trieschmann, hoyt & sommer loss of life chapter 16 ©2005, thomson/south-western

Trieschmann, Hoyt & Sommer

Loss of Life

Chapter 16

©2005, Thomson/South-Western

22

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

33

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

44

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

55

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

66

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

77

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

88

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

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• 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

1010


• 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

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• 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

1212

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

1313

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

1414

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

1515


• 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

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• 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

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• 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

1818

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

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• 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

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• 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

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Table 16-1: Illustration of Type B Universal Life Insurance Policy Structure (Male, age 25)

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• 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

2323

Table 16-2: Interest Rate Sensitivity of Type B Universal Life Policy Cash Values (Initial Death Benefit of $100,000)

2424

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

2525

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

2626

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

2727

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

2828

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

2929

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

3030

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

3131

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

3232

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

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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

3434

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

3535

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

3636

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

3737

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

3838

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

3939

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

4040

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

4141

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

4242

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

4343

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

4444

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

4545

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

4646

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

4747

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

4848

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

4949

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

5050

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

5151

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

5252


• 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

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• 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

5454

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

5555

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

5656

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

5757

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

5858

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

5959

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

6060

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

6161

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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• 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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• 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

6464

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

6565

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

6666

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

6767

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

trieschmann, hoyt & sommer loss of life chapter 16 ©2005, thomson/south-western

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