefits without consent of the beneficiary. These changes include:

• Assigning the policy
• Canceling or surrendering the policy
• Taking a policy loan

An irrevocable beneficiary has a vested interest in the policy benefits. A divorced spouse with a vested interest in the policy is an example of an irrevocable beneficiary.

Question 28

Beneficiary Succession

Answer 28

• Primary beneficiary
• Contingent or secondary beneficiary
• Tertiary beneficiary

**If there is no surviving beneficiary at the time of the insured’s death, the proceeds are payable to the policyowner, if living, or to the insured’s estate.

There may be multiple primary or contingent beneficiaries named. When naming multiple beneficiaries, it is important to indicate each beneficiary’s share of the proceeds in percentages rather than in dollar amounts unless they are to share in the proceeds equally.

Question 29

Primary Beneficiary

Answer 29

The first line to receive the death benefit upon death of the insured.

Question 30

Contingent or Secondary Beneficiary

Answer 30

The contingent beneficiary receives the death benefit ONLY if there is no primary beneficiary alive following the death of the insured. In other words, the death benefit is payable to the contingent beneficiary only if the primary beneficiary predeceases the insured.

Question 31

Tertiary Beneficiary

Answer 31

Receives the policy proceeds if BOTH the primary and the contingent beneficiaries predecease the insured.

Question 32

Beneficiary Designations

Answer 32

A beneficiary designation is selected at the time of application. A change of beneficiary will take effect on the date the request was signed by the owner, whether or not the insured is alive at the time the insurer actually receives the notice.

Question 33

Individual/named beneficiary

Answer 33

This designation is very specific. An individual is specified by name as the beneficiary, such as Mary Doe (wife) or John Doe (husband). This prevents probate proceedings.

Question 34

Class or classification

Answer 34

This designation is used in instances where each beneficiary is not directly identified by name. The wording of the class designation must be specific and carefully worded to remove any doubt of the owner’s/insured’s intentions. For example, “any children of this marriage”, or “the insured’s spouse” may be classified as beneficiaries. This could cause complications if the insured as step children or has been married more than once.

Question 35

Additional beneficiary designations include:

Answer 35

• Per capita
• Per stirpes
• Estate
• Trust
• Minors
• Creditor

Question 36

Per capita

Answer 36

This is a designation that will pay surviving beneficiaries equally if a named beneficiary predeceases the insured.

For example, if any insured names their three children as beneficiaries and one of the children predeceases the insured, the benefit will pay equally to the surviving named beneficiaries. Each beneficiary receives 50% of the death benefit in this example.

Question 37

Per stirpes

Answer 37

This is a designation that will pay a deceased beneficiary’s share to the heirs of the beneficiary who predeceases the insured.

If an insured names their 3 children as beneficiaries and one of the children predeceases the insured, the deceased beneficiary’s share will be paid to their heirs. The surviving beneficiaries will each receive 1/3 of the benefit and the remaining 1/3 will be paid to the deceased beneficiary’s heirs in this example.

Question 38

Estate

Answer 38

The estate may be the tertiary beneficiary in case the insured outlives all other beneficiaries. By default, if the insured outlives all other beneficiaries, benefits are paid to the insured’s estate. The death benefit increases the estate value and may have tax implications.

Question 39

Trust

Answer 39

When a recipient does not have direct benefits, such as in the case of minor children, and the proceeds are to be distributed as per the insured’s directions set forth in a trust. A trust beneficiary may also be used in estate tax planning strategies when using an irrevocable life insurance trust.

Question 40

Minors

Answer 40

If minors are named as beneficiaries, but no trust has been established, the funds are placed in a settlement option (held with interest), with the insurer acting as trustee. The legal guardian or legally responsible adult may receive payments for the benefit of the child, until the child receives the lump some at the age of majority.

Question 41

Creditor

Answer 41

Designated by assignment, or named at application, to cover indebtedness. The creditor may either be the named beneficiary or can be the assignee under a collateral assignment. The creditor can only receive the amount of the indebtedness. The benefit may be purchased as decreasing term insurance so the benefit will decrease by the amount of the loan automatically.

Question 42

Common Disaster Clause

Answer 42

Provides that if an insured and primary beneficiary are in the SAME accident, the primary beneficiary must survive the insured by a specific number of days (usually 90) or the insurance company will assume the insured dies last (the primary beneficiary died first). This provision is designed to pay the benefits to either the contingent beneficiary or the insured/policyowner’s estate if no contingent beneficiary has been designated.

Question 43

Uniform Simultaneous Death Act

Answer 43

Has been adopted by ALL states and provides that when the insured and primary beneficiary die as a result of the same event and the order of death CANNOT be determined, it is assumed the insured died last, protecting their secondary beneficiary or heirs.

Question 44

Spendthrift Trust Clause

Answer 44

Denies the beneficiary their right to assign their interest in the policy proceeds. The purpose is to prevent creditors of a beneficiary from claiming any benefits payable to the beneficiary before their are actually received. This clause does not protect the beneficiary if the benefits are payable in a lump sum, only when the proceeds are held by the insurance company under a settlement option.

Question 45

Change of Insured

Answer 45

This is typically a rider found in corporate-owned life insurance when an executive moves to another company or retires.

A change of insured benefit allows the owner to exchange the insured covered by the policy for a new insured in which the owner has an insurable interest or to exchange the policy for a new policy covering a new insured in which the owner has an insurable interest. Change of insured benefits are most often used in the business insurance market to exchange insureds in the case of personnel departures, without having to purchase an entirely new policy and without upfront loads and surrender charges. The new insured bys be insurable.

Question 46

Facility of Payment Clause

Answer 46

This provision allows the insurer to pay a relative or anyone it deems entitled to the benefits in the absence of a properly designated beneficiary or in cases of no living beneficiaries. This can alleviate any lawsuits and can be used to reimburse someone who may have paid expenses on the insured’s behalf, such as funeral costs.

Question 47

Life Policy Settlement Options

Answer 47

Directs the insurance company how to pay out the death benefits. Characteristics Include:

• Paid in lump sum unless another mode has been selected
• Used in place of receiving a lump sum death benefit or living benefit at the time of maturity
• Choice of settlement option may be made by the policyowner if insured is living OR by the beneficiary if insured is not living and not option was previously selected.
• If owner has selected a settlement option, beneficiary CANNOT change that option.
• Principal payments of the death benefit are made after an insured’s death are NOT taxable as income. However, any interest received from a settlement option distribution is taxed as ordinary income.
• Benefits paid in a lump sum are INCOME TAX FREE

Question 48

Settlement Options Include:

Answer 48

• Interest Only
• Fixed Amount
• Fixed Period
• Life Income Option
• • Straight life (Pure or Life Income Only)
• • Life Income Period Certain
• • Life Refund
• • Joint and Survivor Income Option
• • Joint Life Income Option

Question 49

Interest Only

Answer 49

Death benefit proceeds may be left with the insurer while interest payments are paid annually or more frequently. The principal amount does not decrease, and the interest generated is taxed as ordinary income when paid to the beneficiary. This method of providing income is known as capital conservation. The principal (capital) is left with the insurer at interest, conserving the capital. When this option is selected, the owner or beneficiary must direct the insurer as to when the principal will be paid as a benefit.

Question 50

Fixed Amount

Answer 50

Payments are for a specified dollar amount paid monthly until the benefits along with interest are exhausted. In this example, the interest will extend the time period in which the benefits are paid. Only the interest portion of the benefits is taxable.

Question 51

Fixed Period

Answer 51

Payments are guaranteed for a specified period of time, such as 10 or 20 years, after which payments will cease. The proceeds and interest are used to make the payments. The interest will increase the amount of each payment, and the interest is taxable.

Question 52

Life Income Option

Answer 52

This option allows the insurer to use the death benefit to purchase an annuity on behalf of the beneficiary. As with other settlement options, any interest paid is taxed as ordinary income. There are several additional options available:

• Straight life (Pure or Life Income Only)
• Life Income Period Certain
• Life Refund
• Joint and Survivor Income Option
• Joint Life Income Option

Question 53

Straight life (Pure or Life Income Only)

Answer 53

Payments are guaranteed for the lifetime of the recipient. Upon death, payments will cease. The dollar amount of each payment will depend on the age and gender of the recipient. This is an example of a SINGLE LIFE OPTION since payments will not be made to anyone other than the original recipient.

Question 54

Life Income Period Certain

Answer 54

Payments are guaranteed for the lifetime of the recipient or a specified period of time, whichever is longer. If the recipient dies prior to the end of the period certain, the payments continue to another person until the end of the period certain.

Question 55

Life Refund

Answer 55

Payments are made for the lifetime of the recipient. Upon death, if a recipient has not received an amount equal to the total death benefit, the balance is refunded to the beneficiary either in a lump sum called a CASH REFUND OPTION, or in installments, as in the INSTALLMENT REFUND OPTION.

Question 56

Joint and Survivor Income Option

Answer 56

Payments are guaranteed for the lifetime of 2 or more recipients. Upon death of the first recipient, payment CONTINUES to the survivor(s) until the death of the survivor. The survivor’s payment may be full (100%), 2/3, or 1/2 of the original payments. This payout option may be referred to as Joint and Full Survivor, joint and 2/3 Survivor, or Joint and 1/2 Survivor, depending on which option is selected.

Question 57

Joint Life Income Option

Answer 57

Payments are guaranteed to 2 or more recipients until the FIRST RECIPIENT DIES, then all payments cease.

Question 58

Nonforfeiture Options (Guaranteed Values)

Answer 58

These options are found in policies that accumulate cash values and protect the policyowner against a total loss of benefits if the policy lapses due to nonpayment of premium or is intentionally cancelled. Three nonforfeiture options add flexibility to a cash value policy:

• Cash Surrender
• Reduced Paid-Up
• Extended Term

Question 59

Cash Surrender

Answer 59

Upon surrendering the policy back to the insurer, the policyowner will receive the cash surrender value stated in the policy less any outstanding loans and accrued interest. Any amount that exceeds the premiums paid into the policy is taxable as ordinary income. The insured no longer has insurance coverage if this option is selected.

Question 60

Reduced Paid-Up

Answer 60

Present cash value is used to buy a single premium, permanent paid-up policy of a reduced face amount. This option provides the LONGEST period of coverage offered by a nonforfeiture option. Coverage, although reduced in face value, will continue to age 100.

Question 61

Extended Term

Answer 61

Present cash value is used to buy a single premium term policy of the same face amount of as long a period as it will buy, expressed as a combination of years and days. This option provides the LARGEST DEATH BENEFIT and is sometimes referred to as the AUTOMATIC (or DEFAULT) OPTION if no other option has been selected. This insured no longer has rights to the cash value under this option, and the policy will expire prior to age 100.

Question 62

Dividend Options

Answer 62

Dividends represent the favorable experience of the insurer and result from excess investment earnings, favorable mortality, and expense savings.

Dividends are available on participating policies by MUTUAL INSURERS. They are paid annually, if declared, and CANNOT be guaranteed. Since dividends are essentially a return of excess premiums paid, they are NOT TAXABLE as income UNTIL all of the premiums paid-in have been recovered. Should the total accumulation of dividends exceed the total premiums paid, the excess amount IS TAXABLE as ordinary income. Interest earned on dividends left to accumulate IS TAXABLE as ordinary income.

The policyowner decides which dividend option is in effect and can change the election at any time. If dividends are designated for any option other than cash and all current accumulations are withdrawn, the option will begin again at the next declared dividend.

Question 63

Dividend Options Available

Answer 63

• Cash
• Premium Reduction
• Accumulate at Interest
• Paid-Up Additions
• 1-Year Term
• Paid-Up Option

Question 64

Cash Dividends

Answer 64

The policyowner receives the declared dividends in the form of a check on or near each policy anniversary.

Question 65

Premium Reduction Dividends

Answer 65

Dividends are applied toward the next premium due. The same could be accomplished if the policyowner received the dividends in cash and remitted the full premium. If the declared dividends equal or exceed the premium, the premium payment may be suspended.

Question 66

Accumulate at Interest Dividends

Answer 66

The dividends are retained by the insurer and the interest rate paid to the policyowner is compounded annually.

Question 67

Paid-Up Additions

Answer 67

Purchases single premium, additional permanent benefits at the insured’s attained age. The additional insurance is paid out in addition to the face amount if the insured dies. While the insured is living, it generates cash value and dividends as if the paid-up additional benefit was part of the original policy.

Question 68

1-Year Term

Answer 68

Purchases a single premium, 1-year term benefit. Premiums are calculated at the insured’s attained age; this is also referred to as the FIFTH DIVIDEND OPTION.

Question 69

Paid-Up Option

Answer 69

Pays off the policy more quickly than scheduled. If the company’s overall performance declines, premiums may have to be resumed.