Understanding your life insurance policy

A life insurance policy is the written contract between the insurer and the policyholder. It contains all of the information relevant to the agreement. Several parties will be named in the life insurance contract (policy). The owner, or policyholder, retains all rights and privileges granted by the policy, including the right to amend the policy and the right to designate who receives the proceeds. The insured is the person whose life is insured. In addition to the beneficiary, the owner will name a contingent beneficiary who will become the beneficiary if the original beneficiary dies before the insured. Although the owner and the insured are often the same person, it is possible for four different people to play all these roles.

Policy Terms and Provisions Unique to Life Insurance

 Life insurance policies define the terminology used in the policy and outline the basic provisions of such insurance. This information serves to clarify the meaning of the policy and the protection afforded the insurer and the policyholder.

The Application 

The life insurance application is the policyholder’s offer to purchase a policy. It provides information and becomes part of the life insurance policy (the contract). Any errors or omissions in the application may allow the insurance company to deny a request for payment of the death benefit

Lives Covered 

Most life insurance policies cover the life of a single person the insured. It is also possible to cover two or more people with one policy, however. First-to-die policies cover more than one person but pay only when the first insured dies. These policies are less costly than separate policies written on each person, but the survivor then has no coverage after the first person dies. An alternative is the survivorship joint life policy, which pays when the last person covered dies.

The Incontestability Clause

 Life insurance policies generally include an incontestability clause that places a time limit usually two years after issuance of the policy on the right of the insurance company to deny a claim. This clause addresses the problems arising out of erroneous statements in the application.

The Suicide Clause

 Life insurance policies generally include a suicide clause that allows the life insurance company to deny coverage if the insured commits suicide within the first few years after the policy is issued. If the specified number of years (usually two) has elapsed, the full death benefit will be paid. If not, only the premiums paid up to that point will be refunded.

Cash Dividends

 Insurance dividends are defined by the Internal Revenue Service as a return of a portion of the premium paid for a life insurance policy; they are not considered taxable income. They represent the surplus earnings of the company when the difference between the total premium charged exceeds the cost to the company of providing insurance. Policies that pay dividends are called participating policies, and policies that do not pay dividends are called nonparticipating policies. Both term and cash-value policies may pay dividends. Owners of participating policies may receive dividends as a cash payment, leave them with the insurance company to earn interest, or use the dividends to purchase small amounts of additional paid-up life insurance.

Death Benefit 

The death benefit of a life insurance policy is the amount that will be paid upon the death of the insured person. The amount of the death benefit may be either higher (due to such items as earned dividends not yet paid or premiums paid in advance) or lower (due to outstanding policy loans or unpaid premiums) than the face amount. Consider a $100,000 participating whole life policy with annual premiums of $1380. If the insured died halfway through the policy year, with an outstanding cash-value loan of $5000 and earned but unpaid dividends of $4000, the death benefit would be $99,690, calculated as follows:

Grace Period

 Prompt payment of the premium is crucial to the continuation of coverage provided by any insurance policy. A lapsed policy is one that has been terminated because of nonpayment of premiums. More than one-half of all whole life policies lapse within ten years of being issued. If your life insurance policy lapses, you must prove insurability and pay any missed premiums, plus interest, to be reinstated. Alternatively, you might pay a higher premium for a new policy, reflecting your current age. To help prevent a lapse, state laws generally require that cash-value and multiyear term policies include a grace period—that is, a period of time (usually 30 days following each premium due date) during which an overdue premium may be paid without a lapse of the policy. During the grace period, all provisions of the policy remain intact, but only if payment is made before the grace period ends. Assume, for example, that payment was due but not paid on January 1. If the insured were to die on January  15, the policy could be reinstated as long as payment was made by January 30, given a 30-day grace period. It also may be possible to “buy back” a lapsed cash-value policy by paying any missed premiums and the cash value that would have accumulated while the policy was lapsed.

Multiple Indemnity

 A multiple indemnity clause provides for a doubling or tripling of the face amount if death results from certain specified causes. It is most often used to double the face amount if death results from an accident. Such a clause is often included automatically as part of the policy at no extra cost, but sometimes a charge is assessed. If you are adequately insured, a multiple indemnity clause is unnecessary.

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