Important Life Insurance Policy Provisions

Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll define life insurance, the insured, insurer and beneficiary. You'll also learn about various provisions that protect the company, policyholder and recipient of the death benefit.

What Is Life Insurance?

Jared just graduated from college and started his first job at Reunion Engineering. On the first day of orientation, the human resource director, Mrs. Smith, explains the different types of life insurance plans. Life insurance is a contract between the insurer and insured to provide death benefits to the beneficiary.

Jared asked Mrs. Smith if she could define the insurer and insured since he was unfamiliar with those terms. Mrs. Smith explained the insurer is the insurance company, and the insured is the person or entity for whom the policy is written.

Key Provisions to Life Insurance Policies

Let's now take a closer look at important provisions to life insurance policies. Some of these are for the advantage of the insured and beneficiary, while others protect the insurance company.

Naming A Beneficiary

There are many reasons why people purchase life insurance, including to replace household income, pay off debt or give a gift. Mrs. Smith shares several unique circumstances but says every policy must have a beneficiary. A beneficiary is the recipient of the death benefit and is selected by the insured. More than one beneficiary may be selected, and proceeds can be split by dollar amount or percentage.

Jared shared that he heard on the news that a rich person made her dog the beneficiary. Everyone in the crowd laughed and looked at Mrs. Smith for validation. Mrs. Smith explained anyone or anything can be a beneficiary - a dog, person, church, or organization. The selection of a beneficiary is solely up to the insured. Now, let's review some important factors every insured must keep in mind when selecting a life insurance policy.

Grace Period

Mrs. Smith then explains that several options exist when paying for a life insurance policy, with the most common being annually, quarterly or monthly. If the premiums aren't paid, the policy will lapse, meaning no coverage will exist. If the insured dies during the lapsed period, the beneficiary will not receive the death benefits. However, some insurance policies have a grace period in which the insured has 30 days past the due date to pay the premium before the policy lapses.

Policy Reinstatement

If the policy lapses, the insurance company may also have a policy reinstatement period in which the insured can pay past due premiums and resume the same policy without applying for a new one. The insured should pay close attention to the reinstatement period as it can vary by insurance company. Jared asks Mrs. Smith what happens if the insured doesn't pay during the reinstatement period. She responds that the policy remains terminated and the insured must reapply. Reapplication could result in a higher premium or denial since the process is based on several different factors, such as health, occupation and the age of the insured.

Misstatement of Age Provision

Mrs. Smith says that since she just mentioned age, it's a good time to discuss the misstatement of age provision. A major factor in calculating life insurance premiums is age, and insurance companies utilize actuarial tables that calculate the probability of death. Mrs. Smith explains the direct correlation between age and premiums. Essentially, the older you are, the greater risk of death and the higher your premium. If you lie about your age, the misstatement of age provision allows insurance companies to adjust the premium based on your true age or to cancel the policy.

Policy Loan Provision

There are two main types of life insurance policies: term and whole. A term policy provides coverage for a specific period of time, while a whole policy lasts until the death of the insured. An additional benefit to whole policies is they build cash value (called reserves) when the insurance company invests the premiums.

Mrs. Smith provides an example of purchasing a whole life policy for $100,000, and after 10 years, the invested premiums create a cash value of $10,000. The insured can borrow up to $10,000, hence the policy loan provision. Typically, the insured must pay back the $10,000; if they do not, the beneficiary will simply receive the stated amount of $100,000 (rather than $110,000) after the insured dies.

Non-Forfeiture Clause

Now, let's say the insured has the same cash value of $10,000. The non-forfeiture clause allows for the:

  • Reserves to pay the policy premiums up to the amount of the reserves in the event the insured ceases to pay the premium
  • Insured to surrender the policy and receive the cash value

Jared asked Mrs. Smith why the insured can only receive the cash value and not more. Mrs. Smith reminds Jared that the purpose of life insurance is to provide a beneficiary with death proceeds after the insured dies; therefore, the insured is only entitled to the profit received from the investment. Next, let's review another advantage for the insured, incontestability.

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