Chapter 17

Contract Provisions in Life

Insurance
PRINCIPLES OF RISK MANAGEMENT AND INSURANCE
1 1 TH E D I T I O N
REJDA
(WEEK 3)

Agenda
An Overview*

Life Insurance Contractual Provisions

Privileges and Conditions*
Dividend Options

Non-forfeiture Options
Settlement Options
Additional Life Insurance Benefits

*An Overview
A life policy may be defined as any instrument by which

the payment of money is assured on death or the

happening of any contingency dependent on human life,
or any instrument evidencing a contract which the
subject to payment of premiums for a term dependent on
human life (Section 33 of the Insurance Companies Act
1958, UK).
The words policy and contract are not synonymous:

Contract intangible thing, legal binding agreement between

concerned parties;
Policy written document which embodies that agreement is in
concrete form.

Life Insurance Contractual Provisions

Under the ownership clause, the policy owner possesses all

contractual rights in the policy while the insured is living:

Rights include naming beneficiaries and surrendering the policy for

its cash value;
The policyholder can designate a new owner by filing an appropriate
form.

The entire-contract clause states that the life insurance

policy and attached application constitute the entire

contract between the parties:

Prevents the insurer from making amendments without the

policyholders knowledge.

Life Insurance Contractual Provisions

The incontestable clause states that the insurer cannot

contest the policy after it has been in force two (2) years
during the insureds lifetime:

Protects the beneficiary if the insurer tries to deny payment of the

claim years after the policy was first issued;
The insurer has two (2) years to detect fraud;
The insurer can contest a claim after the incontestable period if:

The beneficiary takes out the life insurance policy with the intent of
murdering the insured;
The applicant has someone else take a medical examination;
An insurable interest does not exist at the inception of the policy.

Life Insurance Contractual Provisions

The suicide clause states that if the insured commits suicide

within two (2) years after the policy is issued, the face
amount of insurance will not be paid; there is only a refund
of the premiums paid:

Reduces adverse selection against the insurer.

A life insurance policy contains a grace period during which

the policyholder has a period of 31 days to pay an overdue

premium:

Prevents the policy from lapsing by giving the policy owner

additional time to pay.

Life Insurance Contractual Provisions

The reinstatement provision permits the owner to

reinstate a lapsed policy:

To reinstate, the following requirements must be met:

Evidence of insurability is required;
All overdue premiums plus interest are paid;
Any policy loans are repaid or reinstated;
The policy was not surrendered for its cash value.

The policy must be reinstated within a certain period, usually

3-5 years after the date of lapse;

Although it may require a large outlay of cash, it may be

cheaper to reinstate a lapsed policy than to purchase a new
policy.

Life Insurance Contractual Provisions

The beneficiary is the party named in the policy to

receive the policy proceeds:

Primary beneficiary is the first entitled to receive the policy

proceeds;
Contingent beneficiary is entitle to the proceeds if the primary
beneficiary dies before the insured;
A revocable beneficiary means that the policy owner reserves
the right to change the beneficiary designation without the
beneficiarys consent;
An irrevocable beneficiary is one that cannot be changed
without the beneficiarys consent;
A specific beneficiary is specifically identified;
A class beneficiary is a member of a group, e.g. children of the
insured.

Life Insurance Contractual Provisions

Under the misstatement of age or sex clause, if the insureds age

or sex is misstated, the amount payable is the amount that the

premiums paid would have purchased at the correct age and sex.
A change-of-plan provision allows policy owners to exchange
their present policies for different contracts.
Life insurance contracts do not contain many exclusions:
Suicide excluded for two years;
Insurers might insert a war clause to exclude payment if the
insured dies as a direct result of war;
Some policies contain aviation exclusions.
Premiums can be paid annually, semiannually, quarterly, or
monthly:
If premiums are not paid annually, a carrying charge is
applied.

Life Insurance Contractual Provisions

A life insurance policy is freely assignable to

another party:

Under an absolute assignment, all ownership rights in the

policy are transferred to a new owner;
Under a collateral assignment, the policy owner temporarily
assigns a life insurance policy to a creditor as collateral for a
loan:
Only certain rights are transferred to the creditor;
Purpose is to protect the insurer from paying the policy
proceeds twice.

Life Insurance Contractual Provisions

A policy loan provision allows the policy owner to

borrow the cash value:

The policy owner must pay interest on the loan to offset the
loss of interest to the insurer;
A policy could lapse if the policy owner does not repay a loan
and the total indebtedness exceeds the available cash value.

Under the automatic premium loan provision, an

overdue premium is automatically borrowed from

the cash value after the grace period expires:

Prevent the policy from lapsing;

Policy owner may become lazy and exhaust all cash value.

*Privileges and Conditions

Days of Grace:
Thirty days (or one month calendar) are allowed. If the
renewal premium is not paid within the days of grace, the
policy ceases to have any further cover, subject to any nonforfeiture provisions, if applicable.

Suicide Clause:
If the Insured commit suicide within a stated period of time
(usually 1 or 2 years) from the date of inception or
reinstatement of the policy, the policy becomes void and the
insurer is not liable to pay the claim except to refund all
premiums paid.

*Privileges and Conditions

Incontestability Clause:
Commonly included in most insurance policies.
Section 147 (4) of the Insurance Act 1996 no life policy after
the expiry of 2 years from the date on which it was effected or
reinstated, be called in question by the insurer on the grounds
that a statement made or omitted..was inaccurate or false or
misleading, unless the insurer can show that such statement
was madefraudulent made by the Insured.
Insurer cannot deny liability on a policy after 2 years of its
issuance on the grounds of misrepresentation or nondisclosure.

*Privileges and Conditions

Misrepresentation of Age:
Section 146 of the Insurance Act 1996 a printed notice
stating that proof of age of the life assured may be required
prior to the payment (can be made by the Company).
If there has been a misrepresentation of age, the following
measures can be adopted:
Understated purchase according to the true age;
Overstated excess premium paid be refunded or the sum assured
and bonuses proportionately increase to correspond the true age.

Section 147 (1) of the Insurance Act 1996 stresses that an

insurer shall not dispute liability by reason only of a
misstatement of the age.

*Privileges and Conditions

Reinstatement Condition:
Enables

a person to apply for reinstatement of the

policy.
Policies are reinstated subject to:

Evidence of health;
Payment of overdue premiums with interest.

Reinstatement

following:

normally do not allowed the

A policy which has lapsed for more than 3 years for whole life and
endowment policies and 6 months for term policies;
A female life assured who is pregnant 8 months and above;
A life assured who has attained age 60 and above next birthday.

*Privileges and Conditions

Assignment:
Assignor vis--vis an assignee, the person who takes over the
assigned rights.
Absolute which does not leave any rights with the assignor
except for the payment of premium (if he chooses to pay).
Conditional the assignor can revoke all the rights if the
assignee dies before the payment of the policy money OR if the
life assured survives until the maturity date.
Process / Procedures:
The assignment shall be in writing. Insurer can not be liable due to
absence of a written notice. Must be served to the principal office
of the Insurer;
The assignment may be effected by an endorsement / separate
deed. Earlier dated assignments rank ahead the later ones.

*Privileges and Conditions

Policy Loan:
Policy holder entitle to a loan only after his policy has acquired
a cash value (minimum period of at least 3 years).
Generally granted up to 92% of the acquired cash value of a
policy. Normally the interest rate is higher than that of a fixed
deposit rate.
Loans are repaid during the currency of the policy or may
remain as a charge on the policy money until a claim arises
(together with interest as and when due).

*Privileges and Conditions

Automatic Premium Loan:
APL provides continuation of the insurance cover(from cash
value) in cases where the assured, through either carelessness
or inability, fails to pay a premium, and it also allows the
assured at anytime the right to restore the original status by
repaying the amount owed to the Company.
No evidence of insurability is necessary.
APL also allows continuity of supplementary benefits such as
waiver of premium and accidental benefits.
Drawbacks policy holder take advantage of this method even
when they are able to their payment of premiums (automatic).
The insurance protection decreases each time the amount of
loan increases.

Dividend Options
If a policy pays dividends it is a participating policy ,

Otherwise it is a non-participating policy.

Dividends come from three (3) main sources:
The difference between expected and actual mortality experience;
Excess interest earnings;
The difference between expected and actual operating expenses.
Policy owners have several ways to take dividends:
Take the cash;
Reduce the next premium coming due;
Let them accumulate at interest and withdraw later;
Apply toward the purchase of paid-up whole life insurance under the
paid-up additions option;
Apply toward the purchase of term insurance;
Convert the policy to a paid-up contract, or mature a policy as an
endowment.

Non-forfeiture Options
The payment to a withdrawing policy owner is

known as a non-forfeiture value or cash surrender

value:

A policy owner has a right to the policys accumulated cash

value; all states have standard non-forfeiture laws;
Policy owners have three non-forfeiture options:
The policy can be surrendered for its cash value;
Under the reduced-paid up insurance option, the cash surrender
value is applied as a net single premium to purchase a reduced
paid-up policy;
Under the extended term insurance option, the net cash surrender
value is used as a net single premium to extend the full face
amount of the policy into the future as term insurance.

Exhibit 17.1 Table of Guaranteed Values*

Settlement Options
The policy owner can choose among several options for

paying the policy proceeds:

Or, the beneficiary may be granted the choice.

The most common options include:

Proceeds are paid in a lump sum;
Under the interest option, the proceeds are retained by the insurer,
and interest is periodically paid to the beneficiary:

The beneficiary can be given withdrawal rights.

Under the fixed-period option, the proceeds are paid to a beneficiary

over some fixed period of time;
Under the fixed-amount option, a fixed amount is periodically paid
to the beneficiary until the principal and interest are exhausted.

Exhibit 17.2 Income for Elected Period (minimum

monthly payment per $1000 of proceeds)

Settlement Options

Under the life income option, installment payments are paid

only while the beneficiary is alive and cease on the
beneficiarys death:

There is no refund feature or guarantee of payments.

Other life income options include:

Life income with guaranteed period: if the beneficiary dies before
receiving the guaranteed number of years of payments, the
remaining payments are paid to a contingent beneficiary;
Life income with guaranteed total amount: if the beneficiary dies
before receiving installment payments equal to the total amount of
insurance placed under the option, the payments continue until
the total amount paid equals the total amount of insurance;
Under the joint-and-survivor settlement option, income payments
are paid to two persons during their lifetimes, such as a husband
and wife.

Exhibit 17.3 Life Income with Guaranteed Period

(minimum monthly payment per $1000 of proceeds)

Exhibit 17.4 Life Income with Guaranteed Total Amount

(minimum monthly payment per $1000 of proceeds)

Exhibit 17.5 Joint-and-Survivor Income Option 10-Year

Guaranteed Period (minimum monthly payment per $1000 of
proceeds)

Settlement Options
Settlement options allow for periodic payments to

the family, restoring their financial security.

Disadvantages include:

Interest rates offered by insurers may be lower than rates

offered elsewhere;
The settlement agreement may be inflexible and restrictive.

Additional Life Insurance Benefits

Other benefits can be added to a life insurance policy

for an additional premium:

Under a waiver-of-premium provision, if the insured becomes

totally disabled, all premiums coming due during the period of
disability are waived;

In many cases, total disability means that the insured cannot do any of the
essential duties of his or her job for which he or she is suited based on
schooling, training, or experience.

The guaranteed purchase option permits the policy owner to

purchase additional amounts of life insurance at specified
times in the future without evidence of insurability;

The option guarantees the purchase of specified amounts of life insurance

in the future even though the insured may become uninsurable.

Additional Life Insurance Benefits

The accidental death benefit rider doubles the face amount

of life insurance if death occurs as a result of an accident:

Also known as double indemnity.

The cost-of-living rider allows the policy owner to purchase

one-year term insurance equal to the percentage change in

the consumer price index with no evidence of insurability.
The accelerated death benefits rider allows Insured who are
terminally ill to collect part or all of their life insurance
benefits before they die:

Forms include: a terminal illness rider, catastrophic illness rider, and

long-term care rider.

Additional Life Insurance Benefits

A viatical settlement is the sale of a life insurance

policy by a terminally ill insured to another party,

typically an investor group, who hopes to profit by
the insureds early death.

A life settlement is the sale of a life insurance

policy by a policy owner who no longer needs or

wants the insurance.

These options create a moral hazard problem, and

may not be adequately regulated by the states.