Chapter 5: Legal aspects of life insurance.
This chapter will provide an overview of some of the general principles that govern lifet insurance as a legally enforceable contract and examine the terms and conditions under which life insurance is sold. (1) Keep in mind that this chapter is not meant to be a legal treatise and can only provide a basic survey. Each state's law may (and often does) differ from another's, or its courts' interpretations of a general principle may vary (from slightly to radically) when compared with the conclusions of courts in another state. Nor will this chapter cover the formation of the life insurance contract because the legal aspects will depend on the insurer's policies and contract terminology in addition to state law.
While reading this chapter, planners should consider the documentation necessary to create a "paper trail" to evidence "what happened," "who said and who did what," and "when and how" each step of the contractual process occurred. Careful record keeping can prove invaluable for tax purposes as well as in the event of a dispute among the parties.
A more thorough understanding of the legal safeguards and peculiarities of the life insurance contract with respect to the few duties it imposes on the policyowner or his or her beneficiaries, as well as the multitude of privileges, powers, and rights it bestows will enhance the planner's appreciation for this incredibly unique and socially useful product.
Topics included in this chapter include:
1. parties to the contract;
2. requirement of insurable interest;
3. legal form and contents of the contract;
4. one-month grace period for premium payments;
5. incontestable clause;
6. suicide clause;
7. misstatement of age adjustment clause;
8. dividend clause;
9. nonforfeiture provisions (cash surrender, extended term and paid up insurance);
10. policy lapse and reinstatement clause;
11. naming and changing the beneficiary;
12. modes of settlement;
13. policy loans;
14. automatic premium loan provision;
15. assignments of a life insurance policy; and
16. waiver and estoppel.
PARTIES TO THE CONTRACT
A life insurance policy is a legally enforceable contract issued by the insurer in consideration of the application and the payment of premiums. The essence of that contract is that:
If the insured dies while this policy is in force, we will pay the Sum Insured to the Beneficiary, when we receive at our Home Office due proof of the Insured's death, subject to the provisions of this policy.
There are four "parties" to the life insurance contract: (1) the insurer; (2) the insured; (3) the applicant-policyowner; and (4) the beneficiary. (2)
The first party to a life insurance contract is the "insurer." The insurer almost always operates in corporate form and must be licensed in each state in which it does business.
The "insured" is the second party to the contract. (3) Almost any natural person can be an insured. (4)
A third party, often but not always the same as the insured, is the applicant-policyowner who applies for and "owns" the contract that has been made with the insurer. Again, generally, almost any natural person and most entities such as trusts, corporations, partnerships, limited liability companies, or sole proprietorships can apply for and own life insurance on one or more person's lives. (5) Some state laws give those with "limited contractual capacity" (e.g., a minor) a statutory right to enter into a contract of life insurance and then to void that contract and regain the premiums paid. (6)
Recent cases have created a "fourth" party to the contract (the "third person," assuming the insured and the policyowner are the same)--the beneficiary. Although the beneficiary does not sign the application for insurance and may not even be aware of the existence of the insurance, since the contract is for that party's direct benefit, that party can sue the insurer after the insured's death to collect the policy proceeds. So in a very real sense, at the instant the policy matures through the insured's death, a life insurance policy is a contract for the benefit of the third party beneficiary.
REQUIREMENT OF INSURABLE INTEREST
"Insurable interest" is a key principle in life insurance law. It is the requirement imposed by law (and by insurers) to prevent a "gaming" or "wagering" by one party on the life of another through insurance. Simply put, to insure the life of an individual, the applicant must have an insurable interest, i.e., a greater concern in the insured's living than dying. Courts (and insurers) look for "a reasonable ground ... to expect some benefit or advantage from the continuance of the [insured]." (7) Stated in another manner, the public has an interest in preventing the contract of insurance where the applicant has no interest in the continuation of the insured's life other than the prospect of profiting from the insured's early demise.
It is almost universally accepted that a person has an unquestionable insurable interest in his or her own life. "The mere fact that a man of his own motion insures his life for the benefit of either himself or of another is sufficient evidence of good faith to validate the contract." (8) So, most applicant-insureds will face no insurable interest issue in obtaining life insurance. Nor will their naming of someone other than their estates as beneficiary usually pose a problem since it is generally assumed that the insured will not name as beneficiary someone who wished him harm or who would wager on his life. (9) (Of course, if the policy was obtained expressly for the purpose of wagering or if the policy was really purchased by and soon after issue assigned to the third party beneficiary, the courts will declare such a contract void. (10) Public policy will not allow one to accomplish by fraudulent indirection what one clearly is prohibited from doing directly.)
Every state has either statutory law or case law on insurable interest and all require that either the beneficiary or applicant hold such interest at the inception of the contract. Most states do not require that either the beneficiary or assignee of a policy have an insurable interest. The majority of states hold that there is nothing conclusively illegal about an assignment to one who holds no insurable interest--even where the insured is paid value for the assignment. (11) But some states do require that the assignee have an insurable interest--even though some of the same states allow the insured to name a beneficiary who does not have an insurable interest.
Because each state is free to create its own laws on insurable interest and because different state courts have come to different conclusions on the issue, it is impossible to develop rules that apply without question in every state. Most state laws do not question the insured's insurable interest in his own life nor the interest of close relatives related by blood or law and bonded through natural love and affection with the insured. With respect to others, statutes favor persons who stand to profit by the insured's continued life, suffer economic loss at the insured's death, and who have more to gain by the insured's continued life than death.
Generally, the following rules regarding insurable interest apply:
* A parent usually is deemed to have an insurable interest in his or her child's life.
* A child usually is deemed to have an insurable interest in his or her parent's life. (But once the child becomes a financially independent adult, it is not certain that all courts would hold that the blood relationship alone would be sufficient to meet insurable interest tests).
* A grandchild usually is deemed to have an insurable interest in the life of a grandparent.
* A grandparent usually is deemed to have an insurable interest in the life of a grandchild.
* Siblings usually are deemed to have an insurable interest in the life or lives of brothers and sisters.
* Other relatives, such as an aunt, uncle, niece, nephew, or cousin, generally are not deemed to have an insurable interest merely by virtue of their blood relationship (but may have an insurable interest arising out of a business or financial transaction or out of financial dependency on the insured).
* Spouses have an insurable interest on each other's lives. (12)
* A few courts have held that a person engaged to another has an insurable interest in the other's life. (13)
* Other individuals related to the insured by marriage are usually deemed not to have an insurable interest based solely on a marriage relationship (but may have an insurable interest based on financial dependency). In-laws, for example, or step-sons or daughters, or foster children have no per se insurable interest based on family relationships but can obtain insurable interest because of dependency.
* A person (or business or financial enterprise) that would suffer a financial loss at the insured's death will usually be deemed to have an insurable interest (assuming that the amount of coverage bears a reasonable relationship to the loss that would be suffered at the death of the insured). (14) This means an employer can insure an employee, an employee can insure an employer, a partner can insure a partner, and a partnership can insure its partners, a surety can insure the life of his principal, and a member of a commercial enterprise can insure an individual if that person's death would adversely affect the financial stability or profits of the enterprise. (Although a business generally has an insurable interest in the lives of officers, directors, and managers, or others on whose continued life or lives the business' success may depend upon, a corporation may not have insurable interest in the life of a shareholder who has no working or other financial relationship with the business. The point is that it is not the mere legal relationship that creates the insurable interest, but rather the "existence of circumstances which arise out of or by reason of" the entity.)
* Where business associates have insured each other to fund a purchase of the business interest at the insured's death or the business itself has insured an owner to fund a purchase of that person's interest at death, usually there will be an insurable interest.
* Creditors have been allowed to purchase policies on debtors as long as the relationship between the amount of insurance and the debt were proportionate. But at the point where the transaction was more of a wager than an effort to secure a debt (decided on a case by case basis), the policy is void as lacking insurable interest. (15) So the closer the insurance amount is to the debt owed, the more likely insurable interest will not be an issue. (16) (However, once the policy has been issued to a creditor, the creditor typically is allowed to keep the entire amount of the proceeds even if the amount exceeds the debt.)
Most states require that insurable interest be present only at the time when the life insurance contract is entered into (i.e., at the inception of the policy) and need not be present at the insured's death. (17) Therefore, a wife who is married at the time the insurance is purchased on her husband's life but divorced from him at his death is not barred from collecting. Likewise, if a corporation purchases insurance on the life of a key employee, by definition there is an insurable interest at that time. If the employee later leaves the firm, the corporation can still collect the proceeds of the policy on his life. (18)
Even if the insurable interest tests are met by a third party applicant, state law will void the contract if the insured is not informed and the insured's consent is not obtained. (19) Even a spouse cannot lawfully purchase a policy on the other spouse's life in most states without that person's knowledge and consent. (20) However, there is a practical exception to this general rule: a parent can, without the child's consent, purchase relatively small amounts of life insurance on the life of a minor child since the child does not have the legal capacity to consent and so such consent would be meaningless.
Passing of the contestable period will not bar an insurer from asserting a lack of insurable interest since the strength and validity of the incontestable clause is predicated on the existence of a valid contract. Absent insurable interest, there never was a valid contract.
An insurer has a legal duty to use reasonable care in ascertaining the existence of insurable interest and in assuring that the insured did in fact consent to the coverage. If the insurer does not use reasonable care in both duties, it may be liable for the harm that occurs to the insured and/or beneficiaries. (21) For this (and sound underwriting economic) reason(s), insurance companies are often more stringent than state law requires.
LEGAL FORM AND CONTENTS OF THE CONTRACT
The life insurance policy is highly consumer protection oriented and unique in the law of contracts. In legal parlance, it is an "aleatory, unilateral contract of adhesion."
Aleatory means that the insurer's promise to pay the policy proceeds is conditioned upon an uncertain event (i.e., the insured's death within the term of the contract).
Unilateral describes the fact that the insurance company is the only party to the contract which makes a legally enforceable promise. (The policyowner's payment of premiums is technically a "condition precedent" to the insurer's liability.) The insurer promises to pay a specific dollar amount if the insured dies while the policy is in force. Note that the policyowner makes no promise to continue paying premiums and there is no way the insurer can require that premiums be paid.
Adhesion is a legal recognition that the policyowner was not in a position to negotiate with the insurer on the terms of the contract and the resulting document is not evidence of the normal "give and take" negotiation and bargaining found in a standard contract. The insured may "adhere" to the terms of the policy but cannot change them. Furthermore, the legal terms of the life insurance contract and underlying mathematical assumptions make it difficult for the policyowner to understand. For these reasons, courts will not insist that the policyowner meet the same degree of strict compliance to the terms of the life insurance contract as it might in the case of the typical agreement. Because the insurance contract is a "take it or leave it" agreement in which the insurer selects all wording and there is no negotiation of the terms, ambiguities are typically interpreted in the policyowner's (and beneficiary's) favor and against the insurer. (22)
For these reasons, many courts have adopted one or more theories that have made it possible to construe insurance policy language strictly against the insurer. (23) But since the life insurance contract is one requiring a great deal of reliance on the statements of the insured and/or applicant-owner, honesty--rather than reliance on the leniency of the courts--should be the watchword in the contractual process.
Almost all life insurance contracts have a similar format; there will be a "face page" and both required and optional provisions on succeeding pages. Most contracts also have a page that contains the definitions of terms used in the contract.
The face page contains: the basic promise of the insurer to pay a stated amount upon the insured's death; a statement as to the type of policy that is issued (e.g., term or whole life), the length of time premiums are payable (most provide premiums that are payable for a stated period or until the insured's death) and whether or not dividends are payable; a table of contents guide to the other provisions of the policy; and a statement regarding any additional benefits. It must contain the signatures (facsimile is sufficient) of the president and secretary of the insurer.
Certain provisions are required by state law to safeguard the interests of the policyowner and the beneficiary. These almost universally required provisions (24) include:
1. one-month grace period for premium payments;
2. incontestable clause;
3. suicide clause;
4. misstatement of age adjustment clause;
5. dividend clause;
6. extended term and paid up insurance clause; and
7. policy lapse and reinstatement clause;
Some states prohibit the insurer from inserting certain types of provisions for the same reasons. There are prohibitions in various states against such provisions which:
1. limit (to less than the period fixed by that state's general statute of limitations) the time in which a suit may be brought against the insurer;
2. permit "backdating" the policy more than a specified period of time (usually six months);
3. allow a forfeiture of the policy for failure to repay a policy loan;
4. make the insurer's agent the client's agent; and
5. cut back the insurance ostensibly provided on the face page.
Almost all states forbid the use of the term "warranty" (a statement guaranteed true in every respect) and now hold that a statement by an applicant or by the insured is a "representation" (a statement that must be true only as to facts material to the risk). The distinction is crucial to the protection of the policyowner and his or her beneficiaries. A warranty is part of the contract but a representation is not. Therefore, the breach of a warranty makes the contract rescindable by the insurer but in the event the insurer proves misrepresentation by the applicant and/or insured, the insurer cannot rescind the contract--unless the fact misrepresented is material to acceptance of the risk. Almost every state requires that the policy itself must provide that--in the absence of fraud--all statements by or for the insured are deemed to be representations and not warranties.
Each policy contains an "entire contract" provision stating that the policy--together with the copy of the application that is attached and is legally a part of the policy--is the entire contract. The insurer agrees in this provision not to fight a lawsuit on the basis of any statement unless that statement is made in the application and a copy of the application was attached to the policy when it was issued. (25) The insured and/or policyowner is then put on notice that no one (including the agent, the insured, or the policyowner) has the authority to waive or change a provision in the policy.
Many states allow (and some require) an insurer to insert a provision on the face page of the policy that provides a "free look"--a "trial examination" period to examine and decline the policy within a given period of time (usually 10 days but in some cases as much as 20 days). If declined, the contract would be deemed void from inception and the insurer would be obligated to return the policyowner's money (typically without interest).
ONE-MONTH GRACE PERIOD FOR PREMIUM PAYMENTS
The policyowner's payment of the premium is a "condition precedent" to the insurer's duty to pay a death claim. So nonpayment of premiums will cause a life insurance policy to "lapse." (26) Even an insured in a coma or a person legally adjudicated mentally incompetent must pay premiums in a timely manner or the coverage will end. The insured's rights under the contract end if the specified premium is not paid at the dates specified in the contract. (27)
Most states' laws require that the contract of life insurance contain a "grace period" provision. A grace period gives the policyowner an additional period of time after the due date of the premium during which the policy remains in full force. So if the insured dies during that period of grace, (typically 31 days from the due date (28)) the insurer will pay the full death benefit (less the premium that should have been paid but was not (29)). If the premium is not paid by the last day of the grace period and the insured is still alive, the policy owner does not owe the insurer for the unpaid premium, but of course, the policy lapses.
The incontestable clause typically is stated as follows:
We will not contest the validity of this Policy, except for nonpayment of premiums, after it has been in force during the Insured's lifetime for two years from the policy date. This Provision does not apply to any rider providing disability or accidental death benefits.
So after the specified period of time (usually two years (30)) starting on the "policy date" (31) and running for such period of time during the insured's lifetime, (32) the insurance company is barred from challenging the validity (33) of the contract. Stated in a more legalistic manner, the insurer is "estopped from contesting even a material or fraudulent misrepresentation in the policy."
The incontestable clause provides a balance between the legitimate interests of the parties:
Insurer--The incontestable clause allows a reasonable time for the insurer to discover and resist fraud by the insured and/or applicant-policyowner and deny liability, repudiate the policy, and return the policyowner's premiums.
Policyowner and beneficiaries--The incontestable clause avoids the necessity of a long, expensive, and uncertain litigation to prove the truth of statements made in the application for the policy while the insured was alive and to obtain the policy proceeds after the insured's death. (34)
In other words, the incontestable clause can be considered a "statute of limitations" on the insurer to investigate statements made in the application for insurance and deny coverage on the basis of that inquiry. Once the contestable period expires, even fraud will not vitiate the contract.
Planners should note that the typical incontestable clause will carve out certain exceptions. For instance, the insurer is not barred from resisting a claim if premiums are not paid. Many clauses also except from the protection of the incontestable clause any accidental death or disability payable under a policy rider or exclude from the incontestable clause's scope "war hazards" (where the insured is killed as the result of military service). (35) Some policies will provide within the incontestable clause a statement that if the insured's age is misstated, the amount payable will be appropriately adjusted.
There are also other reasons why payment under a life insurance contract may be legally refused in spite of the incontestable clause. If these are proved by the insurer, the policy will be void (i.e., there never was a valid contract with the proposed insured).
Fraudulent impersonation (36) (i.e., someone, claiming to be the insured, signs the application and/or takes the physical examination using the insured's name)--Either there never was a valid contract or if the contract was valid, it was with someone other than the insured. So the incontestable clause does not bar the insurer from contesting the policy even after the expiration of the contestable period.
Lack of insurable interest (37)--If there is no reasonable expectation of benefit or advantage from the continued life of the proposed insured, the life insurance contract becomes a form of wagering or gaming. To prevent profiting on the lives of others, all states void a contract in which there was no insurable interest at the inception of the contract regardless of the contestable period expiring.
Procurement of the policy with intent to murder--Public policy will not allow a contract to come into existence where it was entered into with the express purpose of murdering the insured. "Where the contract falls, it brings with it all of its constituent parts" and so the incontestable clause, being "no more a part of the contract than any of its provisions" must fall with the contract. (38)
Suicide is the intentional killing of oneself. A typical policy will provide that:
If the insured commits suicide, while sane or insane, within two years from the Policy Date, our liability will be limited to the amount of the premiums paid, less any debt and partial surrenders, and less the costs of any riders. If the insured commits suicide, while sane or insane, within two years from the effective date(s) of any increase in insurance or any reinstatement, our total liability shall be the cost of the increase or reinstatement.
The insurer is stating that the promised death benefit will not be paid if the insured dies as the result of a suicide within the specified period of (usually) two years. (39)
Like the incontestable provision, the suicide clause provides a legitimate balance between the interests of the parties:
Insurer--The insurer is responsible to other policyowners (in a mutual company) or to shareholders (in a stock company) for matching premium charges with risk. If individuals contemplating suicide were allowed to purchase life insurance without restriction, the insurer's increased and accelerated liability would be reflected in higher costs that eventually would be passed on to policyowners (or shareholders). The mere knowledge that suicide within two years would not accomplish the intended goal of enriching beneficiaries at the insurer's expense is thought to discourage those who would take a policy out with the specific intent of committing suicide. The imposition of what amounts to a relatively short "waiting period" for full coverage substantially reduces the threat of unfair additional costs levied upon other policyowners.
Policyowner and beneficiaries - The policyowner and his or her beneficiaries need the insurance regardless of the cause of the insured's death and should not have to bear the expense, aggravation, and uncertainty of litigation if suicide--no matter how long after the contract was purchased--would cause a loss of the proceeds the contract was designed to furnish. Regardless of whether the insured was sane or insane, once the suicide period expires, the insurer is liable at the death of the insured. (40)
Most cases dealing with the suicide clause are concerned with one (or both) of two issues:
1. Was the cause of death suicide or some outside force? (Was the insured murdered?)
2. Assuming the insured killed himself, did he or did he not intend to do so? (Was the death accidental rather than intentional?)
The presumption is that the insured did not commit suicide and the insurer must prove that the facts reasonably demonstrate death did not occur by accident. This burden of proof shifts, however, in the case of accidental death riders. There, the beneficiary must prove that the insured died accidentally and not by self destruction.
Absent a suicide provision, if the insured dies as a result of suicide, in most cases the insurer will be required to pay no matter how soon death occurs after the policy is issued--unless the insurer can prove that the insured purchased the policy with the deliberate intent of killing himself and enriching his beneficiaries at the expense of the insurer by that fraud (the implicit agreement that when a policy is purchased the insured is not intending to do himself in). (41)
Because a suicide is by definition a deliberate act, it will mean the insurer is not liable to pay any accidental death benefits. "A suicide is not an accidental death." (42)
When the clock starts to tick on the (typically two year) suicide exclusion time period varies depending upon the following:
Policy backdated to "save age"--Most courts will start the time at the "issue date" if it is clearly stated in the policy. (43) But, if the terms of the contract are ambiguous, the time may start at the backdate rather than the issue date.
Conversion of term to permanent--Assuming the new policy is obtained through an individual term or group option to convert, many courts will treat the transaction as a continuance of the original contract. This means if the original individual term or group term life was covered by a suicide clause, it continues (and the clock ticks) from the original date. If there was no suicide clause in the original, the new policy would not carry one.
After the suicide period has expired, the insurer is liable for paying the death proceeds regardless of the cause of death.
MISSTATEMENT OF AGE ADJUSTMENT CLAUSE
Yet another protection for the policyowner of an individual contract and policy beneficiaries is the "misstatement of age" clause (44) that is required by law in most states and will typically read similarly to this:
This policy is issued at the age shown on page --, which should be the age attained by the insured on the last birthday before the Policy Date. If the Policy Date falls on the Insured's birthday, the age should be the Insured's attained age on the Policy Date. If the insured's age is incorrectly shown on page --, the proceeds payable under this policy will be adjusted to the proceeds that would have been purchased at the correct age based upon our rates in effect when this policy was issued.
Mortality can vary considerably with age. So obviously, age is a crucial factor in the calculation of the proper life insurance premium for a given class of risk. If the wrong age is stated on the application
(regardless of whether by deliberate misstatement or because the insured just did not know his date of birth), the insurer cannot charge the appropriate premium and the policyowner may pay much more or much less than what should have been paid. The insurance company trusts the applicant to be truthful and as a matter of convenience to both parties (and as a good marketing practice) does not require a birth certificate or other proof of age at the time of purchase. In fact, it is not until the insured dies and the death certificate accompanies the claim for payment that the insurer has documentation as to when the insured was born. So it is not until then that the insurer can compare the ages, meet its burden of proving that the age in the application was incorrect, (45) and make the appropriate adjustment.
The misstatement of age provision provides a legitimate balance between the interests of the parties:
Insurer--The insurer pays neither more nor less than is appropriate for the proper age of the insured at issue and avoids expensive litigation and loss of public goodwill inherent in defenses of claims on the grounds of improper age. This serves as a cost effective "escape valve" for handling innocent mistakes. (46)
Policyowner and beneficiaries--Even if a misstatement of age (a material misrepresentation) is found after the death of the insured, (47) there is assurance that the proper amount of proceeds will be paid, uncertainty will be avoided, and litigation to obtain the rightful amount from the insurer will not be necessary.
An insurer that finds it charged premiums based on an incorrect age can make the adjustment of benefits even if the discovery is made after the policy became incontestable on the grounds that the insurer is not denying the liability to make payments but is merely adjusting an error in how much should be paid.
Owners of "participating" life insurance contracts are entitled to "dividends" if the insurer has sufficient earned surplus. The term "participating" means that the policyowner can participate in that surplus--if there is one. Confusion may result for the following reasons:
1. Both mutual insurance companies (owned solely by policyowners) and stock companies (owned solely by outside shareholders) can legally issue participating ("par") policies (although stock companies traditionally have issued "nonparticipating" ("nonpar") contracts).
2. Both types of companies can write checks called dividends.
Profits enjoyed by a stock company are not typically shared with the policyowners; they usually go only to investors (shareholders) in the company's stock and are taxed in the same manner dividends from General Motors or IBM would be.
But the distributed surplus paid to owners of participating policies is very different than the profits paid out to owners of a stock company even though both distributions may be called "dividends." A dividend paid to an owner of a participating contract is a return of "excess premium" due to the generous margins built into the premium calculation assumptions. (48) In other words, the premium in a participating contract is set high enough to provide not only the amount the insurer expects to need to pay its bills and meet its obligations but also an extra amount to provide a margin of safety. Planners should note that policyholders of participating insurance cannot be surcharged by the insurer. Although dividends may not be as favorable as projected, the policyowner will not have to pay more than the set premium regardless of how poorly the insurer does financially.
Three factors--actually, the insurer's experience in three areas--influence if (dividends are projections only and NOT guaranteed) and how much dividends will be paid:
2. interest; and
3. loading. (49)
"Mortality" represents the insurer's ability to match risk with premiums--that is, how carefully the insurer underwrites policies and how closely the experience (rate of deaths) that actually occurs parallels what was projected by the insurer in setting its rates. If more deaths occur in a given period than expected, dividends will be adversely affected. If fewer deaths occur than projected, dividends will be positively affected.
"Interest" really represents the insurer's investment success with net after-cost premium dollars. If assets earn less than projected, dividends will be adversely affected. If earnings and growth are greater than projected, dividends will be positively affected.
"Loading" is a term that encompasses all the insurer's business expenses in marketing, issuing, administering, and paying claims on policies. If the insurer's cost of doing business is greater than projected, dividends will be adversely affected. If the insurer is able to contain costs and keep them below the projected amounts, dividends will be positively affected.
The interplay between all three of these factors, and the level of additional financial safety the insurer's officers deem necessary determines (as stated above) whether the company will be able to refund the excess amounts of premium the policyowner paid in and the extent of that refund. Once this refund is decided upon, it must be "fair." This does not mean that every class of policyowners must be treated equally. For instance, policies purchased 21 years ago may be entitled to higher dividends than those issued five years ago (perhaps because the premiums charged to policyowners 21 ago were higher than those charged to policyowners five years ago). Likewise, "preferred risk" policies (i.e., those requiring the purchase of larger amounts and/or more stringent underwriting) may be awarded higher dividends than standard policies. But fairness does imply that distributions among the policyowners in any class must be equal.
Dividends are payable to and legally the property of the policyowner and can therefore be assigned with or separately from the policy itself. (50) At the policyowner's death, dividends that were held by the insurer to earn interest technically should pass to the policyowner's estate unless previously assigned or disposed of in another manner in the policy.
Most participating policies provide five ways a policyowner can choose to accept dividends:
1. take dividends in cash;
2. have the insurer automatically use the dividend to reduce the next premium;
3. have the insurer automatically use the amount of the dividend to purchase "paid-up" additional insurance ("paid up" adds) in the same type as the basic policy; (51)
4. have the insurer automatically hold the dividends in an account for the policyowner and pay interest on that account; or
5. have the insurer automatically purchase units of one-year term insurance equal in amount to the cash value of the policy at the date the term insurance is purchased (this is the "fifth dividend option" that is often used in split dollar arrangements but can also be used to considerably increase insurance coverage on a very cost effective net rate basis for other reasons such as the repayment of a policy loan).
Policy dividends are also commonly used to help pay up the policy more quickly than otherwise expected. High levels of dividends have been used to help create the appearance that premiums would "vanish." Of course, premiums do not really vanish. This marketing presentation of dividends depends on dividends being paid at the (sometimes optimistic) level projected by the insurer and, in difficult economic times, the "vanish" may not occur when scheduled.
Dividend options can be prospectively changed. Policyowners can also "mix and match" these options. For example, a policyowner might choose to use dividends to purchase one-year term insurance to the extent allowable and have the balance of the dividend--if any--to reduce premiums, purchase paid up additions, or take the remainder in cash.
If no dividend option is elected by the policyowner and the contract is silent, state law directs the disposition of that money. But insurers are allowed to specify in the policy what will happen if the policyowner does not select a dividend option. For instance, the contract might state that if the policyowner has not selected an option (or if there is excess money from a dividend after another option is elected), the dividend (or any excess) will be used to purchase paid up additional insurance. This is called the "automatic dividend option."
If dividends are used to pay premiums, a policy can not lapse if the insurer holds a sufficient amount of the policyowner's dividends to pay a full premium. If any of the other four options have been selected, the insurer will not apply dividends to pay premiums even if the policy will lapse.
State laws and policy provisions combine to provide a number of protective options for the policyowner who stops paying premiums (for whatever reason) after the policy has been in force for a number of years. (52) The equity in the policy (assuming a type of policy in which the premiums exceed the current cost of carrying term insurance) is not lost but can be used advantageously in several ways. In other words, in level premium contracts where a policy requires that a "reserve" be established in early years to meet higher insurance costs as the insured grows older and the probability of death grows greater, that reserve is "released" to the policyowner when the insurer is no longer obligated under the contract. The policyowner will receive an equitable portion of the total values his or her premiums have helped to accumulate.
How much the policyowner will receive is a function of (1) a statutory formula and (2) the insurer's internal policies (the insurer can promise to pay more than the statutory minimum). The values the insurer will pay are printed in the policy. Generally, at least 20 years' (or the term of the policy if less) values are shown.
The policyowner usually has three nonforfeiture options:
1. Cash surrender--Cashing in (technically called a "cash surrender" of) a policy is the simplest nonforfeiture option. (53) The contract is physically surrendered to the insurer and the insurer issues a check to the policyowner for the policy's "cash value." The cash value (also called "cash surrender value") is the amount shown in the policy itself (sometimes "per thousand dollars" of face amount) as the cash available at the end of specified policy years (reduced by any loans against the policy). (54) The contract will contain a table showing year by year the amount that is available if the policy is cashed in and will make certain other statements in compliance with state law nonforfeiture rules. Although the insurer is allowed in most states to defer the payment of this cash surrender value for up to six months after the contract is tendered to the insurer (to insulate insurers from a "run" on its cash reserves and the consequent self-generating economic crisis such a drain could precipitate), payments are almost always made within days or weeks of the policyowner's surrender of the policy.
2. Extended term option--If the policyowner elects to use the cash in the policy to create "extended term," the face amount of the coverage is undiminished. The same death benefit payable under the original contract remains payable after the option becomes operative (less any outstanding loan). In essence, the insurer takes the cash in the policy and purchases term insurance (without the payment of commissions or charging of other expenses against the policy). Since the death benefit is the same, only the term of time for which coverage will last changes. If the insured dies during the term, the insurer must pay. If the insured dies after the term, the insurer has no liability. Once the term expires, the policyowner cannot continue the coverage--except by formal reinstatement according to the provisions of the contract (see below). The extended term option would be a good choice where the insured had a shortened life expectancy because of an accident or illness. No policy loan can be taken since extended term coverage makes no provision for policy loan values.
3. Reduced paid up insurance option--As its name implies, an insurer takes the cash values of the policyowner's contract and uses that money to pay up the contract for the life of the insured. Unlike extended term where the face amount is unchanged but the term is shortened, when the reduced paid up option is elected the face amount is reduced to what a net single premium in the amount of the policy's cash value will purchase at the attained age of the insured. The same type of insurance continues at that reduced amount for the insured's life no matter how long he lives (up until the maturity date of the policy). The amount of paid up coverage is listed in the contract itself. The amount of coverage purchased is a function of the insured's age at the date the option is elected as well as the type of coverage being purchased and the level of cash values available. But the death benefit is reduced by loans against the policy (and increased by dividend accumulations). Reduced paid up insurance, unlike extended term, has both cash and loan values and is therefore more flexible than extended term. The reduced paid up option would be a good choice where the insured was in average or superior health but for whatever reason the policyowner stopped paying premiums.
State law requires that the policy state an "automatic nonforfeiture benefit" if no option has been selected upon (or within 60 days of) the lapse of a policy. In the case of a "rated" (premiums adjusted to reflect a higher than standard mortality risk) policy, the automatic nonforfeiture benefit is reduced paid up insurance. With respect to all other policies, the automatic nonforfeiture benefit is extended term insurance.
Where an insured dies after selecting a nonforfeiture option but before receiving any benefits from it, the general rule is that, even if the insured dies before the insurer has completed its obligation under the nonforfeiture option, the option and not the death benefit is payable. (55)
POLICY LAPSE AND REINSTATEMENT CLAUSE
A policy "lapses" when premiums are not paid by the end of the grace period. (56) (A policy "expires" when it has run past its grace period with premiums unpaid and has exhausted any benefits available under the nonforfeiture option or the policyowner has allowed the policy to lapse by not paying the next premium due and then decides to cash in the policy.)
However, a lapsed policy can be resuscitated if the insured meets certain tests and the policyholder puts the insurer back to the position it would have been in had the policy never been allowed to lapse. Almost all states require that life insurance contracts contain a clause allowing "reinstatement"--a restoration and, according to most courts, a continuation of the original contract. (57)
Such a clause might read as follows:
This policy may be reinstated at any time by a request, in writing and submitted to the Company's Home Office within five years from the date of default in premium payments, unless the policyowner has surrendered the policy for its cash value, if the policyowner:
1. applies for reinstatement;
2. provides evidence of insurability satisfactory to the insurer;
3. pays all overdue premiums with interest at a rate not exceeding 6% per year compounded annually; and
4. pays or reinstates any policy indebtedness with interest at a rate not in excess of the applicable policy loan rate or rates determined in accordance with the policy's provisions.
There are many reasons why this reinstatement provision can be quite valuable: (58)
1. Annuity purchase rates in the original contract may be more favorable than those currently offered.
2. More favorable policy loan rates may be available in the original contract than those currently offered.
3. Mortality or interest assumptions may be more favorable in the original contract than in contracts issued currently.
4. Premium payments will almost inevitably be lower in the older original contract than in one which may be purchased at a later date.
5. A new policy would take a considerable amount of time to start to build up cash values and dividends.
6. The process of reinstatement is often quicker and simpler than applying for a new contract.
7. Typically, the suicide clause does not run anew from the date of reinstatement but instead starts to run from the original date of the contract. (59) (This assumes the reinstatement was not procured with the intention of committing suicide and also assumes the reinstatement clause itself did not start another suicide period to run.)
8. On a new contract, the incontestable and suicide clauses start anew.
Of course, there are also reasons why reinstatement may not be the appropriate course of action for a particular client to take. Reasons for applying for a new policy rather than reinstating an older one include: (60)
1. A type of policy not available when the policyowner applied for the original coverage may be available now and the new coverage may be more appropriate than the old.
2. Reinstatement often requires a large outlay since the policyowner must not only pay all unpaid premiums but also interest.
3. Rates for new insurance may be lower than the rates charged per thousand of death benefit on the original coverage.
Insurers are usually more liberal than state law requires them to be with respect to policy reinstatement. (61) But to prevent those who are ill or at greater risk from "selecting against the insurer" (this is called "adverse selection"), state statutes and policy provisions uniformly require that the insured must be "insurable"--to the insurer's satisfaction (62)--at the date of reinstatement. Were it not for such a provision, former insureds who have become uninsurable would uniformly seek to become insureds again and by doing so adversely affect the mortality experience of the insurer.
Merely completing the application for reinstatement is not sufficient to restore the policy's benefits. The insured and policyowner must meet all the conditions of reinstatement before the insurer becomes liable to pay anything other than any nonforfeiture benefits that already existed before the application for reinstatement. So if the proposed re-insured dies after signing the reinstatement form but before satisfying all the requisite tests, the insurer is not liable to pay the policy death benefit.
But once all of these "conditions precedent" to the insurer's liability are met (such as full compliance with all the contractual terms including insurability and payment of back premiums and interest), if the insured then dies from a cause such as an accident unrelated to insurability before the reinstatement is approved, most courts will hold that the reinstatement holds and dates back to the time the application and back premiums were tendered to the insurer. (63) An unreasonable delay on the insurer's part may be held to bar the insurer from declining coverage. (64)
Can a reinstated policy be contested? Most courts have held that for other purposes the reinstated contract should be considered the exercise of a contractual right under the original policy, i.e., a continuation of the original. This follows the ordinary meaning of the term "reinstatement," that is "to restore to the former state or position." But for purposes of contestability, a new period applies--but solely to statements made in the reinstatement application. (65) In other words, the incontestable clause runs anew as to fraud or misrepresentations in the application for reinstatement. Generally, the same contestable period that applied to the original contract applies to the reinstatement. (66)
NAMING AND CHANGING
A "beneficiary" is a person (or entity) named (or designated such as by a check off) by the policyowner to receive the death benefits under a life insurance policy at the death of the insured. (67) A revocable beneficiary is one whose potential receipt of the proceeds can be cut off at any time. An irrevocable beneficiary is one whose interest in the contract cannot be changed or reduced without his consent. Such a beneficiary has a vested right to the death benefit as soon as he or she is named irrevocably.
Within reasonable limits, the policyowner can change the beneficiary as often during lifetime as he wants--and name anyone he or she wants--subject to the procedures specified in the policy (68) and the following limitations:
1. Some states require that the beneficiary have an insurable interest in the insured's life where the policyowner is someone other than the insured.
2. A community property resident is, during marriage, unable to freely dispose of community assets without the written consent of the other spouse. This is because (aside from gifts and inheritances received before or during the marriage) each spouse is deemed to own a one-half, undivided interest in property acquired during the marriage while living in a community property state. If community funds are used to pay premiums, each spouse has an interest in the policy. So neither spouse can name someone else as beneficiary of the entire proceeds--even a child--without the other spouse's consent (but can name anyone he or she wants with respect to the policyowner's one-half interest).
3. State laws frequently limit the class of beneficiaries that can be named where a minor is the insured. Typically, such statutes allow the naming of the insured's parent, spouse, sibling, or grandparent. A minor, upon reaching the age of legal competency, can change the beneficiary designation at that time.
4. Many states bar an insured under group term life coverage from naming the employer as beneficiary.
5. If an "irrevocable" beneficiary has been named, the policyowner cannot change the beneficiary without that party's written consent. An irrevocable beneficiary has a vested right to receive the proceeds of the policy--but contingent on surviving the insured. If the irrevocable beneficiary predeceases the insured, his or her rights are terminated at death.
6. Divorce does not, per se, affect the policyowner's right to change the beneficiary nor does it effect a change of beneficiary in most states. However, in some states, there is automatic termination of a spouse's interest after divorce while in others the policyowner can change the beneficiary even if it was "irrevocable" before the divorce. Furthermore, the right to change the beneficiary may be restricted by the divorce decree or property settlement agreement. On the other hand, sometimes at the remarriage of a spouse or upon the legal majority of the children, the policyowner regains the right to change the beneficiary.
7. A legally adjudicated incompetent cannot make or change a policy beneficiary nor can one who is mentally incompetent though not legally declared so. However, the test in the latter case is essentially the same as the test for competency to make a will: Does the policyowner have sufficient capacity to understand the extent of the property (i.e., the amount of the proceeds), the nature of the disposition, and the people who were the natural objects of his bounty? Usually, there is a presumption of competency. The burden of proof of incompetency is placed on the party that alleges it (typically the person who would have been the beneficiary had it not been changed).
8. A beneficiary can collect the proceeds of a life insurance policy if he or she kills the insured in an accident (even through gross carelessness or manslaughter) or in self defense. But every state bars an "intentional and wrongful killer" from enrichment because of that act. (69) Typically, once such a person is disqualified, a secondary beneficiary or the insured's estate will receive the proceeds. (In most situations the issue is not whether the insurer is liable to pay but rather who is the payee. However, if the beneficiary was also the applicant-policyowner and purchased the policy with the express intent of killing the insured, it is likely that the contract is void and the insurer will not be liable to anyone. (70)) The insurer may have no legal liability to make payment to anyone where the insured is legally executed (71) but in a number of states unless the insurer has specifically excluded death by legal execution, the insurer is liable to pay (particularly if the contestable period has passed).
9. Where the beneficiary and the insured die in a common disaster, the disposition of the proceeds is generally governed by the Uniform Simultaneous Death Act (USDA) that has now been enacted in some form in almost every state. The general rule is as follows:
Where the insured and the beneficiary die and there is no sufficient evidence that they have died in a manner other than simultaneously, the proceeds of the policy shall be distributed as if the insured survived the beneficiary.
The USDA does, however, specifically allow the policyowner to override that result in the policy's beneficiary form by making a presumption of a "reverse simultaneous death" (as if the insured was survived by his or her beneficiary). Planners should note that such a clause may be used to reduce federal estate taxes by fully utilizing the surviving spouse's unified credit. (72)
The USDA will not apply if: (a) there is evidence that the insured and beneficiary died other than simultaneously, or (b) one of the parties did in fact survive the other for any length of time no matter how short. (73) The problem here is that if the named beneficiary survives for even one minute the proceeds are paid to her estate and pass under her will (if she has a valid will, otherwise by intestate law) and not necessarily to the person the policyowner-insured wanted to benefit.
A solution is the "time clause" or "delay clause." This requires the beneficiary to survive the insured by a given period of time, such as 30 or 60 days, before he or she will be entitled to the proceeds. Beware, however, of a time delay clause lasting for more than 180 days as this will cause the loss of the federal estate tax marital deduction. (74) A simple and practical solution is for the policyowner to elect a settlement option and name contingent payees to receive any proceeds not payable to the primary payee at his or her death. The insurance contract itself will provide the mechanism for payments to continue with almost no delay or cost at the death of the primary payee.
10. A policyowner can, of course, name children as beneficiaries of life insurance but, except for very small amounts, insurers generally will not make settlements directly to minors. This means a guardian would have to be appointed (and suggests to the planner the use of a trust).
A policyowner can--and should--name more than one beneficiary. A planner is derelict in duty if the policyowner is not told of the privilege and advantages of naming both a "primary beneficiary" (which can be more than one person or entity) and one or more "contingent" or "secondary" beneficiaries. Throughout this book are numerous examples of tax savings and creditor protection available through properly arranged life insurance. The authors have found few instances where allowing the policyowner's estate to dispose of insurance proceeds (by default in not naming a contingent beneficiary) is advantageous in comparison to shifting wealth directly through the insurance contract.
The primary beneficiary is the first person (or class of persons) in line to receive the proceeds when the insured dies. But to be entitled to the proceeds, the primary beneficiary must be living on the date the insured dies. Otherwise, the proceeds are paid to the class of beneficiary whose interest is contingent upon surviving both the insured and the primary beneficiary. This class is appropriately called the "contingent" beneficiary.
There can be more than one individual, entity, or combination of individuals and entities in each class. For example, a policyholder may name his spouse if living and otherwise his two children. Where more than one beneficiary is in a given class, they typically share the proceeds equally unless the policyowner specifies otherwise in the beneficiary designation.
Policyowners can (and in the opinion of the authors should) even name a third level of beneficiaries or "final" beneficiaries in case all beneficiaries in a higher class have predeceased the insured. Often, parents, nieces, nephews, cousins, or a charity such as a church, synagogue, or university are named at this level. Alternatively, "the estate of the insured" can be designated and the proceeds will then be added to the other probate assets and be disposed of according to the insured's will or under state intestate laws.
Usually, a lower class' rights are extinguished if payment is made to members of a higher class. For instance, a contingent beneficiary will receive nothing if the primary beneficiary is alive when the insured dies. Likewise, the final beneficiary has no expectancy of a share of the proceeds if the contingent beneficiary survives the insured and the primary beneficiary predeceased the insured. Even if proceeds are taken in installments, once payable to a higher class of beneficiaries, any remainder payable at the death of a member of that higher class will be payable to the decedent's estate (or contingent payee) rather than to the next class of beneficiary.
Even where it seems inherently unfair, the insurer is almost always held by the courts to be bound to pay the proceeds to the named beneficiary. There are numerous cases where the proceeds were payable to a spouse long divorced by the insured because the policyowner had forgotten to designate a new beneficiary.
Specificity is essential. The beneficiary designation should describe the person with sufficient clarity and certainty so that the insurer can easily identify the proper person, make payment, and obtain a valid release.
Planners should therefore take special care in the following beneficiary situations:
The policyowner's spouse is specifically named--Courts look to the person's name rather than description as "husband" or "wife" or "fiancee." So even if that person is no longer a husband, wife, or fiancee when the insured dies, absent specific state law to the contrary, the proceeds will still be payable to the named person. (75) Courts do not pass on the morality of its citizens and recognize the right of the policyowner to make any beneficiary designation he or she pleases.
The policyowner merely says, "To my husband" or "To my wife" but does not name the person--Here, proceeds are payable to the person who, at the time of the insured's death, meets that description. (76)
The policyowner names each child individually and describes the relationship--This is the clearest and safest approach. But a child born after the beneficiary form is signed may be excluded.
The policyowner names his children as a class rather than naming them individually--The insurer may have difficulty in verifying who is included in the class--especially if name changes have occurred. The term "my children" may also cause legal problems and in many cases will include illegitimate, legally adopted, and children from a prior marriage as well as children born after the beneficiary form is signed and even those born after the insured's death. (77) The term "lawful children" will disqualify illegitimate children.
The policyowner names "My Issue and Heirs"--"Issue" is a term far broader than "children" and includes any lineal descendant no matter how far down the line. So grandchildren and even great grandchildren would be included. "Heirs" means those who would inherit under state intestacy laws (i.e., in the absence of a valid will). This designation is not generally recommended.
The policyowner names a class of beneficiaries "per capita" or "per stirpes"--A per capita (by the heads) distribution means that the proceeds will be split according to the number of beneficiaries in the class. If there are three children, each takes one-third. If there are only two out of the three that survive the insured, each takes one-half. A per stirpes (by the branches) distribution means that the distribution is first divided among the class--including a share for any predeceased member that is then split among that member's children. If two out of three children survive, the proceeds are split three ways with the deceased child's children equally splitting the share the deceased child would have had. (78) The choice between per capita and per stirpes is personal but often causes confusion. The authors recommend the policyowner's intent be specified with an example.
The policyowner names a minor as beneficiary--Few states would allow payment of policy proceeds to a minor and few companies would agree to do so even if not forbidden by law since minors cannot give a valid release to the insurer. For this reason, a trustee should be named as beneficiary in most cases involving minors. (79)
The policyowner names a trust as beneficiary--This designation provides the ultimate in flexibility, by assuring that the trustee will survive the insured and spouse, and increasing the chances of proper investment management and higher returns. (80)
The policyowner names a corporation, partnership, limited liability company, or charity--It is essential that the full legal name of the entity be specified.
The policyholder names himself--This is common and proper practice where one party owns life insurance on the life of another. In fact, there are almost always income or gift tax problems where one party owns insurance on the life of another but makes a third party the beneficiary. We call this the "Unholy Trinity."
The policyowner has failed to name a beneficiary--Some smaller policies and group term life contracts provide a "facility of payment" clause that enables the insurer to pay a limited amount directly to the providers of the insured's last illness and burial expenses. Most larger amounts will be paid according to the policy provisions that specify the recipient when no beneficiary has been designated (or where all primary and contingent beneficiaries predecease the insured). Selecting a beneficiary by default is obviously not the preferable manner for disposing of policy proceeds.
Planners have an obligation to suggest to clients that they review the beneficiary designations made under life insurance policies (as well as employee benefit and retirement contracts) at least every two to three years or upon the occurrence of circumstances marking changes in marital status (the client's or the beneficiaries'), the beneficiaries' needs or abilities to handle money, or tax law. It is also important that life insurance beneficiary designations be coordinated with the entire estate plan.
Planners should note that a designation in a will typically does not result in a change of life insurance beneficiary (especially if the method of beneficiary change in the policy is exclusive which it almost always is) nor, as stated previously, does divorce make a change effective in most states. (81)
MODES OF SETTLEMENT
Beneficiaries can chose to "settle" with the insurer in a number of ways aside from the obvious and common method of a lump sum payment. (82) These "optional modes of settlement" include the following:
1. leave the proceeds with the insurer and receive annual interest payments;
2. accept the proceeds in installments for a specified period of time ("fixed years installments");
3. accept the proceeds in installments of a specified amount ("fixed amount option"); and
4. accept the proceeds as a life annuity (systematic liquidation of principal and interest) for the life of one or more persons.
Interest option--Here, the interest rate payable by the insurer is guaranteed and may be increased by payments of "excess" interest (also called a "dividend," "extra interest" or "surplus interest") to keep the insurer competitive with alternative investments. Payment intervals such as annually, semiannually, quarterly, or monthly, are agreed upon by the insurer and beneficiary (unless pre-selected by the policyowner). The payee can be given the right to change to another settlement option and can have either a limited or unlimited right to take all or any portion of the principal. In some cases, the income beneficiary may be given no right to make a withdrawal of capital in which case it will pass to the payee's estate or to a third party depending on the terms of the agreement. The principal may be paid, at the option of the beneficiary, to someone other than the interest recipient. A successor-payee should always be named to receive any amount remaining payable at the primary payee's death.
Planners utilize this option as a temporary investment repository to give the beneficiary time to make a rational and studied decision as to how the proceeds should be invested. It is also convenient if the beneficiary does not currently need income under one of the other options but is planning to utilize one of them at a later date.
Fixed period of years installments--Payments under this option are paid in equal amounts over a specified period selected by the beneficiary. If the primary payee does not survive to the end of the payment period, the balance of payments will be made to the contingent payee. The contract contains a table that shows the amount of the individual payments (usually per $1,000 of death benefits) that can be made over various periods of time ranging from one to 30 years. Extra interest will increase the amount of income paid (rather than extending the period). This option is indicated where the beneficiary needs the largest possible guaranteed income over a relatively short and fixed period of time.
Fixed amount option--Payments under this fixed amount option are paid to the beneficiary (and to the beneficiary's successor-payee after the original beneficiary's death) for as long as the proceeds (compounded at guaranteed interest) last. If the insurer pays excess interest, the period over which payments will be made increase accordingly (but the amount of each payment remains the same). Planners use this easy to explain option to augment Social Security benefits and other income.
Unpaid installments under either the fixed years or fixed amount option can generally be commuted (i.e., the present value of the future stream of income can be taken in an immediately payable lump sum) or applied under another option.
Life income option--Payments under this option are made over the lifetime of the beneficiary. The insurer uses the proceeds to "purchase" (no commissions or other acquisition costs are charged) a single premium life annuity for the designated payee. That annuity then pays out to the named payee an income of a guaranteed amount for the payee's lifetime. A "period certain" guarantee--a guarantee that payments will continue for a selected period of years, regardless of whether the payee is alive or dead--can be chosen. Ten-, fifteen-, and twenty-year period certains are common.
There are four basic forms that the life income option can take:
1. Straight life (annuity) income--Payments will last for as long as the payee lives and stop at the payee's death. This provides the highest annual income of the four forms of life income because it stops when the payee dies.
2. Life income with period certain--The insurer makes payments for a period selected by the beneficiary. Payments will be continued to a contingent payee for the balance of the period if the primary payee dies before the period ends. (83)
3. Life refund annuity--Payments are made to the payee (and or contingent payee) until an amount at least equal to the proceeds paid at the insured's death has been paid out.
4. Joint and survivor annuity--Payments are made to two individuals as long as both are alive and then continue for the life of the survivor. Payments of a smaller amount can be selected to continue at the same level for both lives or payments of a larger amount can be paid until the first of the two payees dies and then the amount of each payment will be reduced.
Planners should consider settlement options where the amount of insurance is relatively small and the cost of establishing a trust is relatively high. Some consider a settlement option the "poor man's trust." These optional modes of settlement do have a number of advantages including:
1. no separate charge is made by the insurer;
2. no other commercial institution can pay a life income; and
3. both principal and a minimum rate of interest are guaranteed.
But planners should also consider the following downside costs and disadvantages:
1. higher earnings may be possible from alternative investments;
2. a trust may prove more flexible; and
3. a trust may be more responsive to the beneficiaries' needs and circumstances.
Figure 5.1 compares settlement options to trusts.
The ability to use the contract as a source of emergency or opportunity cash is one of the most valuable attributes of permanent life insurance. A policy loan provision can be found in almost every cash value policy. (84) As property, the policy can also serve as collateral for a loan from a bank or other lender but more often the insurer will provide the cash under the more favorable terms of the policy's loan provisions. (85)
When a policyowner borrows money directly from the insurer what is actually occurring is something other than a "loan" in common parlance. The difference is this: In a true loan the borrower must agree to repay the money. A policy loan does not require repayment. It is more like an advance of the money the insurer will eventually pay out under the contract. (86) The policyholder is receiving an advance--of his own money.
Even though federal tax law treats a policy loan as a classic loan, it is not. There is never a "debt" or a debtor-creditor relationship. During the insured's lifetime, the insurer is always 100% secured against loss because the amount that can be borrowed can never exceed the amount the insurer would have to pay the policyholder if he chose to surrender the policy. In fact, during lifetime, the "loan" can never exceed that amount (less the interest payable on it). Furthermore, the loan value, plus interest, can be deducted by the insurer from the proceeds otherwise payable if the "loan" has not been repaid before the death of the insured.
Once the insurer advances money to the policyowner, that person or entity can use the money for any purpose. Nor is the permission of a revocable beneficiary required since that party has a mere expectancy in the net (face amount less indebtedness) proceeds. Even an irrevocable beneficiary has no right to demand consent to a policy loan--if the policy states clearly that such consent is not required. (87) Once the policyowner makes an "absolute assignment" (i.e., a total and irrevocable transfer of all interests in the policy) to a third party beneficiary, even if the former policyowner is the insured, he may take no further loans from the policy. (88)
The amount of the loan is limited essentially to the policy's cash value (less a "holdback" for interest). Technically, the policy might state something to the effect of:
The loan value is the amount which, with interest at a daily loan interest rate of --%, (89) will equal the policy's cash value. (90) Interest on the loan will be payable on each policy anniversary but if not paid when due it will be added to the loan.
Every year the amount that can be advanced to the policyowner increases as the cash value grows. But if the point is reached where the total of principal and accumulated unpaid interest equals or exceeds the policy's cash surrender value, the policy will (after a one month's notice) terminate and all benefits are canceled. (91)
Why does the insurer charge interest on an "advance" of money that will someday be paid to the policyowner? Because the insurer's statement of what policy values will be year after year is based on the assumption that the insurer will have a "reserve" (i.e., an amount in excess of that needed to pay for the current year's costs) to invest so that future contractual promises can be kept. If premiums unused for costs in early years are not on hand, the insurer cannot invest that money and pay the amounts promised in the future. The charge made to policyowners who accept these advances puts the insurer back where it would have been had it been able to invest the money. (In fact the interest rate may be somewhat higher than the amount assumed by the insurer in calculating policy loan values because the insurer needs to pay for administrative costs in making, keeping track of, and repaying these "loans" and, to some extent, to create a disincentive to "borrowing.")
Repayment of a policy loan is allowed at any time while the insured is alive (subject to a minimum payment for administrative aggravation and cost purposes). Once the insured has died (or the policy has been placed on extended term status), typically the insurer will not accept repayment of a loan. (92) If the advance is not repaid, either the cash value of the policy available to the policyowner or the death proceeds paid to beneficiaries will be reduced.
AUTOMATIC PREMIUM LOAN (APL) PROVISION
"Premium loans are advances of policy cash values that the insurer makes to the policyowner for the purpose of paying the premium. Automatic premium loans are advances the insurer makes under a policy clause providing that, if the policyowner fails to pay a premium by the end of the grace period, the insurer will automatically advance the amount of the premium if the policy has a sufficient net cash value." (93) Usually, the policyowner is notified of this action by the insurer.
If the loan value of the policy is insufficient to pay an annual premium, the insurer will typically pay a semiannual, quarterly, or monthly premium (94) although it is not required to do so. (95) When the loan value is so small that even a monthly premium cannot be paid, nonforfeiture benefit options will apply.
In most states, the payment of premiums by APL has the same result as paying premiums with cash, so the death benefit continues (decreased by the policy loan) and cash values continue to increase. Most states do not require an insurer to notify a policyowner that there is insufficient cash value to make a policy loan through APL or to tell a policyowner how long the loan will keep the policy in force.
A device that pays premiums at the end of a grace period by automatic loan from policy values is an incredibly valuable safety device to keep insurance protection in full force. (96) But the automatic premium loan is effective to prevent a policy lapse only if it is requested by the policy-applicant (or at some later date by the policyowner at a time when no premium is unpaid beyond the policy's grace period). The authors suggest that this provision is extremely valuable and should be considered in every case--especially since it may be canceled at any time.
There is a downside to the automatic premium loan when abused; "the automatic premium loan provision makes it too easy for the insured to avoid the payment of premium in cash." (97) Furthermore, to the extent interest is still deductible, it is not deductible in the case of an automatic premium loan since the interest is borrowed from the insurer rather than paid by the policyowner in cash. (98) A third potential disadvantage is that the contract may last longer if placed on extended term rather than allowing the policy to exhaust itself through automatic premium payments. But planners should keep in mind what this provision is really intended to do: prevent an accidental lapse.
ASSIGNMENTS OF A LIFE INSURANCE POLICY
As property, (99) the life insurance contract can be transferred to another person or entity. The policyowner can transfer either all or only some of the "bundle of rights" that comprises a life insurance policy to almost any person or entity. (100)
The two basic ways of making a lifetime transfer (101) of a policy are (1) the "absolute" assignment, and (2) the collateral assignment. An absolute assignment, as its name implies, transfers all the policyowner's rights irrevocably. A collateral assignment, again as its name implies, assigns so much of the death benefit as necessary for as long as necessary to secure a lender's rights. But no more of the proceeds will go to the lender than the amount of debt owed.
The assignment does not have to be of any particular form (absent specific provision in state law or the contract to the contrary). Since life insurance is treated as "personal" property, ownership rights may be transferred not only by many different types of documents (102) but also by many different actions. For example, if a business is sold and the business owns a life insurance policy, the sale of all the assets of the business carries with it the personal property the business owned--including the life insurance. Likewise, a property settlement in connection with a divorce may have the effect of transferring the ownership of life insurance on the life of one or the other (or both) spouse(s) even though the word "assignment" has not been used. But this type of transfer (where a clause in the divorce decree disposes of life insurance) is both very dangerous and very awkward. If a policyowner names his new spouse as beneficiary of the insurance proceeds and the insurer has no notice or knowledge of the divorce decree's change, both spouses are likely to claim the proceeds. (103) Furthermore, if the decree requires the policyowner spouse to maintain the policy for the benefit of his or her ex-spouse, the policyowner cannot obtain a policy loan--even to keep the policy in force through a premium loan.
But before either the absolute or collateral type of assignment or any other instance of a policy ownership transfer is valid, the insurer must be notified by the policyowner (and where required by the terms of the contract must consent to the assignment). Once notified in writing at the insurer's home office, the insurer must honor the policyowner's transfer--unless the terms of the contract itself forbid assignments. So if the insurer then disregards (by intention or neglect) the assignee's rights and makes payment to someone else, the courts may force the insurer to make a second payment to the assignee. If no notice is given to the insurer, it will be protected in a transaction initiated by a former owner. For instance, if the former owner applies for a policy loan and the insurer has not been given notice that the policy has been assigned, the insurer is protected in making that loan. (104)
The insurer does not, however, have to verify the bona fides of the transaction between the policyowner and the transferee nor the validity of the transaction. In other words, the insurer is not accountable for the mental or legal capacity of the policyowner to make the assignment (unless it had knowledge that the policyowner was not legally competent to make it or there were irregularities in the assignment form).
Reasons for an absolute assignment--An absolute assignment is used in life insurance planning when the policyowner wants to sell or give away all of his or her rights under the contract. The goal might be to obtain valuable consideration, to save estate taxes, avoid creditors, or may be made purely for love and affection and to assure the transferee of financial security. There are many common examples of sales and gifts:
* A client might sell a policy on his life to his business.
* A business might sell a policy on an employee's life to the employee or to the employee's spouse or child or trust (or to a pension plan).
* A shareholder might sell a policy on his life to a new business associate.
* A client might give a policy on her life to her spouse.
* A client might give a policy on his life to his children or to a family trust.
Both sales and gift transactions have important and sometimes unexpectedly expensive tax implications. (105)
Non-tax implications of an absolute assignment--Planners must be aware of the non-tax implications of an absolute assignment in order to avoid them and/or alert the client to their potential effect. Some of these are:
* Although an absolute assignment itself may not per se change the interest of a revocable beneficiary, as a practical matter the new owner can immediately change the beneficiary and often makes that change almost simultaneously with the assignment. Some absolute assignment forms state that the new owner is automatically the primary policy beneficiary until a further change is made. (106)
* If the beneficiary before an absolute assignment was named irrevocably, in most states the assignment will not defeat that designation (without the written consent of the beneficiary) and the transferee should be apprised of this fact.
* Absolute assignments may put the policy and its proceeds beyond the claims of the policyowner's creditors,--but the policyowner should be informed that--like diamonds--an absolute assignment is forever. There is a loss of both control and flexibility from the transferor's viewpoint.
Reasons for a collateral assignment--A collateral assignment ("as the creditor's interest may appear") form of transfer is used almost exclusively as a secondary source of payment when a policy is pledged on a temporary basis as collateral for a loan. (107) The term "collateral" implies that the policyowner-debtor is primarily liable for the loan and only if he or she defaults will the policy be called upon to back up that obligation. The cash values in the policy serve as protection to the lender as long as the insured lives and the death benefit protects the lender if the insured dies. Once the loan is repaid, all rights in the policy automatically revert to the policyowner.
What is--and what is not--transferred--Policy rights transferred when the collateral assignment form of transfer is used generally include the right to:
1. receive the death benefit (but the excess over the debt unpaid at the insured's death must be transferred to the beneficiary specified by the policyowner); (108)
2. cash in the policy in the event the policyowner defaults on a loan or fails to pay premiums (109) (but the lender must give reasonable notice and the excess over the debt unpaid at that time must be transferred to the policyowner);
3. exercise nonforfeiture options; and
4. receive policy dividends.
The major right retained by the policyowner is the right to change the beneficiary.
After the debt is repaid, the transferee must reassign all policy rights back to the policyowner. Again, the insurer must be informed in writing at its home office before it will allow the policyowner to exercise all policy rights.
"Waiver," the intentional and voluntary surrender of a "known right," (110) is an act which the insurer may (or may not) have committed in many situations. (111) A waiver occurs if the insurer knew it had the right to do or demand some action but acted with the deliberate intention of giving up that right. (112) For example, an insurer who gives a policyowner extra time after the grace period has expired to pay premiums and agrees to keep the policy in force during that time may have waived its right to deny a claim in that time period for nonpayment of premiums.
Planners should be conscious of potential waiver (and estoppel) situations in the following situations:
* the taking and submission of the application (e.g., the agent or medical examiner writes false answers on the application or the insurer fails to follow up on an incomplete answer);
* the premium payment process (e.g., the insurer routinely lets the policyowner "slide" with respect to the prompt payment of premiums or customarily accepts an overdue premium or accepts a late payment after it has knowledge that the insured has died or fails to send premium notices as required by state law),
* the submission of claims under a life insurance contract (e.g., the insurer does not promptly send proof of loss forms upon request by the beneficiary or fails to notify a beneficiary that it intends to dispute a claim or the insurer receives what it feels is a defective proof of loss but does not request additional documentation or the insurer promises to pay a claim it has grounds to resist).
Three types of rights cannot be waived or otherwise abrogated or contracted away by the insurer. (113) These include:
1. Rights designed to protect not only a party to the contract but also the public. An example would be the right of an insurer to demand that an applicant have an insurable interest in the life of the insured. Other examples would include the right of the policyowner to be notified of premiums due or the right to take policy values under nonforfeiture options. "The public policy involved overrides the freedom of contract of the parties." (114)
2. Rights that would create coverage where none previously existed. Waivers cannot create "risk" (legal exposure) if that risk was not already encompassed in the contract nor can coverage be established by waiver where the contract specifically excluded it. In short, the doctrine of waiver cannot be invoked to create liability for benefits that were never contracted for. (115) For instance, if the contract provided benefits for 10 years from the date of issue, the insurer's acceptance of a premium beyond the tenth year would not create a right in the policyowner to continue coverage into the 11th year. The insurer would have the right to refund any premium for coverage beyond the 10th year even if the insured died while the insurer held the excess premium and could not waive the expiration of insurance.
3. Rights to receive a sum of money cannot be waived. An agent, for example, cannot waive the insurer's right to receive premiums. A person can, of course, sign a "release" to an insurer stating that the claim of legal liability is satisfied. But a release can only be given in return for consideration. For instance, when a beneficiary signs the check for the policy death proceeds, he or she is acknowledging that the insurer is released from its obligation in return for that money.
Waivers are made by people. In the case of an insurer those people are its authorized "agents" (used here in a broader sense than sales force). So the term "authorized agent" may encompass sales personnel, officers, medical examiners, underwriters, and "others whose actions affect the insurer's contractual relationships." (116) In many cases, the central issue is whether the party making the waiver was in fact "authorized" by the insurer to do so. If the agent has no power to make a waiver, it will be ineffective assuming the applicant-policyowner knows (or has reasonable notice that) the agent lacks such authority. Notice to the applicant-policyowner of limitations of an agent's authority is usually spelled out in both the application and the life insurance contract itself in a "nonwaiver clause" similar to the one that follows:
No agent is authorized to make or modify contracts, to waive any of the Company's rights or requirements, or to bind the Company by making or receiving any promise, representation, or information, unless it is (1) in writing, (2) submitted to the Company, and (3) made part of the contract. (117)
Quite often, the contract will contain a further statement to the effect that:
Only the President of the Company, our Executive Vice President, or our Secretary has the authority to waive or modify any policy provision. Such waiver must be made in writing. No agent or any other person has the authority to change or waive any provision of this policy.
Since the statement appears in the contract and many states hold the applicant-policyowner responsible for reading the contract, he or she will be bound by a limitation-of-right-to-make-a-waiver clause appearing in both the application and policy. This, of course, does not typically bind a beneficiary (who has no reasonable notice of the existence or contents of the nonwaiver clause) to conditions that must be met after a loss occurs. Therefore, an agent of the insurer could waive such policy provisions as those regarding notice to the insurer or the documents required for proof of the insured's death regardless of the nonwaiver clause.
There are three types of waivers that occur in life insurance situations: (1) express waivers; (2) implied waivers; and (3) waivers by silence.
Express waivers--The surrender of a legal right expressly declared by written or oral words of an agent empowered to act for the insurance company are called express waivers. An insurer might deliberately waive a right, despite a breach of condition by the policyowner or beneficiary, in order to "keep the business on the books" or to maintain or obtain good public relations. Implied waivers--Here, the conduct of the waiving party clearly infers the intention to forego a legal right--even though that surrender is not stated in writing or even orally. For instance, if an insurer time after time accepted premiums tendered by the policyowner well after the grace period expires, a court is likely to conclude that by its repeated inaction (not lapsing the policy) and pattern of actions (acceptance of the premiums beyond the grace period), the insurer, with full knowledge of its rights to lapse the policy, knowingly and voluntarily failed to assert that right. So if the insured died after the grace period but within the time the insurer had customarily accepted late premiums, the insurer would be liable to pay the death benefit. (118) It had waived its right to deny the claim. Waivers by silence--Where an insurer has the legal duty to speak but fails to do so, the rights of the policyowner or beneficiary that would be lost by the inaction are instead protected. (119) Waiver by silence could occur, for instance, where the insurer gains knowledge of some material misrepresentation but deliberately (or negligently) withholds its knowledge more than a reasonable period of time and the insured dies within the contestable period. Most courts would hold the insurer waived its rights by lulling the policyowner or beneficiary into a false sense of security when it should have taken action in sufficient time for the policyowner to redress the situation with the insurer or obtain alternative coverage elsewhere.
Once a waiver has been made, it cannot then be retroactively revoked. For instance, assume a policyowner breached a condition of the contract (such as payment of premiums) but the insurer notified the policyowner that it would allow the contract to continue for a specified period of time (say one month) after the grace period in spite of the breach. If the insured died during the extra allotted time, the insurer would be liable. It could not revoke its waiver. But if the insurer notified the policyowner within a reasonable time that with respect to future nonpayments, the grace period limitation on coverage would be strictly enforced, the former waiver would not protect the policyowner in the future.
"Estoppel" is a legal way of arriving at a fair and just result when one party (typically the insurer) has through words or conduct either directly or through its agent mislead the policyowner or beneficiary into an action or inaction that results in that party's loss. The key elements of estoppel are therefore that the policyholder or beneficiary suffers a detriment by acting to his prejudice in reliance upon a belief engendered by the insurer through its agent's words or actions. (120) Words and actions of the insurer must have lead the policyowner to act (or not act) so that the policyowner was harmed, the policyowner must not know the true facts, and because of a good faith belief in the insurer's (or insurer's agent's) words or actions acted (or failed to act).
For instance, if an insurance agent (the insurer's agent) tells an applicant that:
"You can ignore that one time you fainted. The insurance company is only concerned with a long history of fainting or blackouts."
If the insurer denies the death claim on the grounds that the fainting was not admitted by the applicant, the policy beneficiary can ask the court to estop the insurer from using misrepresentations as grounds for denial. Even though there was in fact misrepresentation, the insurer, through its agent's statement that one blackout does not count induced the applicant into taking action based on that misstatement and is therefore estopped (forbidden) from using the misstatement to deny liability (even if it can be proven that there was in fact a material misrepresentation).
There has been (and continues to be) confusion between the concepts of waiver and estoppel with some courts separating and distinguishing between the two while others treat them as essentially synonymous (and others seem to blend the two). What is important to the planner is (in the opinion of the authors) this: The law will generally try by whatever means necessary and available to balance the interests of the parties and the public. It will insist on a meeting of the responsibilities of the relationships between them by using one or the other doctrine to prevent the insurer from taking an unfair advantage of the policyowner and his or her beneficiaries (and vice versa). (121)
(1.) The following two texts will prove invaluable in reviewing the essential elements of contract law and researching the non-tax oriented legal aspects of life insurance: M. Crawford, Law and the Life Insurance Contract, 7th ed. (Burr Ridge, IL: Irwin Professional Publishing, 1994); B. Anderson, Anderson on Life Insurance (Boston, MA: Little, Brown and Company , 1991).
(2.) Although technically, a beneficiary is not a "party" to the contract, if a contract is for the direct benefit of a third person who is not a party to the contract, that person can sue for damages incurred as the result of a breach of contract. For this reason, the authors have included the beneficiary among the parties to the contract.
(3.) It is the insurability of the insured that is the linchpin of the agreement between the insurer and the policyowner. It is the termination of the insured's life that marks the liability of the insurer to pay the "face amount" of the policy at death, and it is the insured's life that determines the date of the policy's lifetime maturity. Although the insured may not be viewed by some authorities as a party to the contract, it is the authors' opinion that this position is less than complete. Without the insured's consent to the issuance of the policy, there is no legally binding contract.
(4.) State law may bar a legally adjudicated insane or mentally infirm person from being an insured. Generally, other legal incompetents such as minors are not prohibited from being an insured.
(5.) Life insurance contracts between "enemy aliens" or citizens of a country at war with the United States will be void. A corporation's capacity to purchase a life insurance contract depends on the provisions in its charter, by-laws, and the laws of the state where it is domiciled. A corporation can purchase a life insurance policy even if that power is not expressly granted in its charter or the state laws under which it was created if that action is necessary to exercise its express powers. Most corporations and other business entities can therefore purchase life insurance. However, the corporation's board of directors should formally endorse such an action and document its approval in the corporation's minutes.
(6.) Many states allow a minor 15 years old or over to purchase a life insurance contract on his or her own life but upon reaching the age of majority, he or she can void the contract. The insurer is bound by a life insurance contract made with a minor unless and until it is disaffirmed by the minor. That disaffirmation (voiding of the contract) can generally be made at any time while the child is a minor under state law or within a reasonable amount of time after reaching legal majority. If the policy is voided, the former minor is entitled to a return of whatever premiums he or she has paid but must return any dividends or other money received from the policy.
Note that many of these statutes allow the minor to make benefits payable only to close family members such as parents or siblings or the minor's estate. Some, but not all states, limit the insured to the minor himself. Others allow the minor to insure the life of a child or spouse.
(7.) Black's Law Dictionary, 5th ed. (West Publishing Company 1979), p. 720.
(8.) See Anderson, note 1 above, p. 360.
(9.) See, e.g., Continental Cas. Co. v. Brightman, 437 F.2d 67 (10 Cir. 1971). A few states do require that a party cannot be named as beneficiary unless that party has an insurable interest in the life of the insured.
(10.) If, as part of a scheme to avoid the insurable interest rule and pursuant to a plan with a third party, the insured-applicant purchases a policy on his own life and then transfers the policy to that third party (who never had an insurable interest), the court will probably declare the policy void. See Lakin v. Postal Life & Cas. Ins. Co., 316 S.W.2d 542 (Mo. 1958). See also, 17 Couch on Insurance 63A:23 (Lawyers Co-Operative Publishing Co. 1983).
(11.) Beware, however, the transfer for value rule discussed in Chapter 22.
In the past few years, certain life insurance arrangements referred to as "stranger-owned life insurance" (STOLI) or "investor-owned life insurance (IOLI) have generated considerable debate. For a description of a typical transaction and the potential risks involved, see Stephan R. Leimberg, "Stranger-Owned Life Insurance: Killing the Goose That Lays Golden Eggs!" Estate Planning Journal, January 2005, Vol. 32, No. 1, p. 43 (reprinted in Tax Analysts Insurance Tax Review, Vol. 28, No. 5, May 2005). See also Stephan R. Leimberg, "The Many Troublesome Facts of STOLI: An Update on Recent Developments," Keeping Current, June 2007.
(12.) See, e.g., Mutual Life Ins. Co. v. Allen, 138 Mass. 24 (1884).
(13.) In an era where many couples live together without the benefit of marriage, it would seem that an applicant-beneficiary cohabiting with the insured could claim to be a dependent and as such show an insurable interest. But see the (in the authors' opinion relatively ancient) case of Mikesell v. Mikesell, 40 Pa. Super. 392 (1909).
(14.) The opposite is also true: if the applicant has no valid relationship with the insured other than merely as a business associate, this relationship will not per se be sufficient to generate an insurable interest. The courts (and the insurer) are likely to ask:
(a) Did the insured contribute capital or make some other financial contribution to the business that would be lost or jeopardized at his or her death?
(b) Does the insured have any particular skill, technical knowledge, or ability as a worker or manager that would be lost by the enterprise at his or her death?
(c) Is there anything special (such as experience or business contacts) that the insured brings to the firm that would die when he or she dies?
COLI Death Proceeds: Note that under the recently modified rules governing employer-owned life insurance, employers must now satisfy certain notice and consent requirements in order for the death proceeds to be received tax-free. The insured employee must be notified in writing that the employer intends to insure the employee's life, and the maximum face amount the employee's life could be insured for at the time the contract is issued. The notice must also state that the policy owner will be the beneficiary of the death proceeds of the policy. And the insured employee must also give written consent to coverage continuing after the insured employee terminates employment. Under another set of requirements, the insured employee must have been an employee at any time during the 12-month period before his death (or at the time the contract was issued, the insured was a director or highly compensated individual). See IRS Sections 101(j) and 6039I, as amended by the Pension Protection Act of 2006 (PPA 2006).
(15.) See, e.g., Nuuanu Mem. Park v. Briggs, 434 P.2d 750 (Haw. 1967).
(16.) See, e.g., Equitable Life Ins. Co. v. Hazlewood, 12 S.W. 621 (Tex. 1889), where no more would be collected by the creditor than would be necessary to discharge the debt.
(17.) Almost all states adhere to this principle including Texas which up until 1981 required the beneficiary to have an insurable interest when the proceeds were payable. See Tex. Rev. Civ. Stat. Ann. art.3.49-1 (Vernon 1981). See also, "Insurable Interest in Life," 18 Col. L. Rev. 381, 394 (1921).
(18.) See, e.g., Secor v. Pioneer Foundry Co., 173 N.W.2d 780 (Mich. 1969).
(19.) See, e.g., Metropolitan Life Ins. Co. v. Manahon, 42 S.W. 924 (Ky. 1897).
(20.) See, e.g., Ramey v. Carolina Life Ins. Co., 135 S.E.2d 362 (S.C. 1964).
(21.) For instance, say a relative other than a parent insured the life of a niece or nephew and then murdered the child. If it can be shown that the applicant-policyowner-beneficiary never obtained the consent of the child's parent, a court is likely to hold that the insurer failed to exercise due care. In this instance, such negligence could easily result in contributing to the insured's murder. See Liberty National Life Ins. Co. v. Weldon, 100 So.2d 696 (Ala. 1957).
(22.) This is why constraints are imposed on the form and content of a contract. More and more states are insisting that--to the degree possible--a life insurance contract be written in language that is simple and understandable by the typical client. There is a "Life and Health Insurance Policy Language Simplification Model Act" adopted by the National Association of Insurance Commissioners (NAIC) in 1977. This act forbids fine print, encourages short sentences, requires an index or table of contents for most contracts, and suggests a physical format that lends itself to a balanced emphasis throughout the policy.
If a provision required by law is omitted from the contract, it will be construed as though the clause were included. The "adhesion" concept is also why statutes require certain provisions while forbidding others.
(23.) Two such theories are the "doctrine of reasonable expectation" and the "doctrine of constructive ambiguity." The first of these suggests an open disregard of policy language (i.e., that the courts should honor the objectively reasonable expectations of applicants and beneficiaries regarding policy terms even though a careful study of the policy terms or language might negate those expectations). See R. Keeton, Insurance Law--Basic Text (West Publishing Company 1971), p. 351. See also Keene Corp. v. Ins. Co. of North America, 667 F.2d 1034 (D.C. Cir. 1981), cert. denied, 455 U.S. 1007 (1982). The latter doctrine holds that ambiguities in contract language should be resolved against the party who drafted the contract. See Keeton, above. Others describe constructive ambiguity as courts disregarding clear policy language and finding ambiguity where none reasonably exists in order to come to the "right" result. See Anderson, note 1 above, at p. 187.
As Anderson in the text cited above properly points out, "The function of the insurer is to distribute the risk and in fairness to individual policy holders to fix a premium rate commensurate with its estimate of the risk. This is difficult enough when a court indulges in what other courts refer to as 'constructive ambiguity,' meaning ambiguity is found where none reasonably exists, but when a court in the absence of legislative authority completely disregards clear policy language, the insurer's task is almost impossible."
(24.) Many states pattern their statutes on these required provisions on the New York standard policy provision law. Most provide that the actual wording in the policy does not have to be exactly the same as long as it conveys the same substance. In most cases, these laws allow the insurer to insert more favorable terms (from the consumer's viewpoint). There is usually an exemption allowing omission of the "required provisions" if they would be inappropriate for the type of policy in question. For instance, no dividend statement would be necessary in a nonparticipating contract.
(25.) Thus, the policyowner must be provided with a copy of the application that both eliminates uncertainties as to what is contained on it and also assures the policyowner that the policy in his or her hands contains every relevant document. The insured and/or policyowner is given a chance to be sure that his or her responses to the agent's (and/or medical examiner's) questions were properly recorded and request changes if they were not.
However, the entire contract provision works both ways. The policyowner cannot claim ignorance of the statements made in the application. This serves as notification of all the terms and conditions and imposes a responsibility on the insured (and/or policyowner) to read and, if appropriate, to apprise the insurer of errors.
As a practical matter, then, the insurance agent should review the copy of the application attached to the policy with the client and the terms of the policy when it is delivered. Of course, the problems discussed above generally will not be of concern if the insured has survived the period after which the policy becomes incontestable by the insurer.
(26.) Under common usage, a lapse is what occurs after the policy has "run out of steam." Legalistically, however, a lapse is defined as "a default in premiums before a policy has a nonforfeiture value." L. Davids, Dictionary of Insurance, p. 173. According to this definition, a policy could lapse "except as to its nonforfeiture benefits" or lapse and then be cashed in for its surrender value. Then it would be said to "expire."
In certain situations during war when timely payment was impossible, or where some action or inaction by the insurer prevented timely payment, some courts have held that the insurer could not lapse the policy for lack of premium payments.
(27.) Many states require that the insurance company must notify the policyowner not more than 45 days or less than 15 days before the due date of the premium. That notice must specify the amount payable, when it is due (the "due date"), and where it is payable. Some of these statutes penalize the insurer who does not give timely notice by extending the life of the contract for some period of time (e.g., 6 months to a year) after the due date. But these laws (to prevent fraud on the part of the policyowner) allow the insurance company's mail department to testify that notice was mailed. Once that occurs, the burden often shifts to the policyowner to prove that it was not mailed. Even if this presumption is successfully rebutted, the policyowner must also have brought suit within the statutory limit after the due date.
(28.) Some insurers make what is known as a "late remittance offer." This gives the policyowner an additional period of time after the grace period expires during which a lapsed policy can be reinstated without the requirement that the insured prove insurability. The insured must, however, be alive on the date payment is tendered to the insurer. This late remittance offer does not extend the grace period.
(29.) Some statutes also allow the insurer to add interest on the unpaid and overdue premium but, for public relations purposes, many insurers will waive the interest charge even if they have the legal right to collect it.
(30.) Some companies substitute a one-year period of time rather than the customary two-year limit on contests. This is done for marketing and public relations reasons and obviously is a consideration that should be added to the checklist of a planner deciding upon which policy is best for a client.
(31.) Usually the contestable period runs from the "date of issue" which is typically the same as the policy date. But the policy date is not necessarily the date of issue. For instance, if an applicant wants to "backdate" the policy to "save age" (i.e., obtain a lower premium by paying a premium for which no insurance was in force in return for a continuing lower premium), the policy date could be as much as six months earlier than the actual issue date. The contestable period starts at the earlier policy date rather than the issue date in this case. (Most states limit dating back a policy to a six-month period starting at the date of the application.) Backdating is one way to provide incontestability to the policyowner and beneficiary at the earliest possible time.
(32.) The phrase "during the insured's lifetime" makes it clear that if the insured dies before the end of the contestable period, the policy never becomes incontestable since it was not in force for two years during the lifetime of the insured.
(33.) "Void" means no contract exists. "Void ab initio" means no contract ever existed. From the beginning, there was never any legally enforceable contract. A "voidable" contract is one which is legally enforceable and valid--unless and until a party who has the right to do so disaffirms (avoids) the obligations and benefits of the contract. A minor, for example, can upon reaching legal majority, void a contract. Lack of capacity, mutual mistake, and material misrepresentation can all make a contract voidable.
(34.) See the statement of Justice Holmes in Northwestern Mutual Life Ins. Co. v. Johnson, 254 U.S. 96, 101 (1920), that says, "The object of the clause is plain and laudable--to create an absolute assurance of the benefit, as free as may be from any dispute of fact except the fact of death ..."
(35.) There are conflicts in various state courts as to the effect of adding to the incontestable clause an exclusion for certain items but not others. Some say that if the insurer specifies one or more items to be excluded, although those are exempted from the incontestable clause protection, any exclusion clause not mentioned is automatically meant to be ineffective after the incontestable period. (i.e., "the insurer could not contest its obligation to pay except for a reason plainly reserved in the wording of the incontestable clause itself." Bernier v. Pacific Mutual Life Ins. Co, 139 So. 629 (La. 1932). But most courts now hold that an insurer is free to specify risks it is unwilling to assume throughout the life of the contract (even though--after two years--the validity of the contract itself has become incontestable). See, e.g., Metropolitan Life Ins. Co. v. Conway, 169 N.E. 642 (N.Y. 1930). So the incontestable clause in most jurisdictions is not "a mandate as to coverage." It implies only--within the limits of the coverage the contract intended--that after the contestable period has expired, the company cannot protest that the policy was invalid in its inception or became invalid because a condition of coverage was broken.
(36.) See, e.g., Obartuch v. Security Mutual Life Ins. Co., 114 F.2d 873 (7th Cir. 1940), cert. denied, 312 U.S. 696 (1941).
(37.) See, e.g., Aetna Life Ins. Co. v. Hooker, 62 F.2d 805 (6th Cir. 1933), cert. denied, 289 U.S. 748 (1933).
(38.) Henderson v. Life Ins. Co. of Va., 179 S.E. 680 (S.C. 1935).
(39.) A few states impose a one-year limit. Some insurers for competitive and public relations purposes use only a one-year period even though state law permits a two-year period. Planners should consider this factor when deciding upon the appropriate policy for a client.
(40.) See, e.g., John Hancock Mutual Life Ins. Co. v. Moore, 34 Mich. 46 (1876); Connecticut Mutual Life Ins. Co. v. Akens, 150 U.S. 468 (1893).
(41.) Self destruction of the insured, even though deliberately done while sane, is one of the risks assumed by the insurer unless it is by express terms excepted. Grand Lodge Independent Order of Mut. Aid v. Wieting, 48 N.E. 59 (Ill. 1897).
(42.) See Crawford, note 1 above, at p. 430.
(43.) See, e.g., New York Life Ins. Co. v. Noonan, 215 F.2d 905 (9th Cir. 1954).
(44.) Many insurers are now calling this clause an "Incorrect Age or Sex" clause and adjusting the proceeds if sex is incorrectly shown in the same manner as if age had been incorrectly stated.
(45.) The presumption is that the age stated by the applicant-insured is correct. See, e.g., Southern Ins. Co. v. Wilson, 108 So. 5 (Ala. 1926).
(46.) This provision is not intended to shield fraud or collusion. The insurer can deny payment of the proceeds if it can prove the parties intended to cheat the insurer. See, e.g., Lucas v. American Bankers' Ins. Co., 141 So. 394 (La. Ct. App. 1932).
(47.) If the error as to age is discovered by the insurer prior to the insured's death, either premiums or coverage can be adjusted. Usually, if the insured's age was higher than stated in the application, the insurer will allow the policyowner to pay the difference in premiums (with interest) and keep the original policy or it may issue a new policy with a lower death benefit with the original premium level. If the insured was younger than stated in the application, the insurer will almost always refund the excess premiums (often with interest).
(48.) When a stock company issues a contract which is "nonpar," the company usually fixes the premium at a lower amount than a mutual company issuing a similar "par" policy. This nonpar policy's lower premium, of course, is initially appealing from a consumer's viewpoint. However, the buyer has no hope of sharing in the financial success of the company (unless he or she also buys stock in the insurer). From the insurer's perspective, the marketing advantage gained by a lower premium is offset to some extent by lower-per-thousand of insurance investable revenue, the fact that premiums once set cannot be changed even if the company experiences financial difficulties, and the lack of any "cushion" in the premium to take up the slack in that event.
(49.) State law is also a factor in how much is paid and under what conditions. Most states specify what the term "participate" means in terms of legal rights. Almost always, state laws will specify how soon the policy will share in the insurer's surplus (typically not later than the end of the second or third policy year), how the dividend may be applied, and what the insurer must state in the contract about those rights.
(50.) This ownership exposes dividends and the interest they earn to the claims of the policyowner's creditors to the extent state law does not exempt or otherwise protect them.
(51.) This is the most frequently selected dividend choice for the automatic option. One reason is that an insured who is insurable only at a higher-than-standard rate or even one who has become uninsurable can purchase additional coverage at net (no commissions or other acquisition charges are added to the cost of this coverage) rates. Paid up additions may be cashed in separately from the underlying policy which adds to the policyowner's flexibility.
(52.) During the first year or two of a contract, the insurer's costs to put the contract in force and provide current coverage far exceed the amount paid in by the policyowner. So no benefit is required to be provided under state law until the policy has been in force for two (or, in some states, three) years.
(53.) If the beneficiary of the policy is revocable, no consent is needed for the policyowner to exercise any of the nonforfeiture provisions. If the beneficiary is irrevocable, consent of the irrevocable beneficiary is required to cash in the policy (unless the policy specifies consent is not required) but no consent is usually required to select extended term or reduced paid up insurance.
(54.) Actually, the amounts shown in the policy assume premiums are paid to the end of the year. Since surrenders rarely occur exactly on that date, the insurer will interpolate and calculate for the policyowner the exact amount due on any given date.
(55.) The rationale is that the right to exercise a nonforfeiture option is a continuing irrevocable offer made by the insurer to the policyowner. That offer becomes binding on both parties as soon as it is accepted by the policyowner.
(56.) Technically, once a policy develops a nonforfeiture value, if the policy lapses, it lapses "except as to the nonforfeiture benefits."
(57.) See Trapp v. Metropolitan Life Ins. Co., 70 F.2d 976 (8th Cir. 1934). Although a few courts have held that reinstatement is actually the start of a new contract, most follow the rule in Trapp. The distinction is important for many reasons. For instance, the continuation theory bars an insurer from imposing new contractual restrictions or burdens on the policyowner at the time of reinstatement. This means the insurer cannot add an exclusion (e.g., for death while in military service) that was not in the original policy. See Schiel v. New York Life Ins. Co., 178 F.2d 729 (9th Cir. 1949), cert. denied, 339 U.S. 931 (1950). So no new conditions or restrictions can be imposed at the time of or as a condition of reinstatement. See Smith, "What Conditions May an Insurer Impose Upon Reinstatement of a Life Policy?" Legal Proceedings (American Life Convention 1948), p. 130.
(58.) Crawford, note 1 above, at p. 358.
(59.) See, e.g., Tatum v. Guardian Life Ins. Co., 75 F.2d 476 (2nd Cir. 1935).
(60.) Crawford, note 1 above, at p. 359.
(61.) For instance, some insurers provide for reinstatement in term insurance contracts even when there is no state law requirement that they do so. Likewise, although state law does not generally require insurers to allow reinstatement when extended term insurance runs out, quite often the insurer will not deny a policyowner's application.
(62.) In most states, the insurer may consider the same factors as if underwriting the contract for the first time when considering "insurability. " These factors include not only the insured's physical, mental, and emotional health, but also his or her habits, finances, occupation, and avocations. See, e.g., Volis v. Puritan Life Ins. Co., 548 F.2d 895 (10th Cir. 1977).
Of course, most courts will not allow an insurer to act arbitrarily and capriciously in determining if the proposed "re-insured" should be insured again according to its standards and will hold the insurer to a reasonable position based on industry practices. See, e.g., Sunset Life Ins. Co. v. Crosby, 380 P.2d 9 (Idaho 1963).
(63.) See, e.g., Bowie v. Bankers Life, 105 F.2d 806 (10th Cir. 1936).
(64.) See, e.g., Gressler v. New York Life Ins. Co., 163 P.2d 324 (Utah 1945).
(65.) See, e.g., Sellwood v. Equitable Life Ins. Co. of Iowa, 42 N.W.2d 346 (Minn. 1950).
(66.) See, e.g., Johnson v. Great Northern Life Ins. Co., 17 N.W.2d 337 (N.D. 1945).
(67.) Crawford, note 1 above, at p. 241. Crawford points out that there are two types of beneficiaries: "intended" and "incidental."
Intended beneficiaries are the only type with standing (i.e., a legal position that bestows the right) to sue the insurer to enforce their rights under the contract. As its name implies, an intended beneficiary is one who the parties to the contract expected would benefit from its performance. Such parties include those who were named without consideration (so called "donee beneficiaries") and those named in satisfaction of a debt (so called "creditor beneficiaries").
An incidental beneficiary is one who only incidentally benefits because of the existence of the insurance. For instance, if a policy were payable to the policyowner's estate, a creditor of the policyowner could satisfy that debt by informing the estate's executor. All or a portion of the proceeds might incidentally be used for payment. But an incidental beneficiary never acquires rights under the life insurance policy and so cannot sue the insurer. The policy was not taken out for that party's benefit. Crawford, note 1 above, at p. 245-46.
(68.) To name a new beneficiary, the policyowner must meet the terms of the policy. Commonly, it will require the policyowner to file a written request (usually on the insurer's form) with the insurer. The policy itself is not filed. A copy of the change is sent to the policyowner. Usually, that change becomes retroactively effective to the date the policyowner signed the insurer's change of beneficiary request form (but must first be recorded at the insurer's home office).
Under the doctrine of "substantial compliance," once the policyowner has done everything reasonably possible to comply with the insurer's procedure, the change will not fail if circumstances beyond the policyowner's control make it impossible to meet every condition. See, e.g., Dooley v. James Dooley Assocs., 442 N.E.2d 222 (Ill. 1982).
On the other hand, anything less than substantial compliance will be inadequate to make an effective change in benefit. Mere intent without positive action is insufficient. The policyowner must have taken every reasonable step in his power to effect a change of beneficiary. This rule is to protect the interests of the prior beneficiary. See, e.g., O'Connell v. Brady, 72 A.2d 493 (Conn. 1950).
(69.) Neither the killer nor anyone claiming under or through the killer (such as an assignee) can benefit from the life insurance. See McGovern, "Homicide and Succession to Property," 64 Mich.. L. Rev. 65, 78 (1969) and Statler, "The Wrongful Killing of the Insured by the Beneficiary," XXII Proceedings (Association of Life Insurance Counsel 1971), p. 521. Note that intent to kill must be present before the beneficiary will be denied the policy proceeds.
(70.) See, e.g., New York Life Ins. Co. v. Henriksen, 415 N.E.2d 146 (Ind. Ct. App. 1981).
(71.) See, e.g., Northwestern Mutual Life Ins. Co. v. McCue, 223 U.S. 234 (1912). National Service Life Insurance will not pay if death is inflicted as lawful punishment for crime or for military or naval offense (unless inflicted by an enemy of the U.S.). Only the cash value must be paid to the designated beneficiary. 38 U.S.C. 1911. This provision also applies to Servicemen's Group Life Insurance. 38 U.S.C. 1973.
(72.) To utilize the marital deduction at the first spouse's death, he or she must be survived by a U.S. citizen spouse.
What is the value of a life insurance policy where the owner and beneficiary was the spouse of the insured and both died in a common accident? Since the insured is deemed to have survived, the value the instant before the deaths (rather than the face amount) was held to be the proper figure. See Estate of Wien v. Comm., 441 F.2d 32 (5th Cir. 1971); Chown v. Comm., 428 F.2d 1395 (9th Cir. 1970); Old Kent Bank and Trust Co. v. U.S., 430 F.2d 392 (6th Cir. 1970).
(73.) The burden of proof is on the party trying to prove the deaths were not simultaneous where the deaths occur in a common disaster.
(74.) See Chapter 23.
(75.) The name is controlling even if the relationship no longer applies. See, e.g., Outling v. Young, 398 So. 2d 256 (Ala. 1981). Even if the description is not correct, where the insured's intention is clear, courts will carry out that desire. See, e.g., Burkett v. Mott, 733 P.2d 673 (Ariz. Ct. App. 1986).
(76.) There are both advantages and disadvantages to this designation. Obviously, if the policyowner changes marital status, a new wife would be benefited under a "to my wife" designation. This is probably the result desired. On the other hand, the ambiguity and therefore litigation potential is significantly enhanced. The best course of action is to properly name and describe each beneficiary, back up each beneficiary with a contingent beneficiary, and quickly change beneficiary designations when marital status changes.
(77.) Stepchildren are not generally included. Planners should suggest that clients specify which children are not to be included--especially if children from a prior marriage are to be excluded. See, e.g., Pape v. Pape, 119 N.E. 11 (Ind. Ct. App. 1918).
(78.) If the deceased child had left no children, the surviving two children would split the entire amount of the proceeds. It is best when making a per stirpes distribution to specify what is meant since different jurisdictions have varying interpretations of the per stirpes rule. For example, the insured might say something to the effect of:
"I leave the proceeds of this policy in equal shares to my children who survive me but if any predecease me and leave issue who survive me, that deceased child's share is to pass to his or her issue in equal shares, per stirpes."
(79.) Naming a guardian can cause problems because:
(a) it is not certain that the guardian will survive the insured and the insured's spouse,
(b) the court may not appoint the same individual as the policyowner selected, and
(c) the children may be legally competent by the time the insured dies. Crawford, note 1 above, p. 251
Some states, such as Pennsylvania, provide for what is sometimes called a "naked" or "informal" guardian. This is a perhaps misnamed but highly useful creature of statutory law that allows a policyowner to invoke that statute in the beneficiary designation without the trouble and expense of setting up a formal trust during lifetime by appointing a guardian in a life insurance policy. Pennsylvania's statute provides that a person may appoint a guardian of a minor or otherwise incompetent on the insurer's beneficiary form. Payment by an insurance company to the guardian discharges the insurer to the same extent as if it made payment to an otherwise duly appointed and qualified guardian. This type of procedure is a good compromise when the total proceeds do not warrant the creation of a formal trust.
(80.) When naming a trustee as policy beneficiary, it is good practice to name a backup beneficiary in case the trust is terminated (or for some reason never comes into existence or is for any reason found to be defective). Consider providing that if the trustee cannot accept the proceeds within a specified number of days (such as 90) after the insured's death, the insurer may make settlement to the insured's estate. This prevents an indefinite delay and benefits both insurer and beneficiaries. Usually, if a bank is trustee or co-trustee a provision should be inserted in the beneficiary designation exonerating the insurer from liability once it pays the proceeds to the trustee.
(81.) See, e.g., United Benefit Life Ins. Co. v. Cody, 286 F.Supp. 552 (W.D. Wash. 1968); Cook v. Cook, 111 P.2d 322 (Cal. 1941).
(82.) Settlement options are sometimes forbidden to assignees, trustees, and corporations who are restricted to lump sum cash payments (or are allowed to choose options only with the consent of the insurer). This is because some insurers do not wish to provide settlement options (which are expensive) for no charge to entities who are in the business of providing similar services at a charge to the consumer.
(83.) Planners should carefully compare this option with the interest option. Payees may actually be better off taking interest only. Female payees will not receive as much each year under this option as males because their life expectancies are so much longer. At older ages, the "straight life annuity" might have a significant payout advantage over an annuity with period certain.
(84.) Extended term does not have loan values so no loans are available from it but loans can be made from a policy placed on "reduced paid up" status. When there is a loan outstanding at the time a policy is placed on reduced paid up status (or extended term or cash surrendered), the amount available is reduced by the amount of that loan.
(85.) Mechanically, a policy loan is typically made through loan forms and insurers can but do not require the policyowner to send in a contract for a stamped endorsement (notice) stating that there is a loan against the contract. The policy loan agreement usually requires the policyowner to certify that the policy has not already been pledged as collateral for a loan.
(86.) See, e.g., Board of Assessors v. New York Life Ins. Co., 216 U.S. 517 (1910). Typically, the beneficiary of a life insurance policy subject to a loan is entitled only to the net proceeds, i.e., the proceeds remaining after the loan is deducted from the amount otherwise payable. Compare this with the beneficiary of a policy pledged as collateral for a loan; such a beneficiary is generally entitled to have the loan paid from the assets of the estate and may be entitled to the full face amount of the policy. See, e.g., Chaplin v. Merchants National Bank of Aurora, 186 F.Supp. 273 (N.D. Ill. 1959).
(87.) See, e.g., Mallon v. Prudential Ins. Co., 5 F.Supp. 290 (W.D. Mo. 1934).
(88.) See, e.g., State Mutual Life Assur. Co. v. Webster, 148 F.2d 315 (9th Cir. 1945).
(89.) Most companies now use a variable policy loan interest rate (such as Moody's Monthly Corporate Bond Yield Average) to prevent "disintermediation" (i.e., a strong flow of cash out of the insurer's hands when interest rates that can be earned outside the life insurance contract are far higher than the fixed interest rates charged by the insurer a policy loan). Variable loan rates presently incorporated in newly-issued policies are not retroactive to older contracts. The older contracts may provide fixed rates as low as 5 percent. Planners should keep this potential advantage in mind in analyzing the value of older as compared to newer policies (but some insurers have lowered dividends payable on policies with 5 and 6 percent loan rates).
(90.) Interest is typically computed to the following premium date (or if the policy is paid up or single premium to the next policy anniversary). For this reason, the later in the year the loan is made, the more money can be advanced to the policyowner--because less interest need be charged.
(91.) See, e.g., Keeley v. Mutual Life Ins. Co., 113 F.2d 633 (7th Cir. 1940); Protective Life Ins. Co. v. Thomas, 134 So. 488 (Ala. 1931); Cory v. Mass. Mutual Life Ins. Co., 170 A. 494 (R.I. 1934).
(92.) Some insurers will waive this so that total proceeds can be distributed under a settlement option.
(93.) Crawford, note 1 above, at p. 325.
(94.) The terms of the automatic premium loan provision usually give the insurer the right to change the frequency of premium payments.
(95.) See, e.g., First Nat'l Bank v. Lincoln Nat'l Life Ins. Co, 824 F.2d 277 (3rd Cir. 1987).
(96.) It is deemed so valuable that the insurer is allowed to continue using policy cash values to pay premiums even if the policyowner is declared legally bankrupt. 11 U.S.C. 542(d).
(97.) Anderson, note 1 above, at p. 296.
(98.) See Chapter 21.
(99.) Personal property has been defined as any property which is not land or attached to land. The Supreme Court in Grigsby v. Russell, 222 U.S. 149, 156 (1911), held that life insurance is personal property. Writing for the Court, Justice Holmes said:
"[L]ife insurance has become in our days one of the best recognized forms ofinvestment and selfcompelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property.... To deny the right to sell ... is to diminish appreciably the value of the contract in the owner's hands."
(100.) Among the "sticks" in the bundle of rights are the right to obtain a policy loan, the right to withdraw or direct the application of dividends, and the right to surrender the policy for its cash value.
The policyowner should be free to give away or sell his rights under a life insurance policy for his own advantage according to Mutual Life Ins. Co. v. Allen, 138 Mass. 24 (1884). (But that well-seasoned case assumed the insured and the policyholder would be the same and therefore ignored the potential for the "gaming element" in a sale). Even if the assignee has no insurable interest (defined above), the assignment will be valid in almost every state--unless it is shown that there was a lack of good faith and an intent to sidestep the insurable interest rule. See, e.g., Butterworth v. Mississippi Valley Trust Co., 240 S.W.2d 676 (Mo. 1951). See also, note 10 above.
(101.) If the policyowner owns a policy on the life of another, at the policyowner's death prior to the death of the insured or the lifetime maturity of the contract, the policy (absent specific provision in the contract regarding successive ownership) will pass into the policyowner's estate and therefore be disposed of according to his or her will or, if there is no valid will, according to the intestate law (i.e., the statutory provisions that direct the disposition of assets of a decedent who dies without a valid will) of the state of domicile.
(102.) It is best and most convenient to use the insurer's forms where available.
(103.) If the insurer discovered the first spouse's claim prior to paying the proceeds, the insurer would pay the proceeds into a court in a process called "interpleader" in which the court would decide the proper payee. It is the process used when two or more parties claim property held by a third party who does not claim to own the property but cannot determine who the legal owner is. The court decides the identity of the proper owner. This is, of course, an expensive process.
(104.) Keep in mind that this presumes the policy is usually not required to be submitted in conjunction with a policy loan. See, e.g., Elledge v. Aetna Life Ins. Co., 406 S.W.2d 374 (Ark. 1966).
(105.) Planners should thoroughly read Chapter 22 before allowing any sale of a life insurance policy. Chapter 24 should be considered before allowing a client to make a gift of a policy. A valid gift requires that the donor have contractual capacity and an intent to make a voluntary gratuitous transfer, and the gift must be delivered to and accepted by the donee (assignee).
(106.) Planners should beware of "unholy trinity" situations where the policy on the life of the insured is owned by a second party and made payable to a third party. This almost invariably leads to adverse income or gift tax results (and potentially a malpractice suit against the planners who failed to spot the issue).
(107.) The American Bankers Association Collateral Assignment Form No. 10 is the most commonly used collateral assignment form.
(108.) In order to avoid litigation, the collateral assignment form will typically require the signature of the policyowner's beneficiary. This puts the beneficiary on notice that there has been a collateral assignment and that he or she may not be receiving the entire death benefit. It also makes it more convenient for the lender to exercise any policy rights while the insured is still alive. Most importantly, because the beneficiary is consenting to the collateral assignment when he or she signs the form, he or she cannot later object if the proceeds must be used to pay off the loan.
(109.) A collateral assignment does not bind the transferee lender to pay life insurance premiums even if the policyowner defaults. If the lender does so, the amount of those premiums can be added to the total debt owed to the lender.
(110.) An insurer is typically presumed to know the rights it holds under the life insurance contract. However, if pertinent (i.e., material) facts are unknown or deliberately withheld from the insurer, the insurer's actions in ignorance of these facts will not constitute a waiver of its rights. So if a premium payment were accepted on a policy applied for on a "nonsmoking" basis, the insurer's right to deny a claim would not be forfeited if the insured was in fact a heavy and long term smoker. The insurer did not have knowledge of this material fact.
Harsh as it may sometimes seem, most courts hold that "an applicant is responsible for the truth of statements in an application he or she signs"--even if the agent (or medical examiner) knew of a misstatement and filled in an answer accidentally--or on purpose--falsely. In other words, the knowledge of the agent is not universally imputed to the insurer. Nor will knowledge of the agent be imputed to the client--even in those courts which do not hold the applicant responsible for reading the contract and the copy of the attached application--if the client colluded with the agent to defraud the insurer. See, e.g. Aetna Life Ins. Co. v. Routon, 179 S.W.2d 862 (Ark. 1944). Since the insurer has neither actual nor imputed knowledge, it cannot "knowingly" waive its rights to cancel the policy.
Most courts hold the insured responsible for reading the application --before signing it! That also binds the policyowner's beneficiaries. Obviously, this rule would not be applied if the agent lied on the application in order to make a sale and ripped out the copy before giving the policy to the policyowner. See, Hart v. Prudential Ins. Co., 117 P.2d 930 (Cal. 1941).
(111.) Any party to the life insurance contract can waive a right or be estopped from asserting a right. For simplicity, the authors will explain these two terms using the insurer as the violator and the policyowner or beneficiary as the injured party even though in many cases the reverse is true.
(112.) Crawford, note 1 above, p. 116.
(113.) These forbidden waivers also apply to the doctrine of estoppel.
(114.) See, e.g., Fayman v. Franklin Life Ins. Co., 386 S.W.2d 52, 58 (Mo. 1965).
(115.) See, e.g., Pierce v. Homesteaders Life Ins. Assoc., 272 N.W. 543 (Iowa 1937).
(116.) Crawford, note 1 above, at p. 123.
(117.) Here the term "agent" is used in the more narrow sense of a soliciting agent only. Decisions as to whether to allow a waiver would be submitted in writing by the soliciting agent to the appropriate home office agent.
(118.) See, e.g., Hoffman v. Aetna Life Ins. Co., 22 N.E.2d 88 (Ohio Ct. App. 1938).
(119.) Silence will not generally operate to change a legal relationship unless particular circumstances impose a duty to speak (i.e., when remaining silent would prove inequitable to the other party). Anderson, note 1 above, at p. 413, states general rules which have evolved in this area:
(a) Mere nonaction is not enough to bar an insurer from declaring a policy is lapsed where the cause is nonpayment of premiums--unless the insurer had habitually kept the policy in force after the policyholder's default or unless the insurer failed to give adequate notice that premiums were due.
(b) The insurer must notify the insured within a reasonable time when it learns of a ground of forfeiture (other than nonpayment of premiums) or lose the right.
(c) Where the insured dies before the insurer learns of a ground for forfeiture, the insurer by its silence after the loss is not considered to have waived its rights since the policyowner or beneficiaries are not prejudiced by the insurer's silence.
(120.) Crawford, note 1 above, p. 116, states that estoppel (technically equitable estoppel) can only be raised as a defense if three elements are present:
(a) words or conduct of one party (typically the insurer) mislead the other party (usually the policyowner or beneficiary) into believing that facts which were untrue were true;
(b) the injured party had no knowledge of the true facts; and
(c) the party requesting that the other be "estopped" was reasonable in relying on the untrue words or conduct and was consequently injured.
(121.) But see Anderson, note 1 above, at p. 402, who disagrees with the opinion of the authors and states, "cases frequently arise in which the distinction between the two concepts is vital to the sound disposition of the cause [sic]."
Figure 5.1 A COMPARISON OF SETTLEMENT OPTIONS TO TRUSTS SETTLEMENT OPTIONS Discretion Must be administered strictly in accordance with policy provisions and terms of the settlement agreement. Flexibility Although some flexibility can be provided, variations must be specified in advance. Guarantees Safety of proceeds is guaranteed; minimum rate of interest is guaranteed; a share of any excess interest earned by the insurer is guaranteed. Return on Investment possibilities open Investments to an insurer are, by law, limited and conservative. Life Income Proceeds under a life income option can be guaranteed when left with the insurer. Expense Available from insurers at no additional cost. Counseling Insurers will not function as personal counselors. Title The insurer and the payee have a debtor-creditor relationship. Segregation Insurance proceeds retained of Funds by a life insurer are commingled for investment purposes with the insurer's other funds. TRUSTS Discretion Trustee can exercise considerable discretion if the grantor directs the trustee to do so. Flexibility Generally, trusts are more flexible than settlement agreements; amounts payable to the beneficiary can be changed frequently. Guarantees No guarantees whatsoever are offered, either as to principal or income. Return on The prospects for gain (and Investments loss) may be enhanced if a grantor chooses to free the trustee from investment restrictions typically imposed on trusts. Life Income Income for life can be specified but neither the amount nor the duration can be guaranteed. Expense A corporate trustee charges a fee to administer a trust. Counseling A trustee can act as personal counselor to the trust beneficiary. Title A trustee has legal title to the proceeds, and a trust beneficiary has equitable title. Segregation The property of an individual of Funds trust is generally kept separate from the property of other trusts.
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|Title Annotation:||PART I TOOLS|
|Publication:||Tools & Techniques of Life Insurance Planning, 4th ed.|
|Date:||Jan 1, 2007|
|Previous Article:||Chapter 4: How to determine the right policy.|
|Next Article:||Chapter 6: Special policy provisions and riders.|