The insured or the beneficiary determines how the death benefit(s) will be paid, using a “Settlement Option.” Most companies offer all of the options presented in this section. Even though most companies are quite liberal in allowing arrangements not specifically mentioned in the policy, nearly all companies are more liberal at providing settlement options while the insured is still alive. The policyowner can give as much or as little authority in determining settlement options as they want, with the beneficiary having no rights to change the option. Or they could set up a settlement option arrangement that would allow the beneficiary to receive the funds in any fashion they so desire. Insurance companies usually work with the beneficiaries to arrive at a mutually-satisfactory arrangement.
Death benefits may be paid in one lump sum, which is how about 90% of all policy proceeds are paid. If neither the policyowner nor the beneficiary selects a different option, the insurer will always make a lump-sum payment of the face amount of the policy (minus any outstanding loans, interest or unpaid premiums currently due).
Many policies provide for interest to be paid from date of death, even if a settlement option has not been elected. The interest option allows flexibility as it permits adjustments to be made because of changing economic conditions.
Owners or beneficiaries might opt to have the insurer pay interest only, at least for some period of time, in which case the face amount of the death benefit, or the principal, is left with the insurer to be invested and earn interest. The interest is paid to the beneficiary periodically - monthly, quarterly, twice a year or once a year. The policyowner may stipulate the frequency, which the beneficiary may change if they so wish.
Many policies written with the interest only settlement option also provide that the beneficiary may withdraw all or part of the principal amount at some point. Such a provision can be written many ways, limiting the number of withdrawals per year for example. Other options might limit the amount that may be withdrawn at any one time or within a certain time period, or specifying that all may be withdrawn after a certain length of time. A Spendthrift clause can be used to protect the beneficiary from creditors, if specified in the policy.
Policies may also be written so the beneficiary may not withdraw any of the principal. This brings up the question of what happens to the principal amount if the beneficiary dies. There are two possibilities:
The first possibility is more typical. Since the money belongs to the primary beneficiary, now deceased, it goes into his or her estate if no alternate arrangement was made when the beneficiaries were designated.
The second possibility occurs only if the eventuality had been pre-arranged at time of policy issue or prior to the death of the insured. The original arrangement might have been that the contingent beneficiary also receives interest only, rather than the principal amount. But, unless specified otherwise, at this point the principal would be paid in a lump sum either to the primary beneficiary's estate or to the contingent beneficiary.
The fixed-amount settlement option permits the death benefit to be distributed in more than one payment of a fixed amount that is either originally specified by the policyowner or selected by the beneficiary. It is in fact, an annuity certain but the income amount is fixed, rather than the time period (Fixed-period Option, described below). The payment might be made annually, semiannually, quarterly or monthly. For example, the beneficiary could receive $2,500 per month for as long as the money lasts. The portion of the death benefit not yet paid draws interest while the insurer controls it. Because of the interest earnings, the final payout will be greater than the original death benefit amount. Dividend accumulations, additions payable or additional death proceeds, combined with excess interest earned while installments are being paid, will increase the length of time the benefits will be paid, but do not affect the amount of each installment.
The fixed-amount option has more advantages than fixed-period options because they have more flexibility. Policyowners can vary the amount of income at different times, and beneficiaries can withdraw all or part of the benefit; or the beneficiaries may have the right to withdraw up to a certain sum in any one year.
Rather than a fixed amount, benefits might be paid for a fixed period. It is an annuity certain over a defined period of months or years (usually not longer than 25 or 30 years). If an insured wants to be certain the beneficiary has at least some income for a certain period of time, this is better than the fixed amount option. Interest is paid on the retained principal. The amount of each payment depends upon the original death benefit amount, interest earned on the decreasing principal, the length of the fixed period and the frequency of each payment.
Most companies permit policyowners to give the beneficiary the right to receive the present value or all remaining installment payments in one lump sum. This is called the right to commute.
Any accumulations of dividends, paid-up additions, or other additional death benefit payments, increase the income to the beneficiary but the number of installments stays constant.
The life income option pays the death benefit in such a way that the beneficiaries receive an income for the rest of their lives. This option involves the purchase of an annuity contract designed to provide lifetime income. (Annuities pay an periodic income benefit over a specified period of time.) It is not necessary to go into the various types of annuities, but the ones used for settlement options are immediate annuities in most cases – this means that the amount to be distributed will be paid “up-front,” in one lump sum.
The primary advantage of this option is the guaranteed lifetime income. Whether or not that income is plentiful or even adequate, depends upon the amount of the death benefit and the age and sex of the beneficiary, using the "rules" under which annuities are established. For example, since women as a group live longer than men, if the beneficiary is a woman, she will receive a smaller periodic income than a male beneficiary.
Using annuity tables, the insurer establishes the schedule of payments. There are other considerations as well, since a life income annuity option might be set up to benefit more than one person. As an example, the beneficiary might be a husband and two adult children, with the payments continuing to the children after the husband/father dies. In this case, each individual's portion of the income would be smaller.
The refund life income option may either be a cash refund option or installment refund annuity. Both guarantee the return of an amount equal to the principal sum, less the total payments that have already been made. As the names would indicate, the difference is that under the cash refund option, there is one lump sum settlement made. Under the installment refund option, payments are made in installments.
This is the most popular of the options. It will pay the benefits in installments as long as the primary beneficiary lives. If the primary beneficiary dies before a pre-determined period (period certain) of time, then the installments will continue to be paid to the contingent or secondary beneficiary, until the end of that time.
CONSUMER APPLICATION
Jennie was the primary beneficiary under Al’s life insurance policy and their granddaughter Marie was the contingent beneficiary. Al elected the life income option with period certain of 20 years, so that if after he died, Jennie could be taken care of properly for 20 years, if she lives that long. If she didn’t, then Marie would have some money to pay for college or other uses, depending upon her age at the time.(Cont.)
When Al died, the policy benefits allowed a monthly payment of $2500 a month for 20 years to Jennie, who lived for another 5 years. Marie would then receive $2500 a month for 15 years.
Under this type of Settlement Option, the longer the guarantee period, the less the monthly proceeds and the older the beneficiary, the greater the life income. The problem with this type of option is that the amount of income that the beneficiary will receive cannot be determined prior to the death of the insured as it depends entirely upon the beneficiary’s age.
Under the joint and survivorship option, the payments are paid for life as long as one of two beneficiaries is alive (actually the beneficiaries are annuitants, as for all income options). Depending upon how it is written, this option annuity may continue payments in full, or some fraction thereof after the death of the first annuitant – usually 2/3 or ½ payments (joint and two-thirds, or joint and one-half).
The period certain for this type of option can be 10 to 20 years. This is useful in providing for a retirement income for a husband and wife. Actually, the proceeds of a matured endowment policy (yes, there are some old ones around) or annuity, or the cash value of any policy can be applied under this option.
Some companies allow other types of options to suit a particular need.
This type of option provides a fixed income during the 9 or 10 months of each college term, with the remainder provided at graduation.
The flexible spending account operates much like a bank account. Proceeds are paid into an account, which draws interest, and the beneficiary can draft the account for part or all of the funds, as they desire. Many companies use this option automatically instead of a lump sum, as it gives the beneficiary time to determine what they want to do with the money. Usually there is a minimum amount of $10,000 required.
Insurers are very flexible in working with the insured and with the beneficiaries, so that they all are happy. However, the insurance company will not accept any arrangement where it has to exercise its own discretion in fulfilling the terms of the arrangement.
Insurance is “property” - legally and technically - and therefore any ownership rights in a policy can be transferred by the policyowner to another party. The term for this tranfer is “assignment.” There has been considerable interest in assignments of policies recently, principally for “viatical settlements” which has become popular because of AIDS – some 90 percent of viatical settlements cover AIDS victims.
There are two types of assignment, absolute and collateral.
As the word would indicate, absolute assignment is the transfer by the policyowner of all rights in the policy to another person. Absolute assignment is often used as a gift, as it is a non-taxable gift and an excellent choice for personal and for tax reasons.
Ocassionally, and more so now than in previous years, a life insurance policy is sold for a valuable consideration – usually cash. In business insurance, a policy that is owned by a corporation (key man insurance) may be sold for an amount equal to its cash value upon termination of employment. This is usually accomplished using an absolute assignment.
As stated earlier, an irrevocable beneficiary must consent to an assignment of the policy, as they are in effect, a co-owner. The question has arisen as to whether an assignment changes the beneficiary, and the courts are split on this point. It can be a moot point, as the new policy owner can change the beneficiary by following the company procedures for doing so.
The most common use of an absolute assignment is viatical settlements, as described below:
The outbreak of AIDS in the United States created Viatical Settlements as the life expectancy of an AIDS patient is relatively short, they face large medical and hospital bills, and many are not able to work. Many of the AIDS patients had (have) life insurance policies on their own life, so in order to get money NOW, they were (are) willing to sell these policies for a percentage of the face amount.
Individuals, insurance agents and financial planners generally bring potential policy sellers to a viatical firm, which can be a specialized company or a group of
investors, willing to purchase life insurance on the terminally ill. The firm makes an offer to the policyowner which depends on the face amount and the insured’s life expectancy, taking into consideration future premium payments, outstanding policy loans and the present interest rates. Any life insurance policy can be used, but the firm will require certification from a physician that the individual’s condition can reasonably be expected to result in death within a certain time period.
If both sides agree, the policy is transfered, using an absolute assignment. The firm then names itself as beneficiary, and when the insured dies, it collects the policy proceeds.
(Continued on next page)
The NAIC has enacted the Viatical Settlements Model Act in anticipation and concern over possible abuse, which makes the viatical settlement firm disclose to the person who sells their policy (the viator ) certain facts on the transaction, such as eligibility for government benefits, tax implications, the right to rescind, and alternatives (some companies have accelerated death benefits where the insured can receive the present value – or close to it – of the policy benefits).
The proceeds of the viatical settlement are tax free if the viator meets the definition of being terminally ill – the individual must be certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months or less.
Viatical settlements are subject to the “Transfer for Value” rule for tax purposes, as discussed later in the Taxation section of this text.
Since insurance is property, a collateral assignment is a temporary transfer of only some of the property – policy ownership rights – to another person and are usually used for loans from lending institutions. The American Bankers Association Collateral Assignment Form 10 is usually used for this purpose.
The lending institution can collect the proceeds at maturity, surrender the policy and obtain policy loans, receive dividends, and exercise the nonforfeiture rights. The policyowner, on the other hand, can collect any disability benefits, change the beneficiary (but subject to the assignment) and election settlement options (again, subject to the assignment).
The assignee (the lender usually) agrees to pay the beneficiary any proceeds that are in excess of the policyowner’s debt, not to surrender or obtain a loan from the insurance company unless there is a default in premium payments (or default on the debt), and to forward the policy to the insurance company for any change of beneficiary or change in settlement options.
The cash value of a life insurance policy serves as collateral for a policy loan in the same way a house serves as collateral for a mortgage loan. Therefore, in order to borrow $1,000, there must be at least that much cash value in the policy. Actually, there must be slightly more because, typically, a 100% loan is prohibited in order to protect the insurance company. The policyowner could borrow nearly 100% of the cash value, but a small portion would be deducted, equal to one year's interest. For example, if the policyowner wants to borrow the full cash value of $1,000 and the interest rate for the loan is 8%, the insurer will keep 8% of $1,000 or $80 and lend the balance of $920.
As described in a later section, Variable life policies typically restrict the amount that may be borrowed to 90% of the value of the separate account.
The low interest rate traditionally charged for policy loans is one of the features that has made such loans attractive, with a 4% to 6% fixed rate being common in the past. With the overall interest rates at the lowest in many years, it is still attractive, provided the insurers keep their interest rates “in the ball-park” of other commercial loans. In any event, they will probably always be much lower than credit card loans (debt) and that would make these very attractive to many of today’s consumers. Variable interest rates are also available, tied to a financial indicator such as the rate on U.S. Treasury bills or Moody's long-term bond rate. When a variable rate applies, the policy specifies when the insurer will adjust the rate, such as on the first day of each calendar quarter.
Direct recognition is the immediate consideration of present interest rates, mortality experience, and expenses in premiums currently charged. This is critical to the formulation of Current Assumption Whole Life and Universal Life products.
Under the Direct Recognition principle, a policy loan can have a significant negative impact on dividends paid under participating policies. When determining the dividend to be paid on a particular policy, companies that use direct recognition take into account the interest rate the insurer earns on the loan and the dividend interest rate the company has assumed it would have earned on the cash value if part of it had not been borrowed. The difference reduces the dividend.
CONSUMER APPLICATION
A policyowner has an outstanding policy loan of $5,000, for which he is paying 7% interest. The insurer assumes a dividend interest rate of 10%.
The dividend that is due to be paid is $500.
Since the $5,000 loaned to the policyowner is not available to earn the assumed rate of 10%, the insurer earns only the 7% interest paid by the borrower-3% less than assumed. Three percent of $5,000 is $150, so this $150 is subtracted from the dividend paid. Instead of receiving the full $500 dividend, this policyowner receives only $350 because of the outstanding loan.
Insurers believe direct recognition is a fairer proposition for all policyowners because it rewards those who do not borrow money. Under this arrangement, non-borrowers "earn" the higher dividend because all cash value is left with the insurer for earning purposes. Borrowers receive a smaller dividend because not all of their cash value is available to the insurer to earn interest.
As detailed later in this text, for universal and variable life policies, insurers might pay a lower interest rate on the borrowed portion of cash value that is serving as collateral for a loan. That is, the typically higher current interest rate is paid on cash values that are not collateral and a lower rate, often the guaranteed rate, is paid on the portion borrowed. Additionally, universal life policy loans might be "wash loans" with the interest charged on the loan canceling out the interest paid on the cash value that serves as collateral.
Policies other than universal and variable life also have arrangements for paying a lower rate on loaned cash values. Some companies, for example, pay 1% less on the loaned values than on the remainder of the cash value.
Because borrowing cash values represents a loan, repayment is expected, even though the loan need never be repaid. The policyowner may continue paying interest on the loan indefinitely. The negative consequences for not repaying loans from cash values include:
If a policy is about to lapse because of outstanding loans and/or interest due, the insurance company must notify the policyowner in time to repay the loan or make premium payments to keep the policy in force.
The reinstatement clause allows the policyowner to reinstate a policy that had lapsed, under certain requirements. The most important requirement is to furnish evidence of insurability and pay past-due premiums.
“Evidence of Insurability” is required by the company to prevent adverse selection. Otherwise, it would be common for an individual to allow a policy to lapse, and then discover that it would be for their benefit to keep the policy in force (they have just been diagnosed with a fatal disease, for example). The insured is required to furnish evidence of insurability that is satisfactory to the company. While good health is the usual requirement, the company may also require information on the travels of the insured, occupation, financial condition, etc. An example frequently used is of an insured who is in prison and sentenced to the gas chamber. He might be in good health now…
What is interesting about this provision is its relationship to the incontestable clause. If a policy is reinstated, what happens? Does the incontestable period start all over again? While laws are really not very clear on this matter, the general practice is that the incontestable clause is also reinstated, making the policy contestable again but only to statements made in the reinstatement application. While other jurisdictions state that the original incontestable clause is still in effect (period dated from policy date), there are a few jurisdictions that take the view that the reinstatement (itself) is a separate contract that has no incontestable period. Fair? Hardly, because this also means that the policy can be contested for fraud at any time.
For the Suicide Clause, courts have been almost unanimous in holding that the suicide clause does not run again.
In respect to past-due premiums, there is a legitimate argument that there should be no premiums due for past mortality charges as no coverage was provided during the lapse period. Therefore, some jurisdictions limit the past-due premium to the increase in reserves between the time of lapse and reinstatement.
Incidentally, reinstatement is not permitted if the policy has been surrendered (or continued as extended term insurance) and the full term of the policy has expired. If the extended term portion has not expired, most companies will reinstate the policy with little or no evidence of insurability. Regardless, reinstatement seldom is allowed if more than 5 years has elapsed since the policy lapsed.
Policies are required in most jurisdictions to have a misstatement of age provision which simply states that if the insured’s age is found to have been misstated, the amount of insurance will be adjusted to be that which would have been purchased by the premium paid, if the correct age were known.
If the misstatement is determined when the policy is in force, and if the age is understated, usually the insured has the option to pay the difference in premium with interest or having the policy reissued at the proper amount to match the premium. If the age is overstated, a refund is usually made by paying the difference in reserves.
The same rules hold if there is a misstatement of sex – not a usual situation, but it could happen through error in transcribing.
This provision appears in policies so that a misstatement of age cannot be considered a misrepresentation and thus be used to void the policy.
Life insurance policies can be continued by payment of premiums in a timely manner and for the length of time contracted. Most individual life insurance policies stipulate the guaranteed maximum premium that can be charged by the insurer. In other types of insurance there are differing types of renewal rights, such as noncancellable, guaranteed renewable, and conditionally renewable. As important as these are in health insurance, they have little, if any, application in life insurance.
The Riders discusseds in this section are optional, however, if underwriting requires a rider to be attached to a policy, the policyowner would be advised in advance. Some Riders are mandated by law. Riders are even used for substandard risks, as anytime that the premium is increased for underwriting purposes, the insured is informed by a Rider so stating. These types of Riders are not discussed in this section as they are not “typical” riders.
The waiver of premium rider allows the policy to continue without further premium payments if the insured becomes disabled and cannot work. In essence, the insurer takes over the premium payments. The key to this rider is understanding what the insurer means by disability.
F Total disability is the inability of the insured to perform any and all important daily duties of that insured’s occupation.
Most companies require 6 months of continuous disability before the waiver of premium (WP) provision applies. A disability is covered if it begins prior to age 65 (usually) and will continue as long as the insured continues to be disabled.
WP is not a continuance of premium, but is a benefit for which there is a premium. Therefore dividends continue (if participating policy), cash values continue to increase, and loans may be obtained. Actually, it is a benefit that pays an amount exactly equal to the premiums when the insured becomes disabled.
Benefits will not be paid if the disability results from:
• Commission of a crime by the insured.
• War or other military action.
• Self-inflicted injury.
There are 3 different provisions regarding WP riders on Term policies when conversion is involved to a permanent plan:
The Payor Rider is a form of Waiver of Premium, and is usually written on policies insuring children, or when another person pays the premiums. With the payor rider, if the person paying the premiums either becomes disabled (under the same conditions described for the waiver of premium rider) or dies, premiums are waived. Disability or death must occur before the child reaches a certain age, usually 21 or 25. Some payor riders, instead of waiving the premiums for disability, do so only if the payor dies.
Payor riders generally require a medical history and exam for the person who is paying the premiums since it is this person's health, not the insured child's health, that could activate the waiver.
Premium Waiver and Universal Life
When the waiver of premium rider is attached to a universal life policy, the rider works differently than with whole life or term. The usual approach is that the insurer waives only the portion of the premium payment that actually pays for the insurance protection, the mortality charge. Some insurers do offer a universal life waiver of premium rider that calls for the insurance company to pay the entire premium. This is obviously advantageous since cash values can continue to grow as originally anticipated. The amount the company pays is limited to the planned premium established when the policy was issued.
The Accidental Death Rider (also known as “Double Indemnity), when added to a life insurance policy, provides that double (or triple) the face amount of the policy, will be paid if the insured’s death is the result of an accident. Philosophically or financially, there is no reason that a person that dies from an accident should receive so much more insurance benefit, than one who died of disease. The popularity is principally because it is relatively inexpensive, and many people just “feel” that they will die from an accident (actually, less than 10% of all deaths are the result of an accident). If there were no Double Indemnity provisions, think of all of the murder mysteries that would not have been written…
Accidental Death is typically defined in a policy as “death resulting from bodily injury effected solely through external, violent, and accidental means, independently and exclusively of all other causes, with death incurring within 90 days after such injury.”
The accident must be the sole cause of death, and if other factors contributed to the death, in addition to the accident, the rider does not apply. Both the “cause” and the “result” of the death must be accidental.
Death must occur no more than 90 days (or three months) after the accident or, under some riders, 120 days. Some courts have held that the 90 day period does not have to be strictly applied. Accidental death coverage usually expires at age 65 (or 70). Premiums are based upon age at issue (usually 5-year banded).
Certain exclusions apply (three are the same as for the WP Rider, plus the following):
Accidental Death and Dismemberment
Some companies offer an accidental death and dismemberment rider which has the same features as the accidental death rider, plus a benefit paid if the insured suffers accidental dismemberment of specified parts of the body, rather than death. The rider usually applies to loss of eyesight and loss of members such as arms, legs, hands and feet.
A typical benefit schedule would be as follows (“principal sum” is the face amount of the benefit rider):
Sight in both eyes Principal sum
Sight in one eye Half of principal sum
One member Half of principal sum
Two members Principal sum
Similar to the waiver of premium rider, the Disability Income Rider pays a monthly income directly to the disabled person. The insured must be totally disabled to receive payments and the definition of disability follows the standards described for waiver of premium. The same exclusions also apply.
Disability income riders provide a relatively modest amount of income per $1,000 of life insurance coverage - commonly $5, $10 or $15 per $1,000. Most companies also require a three- to six-month waiting period following disability before monthly payments begin. Alter the waiting period, payments are retroactive to the first day of disability.
The Accelerated Death Benefit rider (may also be a policy provision) provides for the payment of all or a portion of the death benefit of the policy prior to the death of the insured if the death of the insured is caused by some specific medical condition. There are three types of Accelerated Death Benefits riders.
The Terminal Illness coverage provides that a specific percentage of the face amount, such as 25% or 50%, will be paid (frequently with a maxmim of $250,000) if the insured is diagnosed as having a terminal illness. Generally, the coverage will specify that the insured have no more than 6 months to live, others may use one year as the maximum. This terminality of the illness must be proven by a physicians certification, as well as a hospital or nursing home, &/or a medical exam ordered by the insurer.
Insurers usually notify beneficiaries and assignees of the acceleration. Dividends and cash values, plus death benefits and premiums, will be reduced by the accelerated percentage.
The Catastrophic Illness coverage closely resembles the Terminal Illness coverage, except that the insured must have been diagnosed with one of the specified diseases (also known as “dread diseases”), such as stroke, cancer, heart attack, coronary artery surgery, renal failure, etc.
This coverage is not as available as it once was, as the marketing of this option has been criticized heavily by insurance departments and other officials because of “fear-based” selling and claims difficulties. The NAIC has published Accelerated Benefits Guidelines for Life Insurance, which specifies the illustrations that must be provided for prospective purchasers.
The Long Term Care Coverage type of accelerated death benefit, provides that monthly benefits will be paid if the insured is confined because of a medical condition. Qualifications are strict, and the insured must be confined in a qualified facility and the confinement must be medically necessary.
Provisions vary, and can cover skilled nursing facilities, intermediate nursing care facilities and custodial care facilities. Some cover home health convalescent care.
The elimination period can be 2 to 6 months, and some insurers require that the policy be in force for a specified number of years.
The monthly benefit typically equals 2 percent of the face amount of the life insurance policy, subject to a specified maximum amount and a specified total maximum payout. Some companies use a “two-tiered” approach, so that the percentages are reduced in relation to the face amount, such as 2% of the first $100,000 of face amount, ½% of the amount over that. The maximum payout is generally 50% of the face amount of the policy.
NOTE: Some financial planners have suggested a Long Term Care rider on a life insurance policy, instead of a long term care insurance (LTC) policy. There is a danger in this, as in many situations, it is less expensive to purchase a life insurance policy and a long term care insurance policy (both). In addition, the LTC policy has much more flexibility and more benefits.
The guaranteed insurability or purchase option rider guarantees future opportunities for insureds to purchase additional insurance without proving they are still insurable. This rider may used with cash value policies only (not term), and typically may be used only to purchase more cash value coverage.
Guaranteed insurability riders are offered to younger people who are more likely to remain healthy. The option to purchase more insurance without proving insurability ends at the insured’s age 40 or any other age stipulated by the insurance policy.
The insurer offers a number of “option dates” on which the insured may elect to purchase the additional insurance. Option dates are usually about three years apart and the number available to a given insured depends upon the insured's age when the rider is purchased and the age at which the option expires. For example, with three year periods and an option ending at age 40, a 25-year-old could purchase additional coverage at ages 28, 31, 34, 37 and 40, with five option dates available. A 34-year-old would have only two, at ages 37 and 40. Some insurance companies permit the purchase of additional coverage ahead of the stipulated option date when the birth of a child occurs. Riders with this provision cost more than the standard rider.
Each insurer establishes certain minimum additional amounts of coverage, such as $5,000 minimum plus additional increments of $1,000. The maximum amount of additional insurance permitted is the amount of the original policy's death benefit.
While this rider guarantees that the insured will be able to buy coverage without proving insurability, the insured's attained age is used to determine the cost, so there are no guarantees about the cost of the coverage.
The Cost of Living Adjustment rider helps the amount of insurance to correspond with inflationary increases, measured by the consumer price index (CPI). For example, if the CPI rises 1.5% over a year's time, the policyowner may purchase more insurance equal to 1.5% of the policy's face value. An upper limit applies, typically 10% of the face value.
Cost of living riders usually allow the purchase of one-year term insurance added to a whole life policy. Some permit a small amount of whole life as paid-up coverage and others might allow a combination of one-year term and the paid-up addition of whole life. If the policy is universal life, the death benefit is simply increased. The COLA rider is usually available only with cash value policies, rarely with term insurance.
The policyowner may choose to activate the cost of living rider or not, but must specifically decline it if no additional coverage is desired. Under universal life policies, policyowners must be very clear about their desires because if they skip a premium the insurer will automatically adjust the cash value account to pay both the premium and the cost to adjust the death benefit to the CPI.
Term Riders attached to a life insurance policy to enhance the benefits have been briefly discussed earlier in this text. Term riders may be attached to cash value policies only and the period during which the term rider is in effect may not be longer than the premium-payment period of the cash value policy. The cost of the term rider is added to the cost of the cash value policy so the policyowner pays a single premium.
Term riders are less costly than separate term policies, but they may be purchased only in conjunction with a cash value policy, so the total cost is greater.
Once the term rider is purchased, the insured may not let the cash value policy lapse and simply maintain the less costly term rider. An insured may, however, cancel the term rider while maintaining the cash value policy, although this practice is discouraged.
The term rider may provide level term coverage, or increasing or decreasing term coverage. Most purchasers in today’s market, purchase the coverage to be added to the base policy so they can purchase a high-value term life insurance rider, or a rider that permits them to make additional premium payments to accelerate the cash value buildup, which may or may not increase the death benefits.
STUDY QUESTIONS
Chapter 3
1. Settlement Options
A. are the exclusive right of the beneficiary.
B. are determined by the insurance company at the time the policy is issued..
C. determines how the proceeds of a life insurance policy will be paid.
2. The beneficiary receives an income for the rest of their life under
A. the life income option.
B. an interest only option.
C. a fixed amount option.
3. A transfer by the policyowner of all rights in his/her life insurance policy
A. is illegal.
B. can only be accomplished by withdrawing the cash value and transferring the cash.
C. is called an assignment.
4. When an insured becomes terminally ill, he/she may sell his/her policy. This is called a
A. collateral assignment.
B. viatical settlement.
C. settlement option.
5. If the owner of a traditional life insurance policy wants to borrow from the policy he/she
A. can borrow up to the face amount of the policy.
B. can borrow nearly 100% of the cash value.
C. must get the consent of the beneficiary.
6. The reinstatement clause of a life insurance policy
A. allows premiums to be paid with 31 days of the due date.
B. allows the policyowner to reinstate a policy that has lapsed.
C. is available to the policyowner at anytime after a policy lapses.
7. The misstatement of age provisions
A. allows the insurance company to void the policy.
B. requires the insured to reapply for the insurance using the correct age.
C. is of benefit to the insured.
8. A waiver of premium rider
A. is mandated by law.
B. allows the policy to continue without further premium payments if the insured becomes disabled and cannot work.
C. is paid if the disability is self-inflected.
9. If an insured becomes disabled and the Waiver of Premium applies; then
A. the policy is considered paid up.
B. the insurance company pays a monthly benefit to the insured.
C. cash values continue to increase and loans can be obtained.
10. A term rider
A. attaches to a life insurance policy to enhance the benefits.
B. attaches to a life insurance policy at no charge.
C. cannot be cancelled without canceling the cash value policy.
11. If a life income option with a period certain is selected by the policyowner the insurance company
A. pays the death benefit in such a way that the beneficiaries receive an income for the rest of their lives.
B. will pay benefits in installments first to the primary beneficiary. If the primary beneficiary dies before the pre-determined period, then the contingent beneficiary receives the payments.
C. will pay benefits for a pre-determined fixed period of time.
12. If there is a “collateral assignment” of a life insurance policy to a lending institution as collateral for a loan
A. the policyowner can borrow from the policy.
B. the lending institution keeps the entire death benefit, even if the loan has been paid.
C. the lending institution collects the proceeds at death.
13. If a policyowner borrows from a life insurance policy
A. the loan is expected to be repaid.
B. there is no interest charged.
C. the cash surrender value is not effected.
14. If a “disability income” rider is added to a life insurance policy, and the insured become disabled, the
A. insurance company will pay the premiums on the policy.
B. insurance company pays a monthly income to the disabled person.
C. death benefits will be reduced by the amount the insurance company paid for the disability.
15. The accelerated benefit of Long-Term Care Coverage
A. us part of all life insurance policies.
B. provides that monthly benefits will be paid if the insured is confined because of a medical condition.
C. takes effect when the first premium is paid.
Answers to Chapter 3 Study Questions
1C 2A 3C 4B 5B 6B 7C 8B 9C 10A 11B 12C 13A 14B 15B