Legal Aspects of Life Insurance

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Introduction • Life insurance is a legally contract • Issued by the insurer • In consideration for application and premium payment • Parties to the contract • The insurer • Operates in corporate form • Licensed in each state where it does business • The insured • The person whose life is insured

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Requirements of insurance interest • Imposed by law to prevent Gaming or wagering • The applicant must have an insurable interest in the insured • Everyone has an unlimited insurable interest in their own lives • Blood relatives • Parent to the child • Child to the parent • Grandparent to the grandchild • Siblings

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Requirements of insurance interest (cont'd) • Marriage • Spouses have insurable interest in each other • Some courts have held that insurable interest holds for those who are engaged • Those related by marriage generally do not • In-laws • Step-sons & step daughters • Business • Employer-employee • Partners in a partnership

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Requirements of insurance interest (cont'd) • Business (cont'd) • Person, or financial enterprise that would suffer a financial loss at the insured’s death • Creditors • Business associates funding the purchase of the business(Buy-sell agreements) • Insurable interest must exist only at the time of inception(Life and health insurance) • Corporations can collect proceeds on the life of a former key employee • Consent of the insured must be present

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Aleatory contract • The insured’s promise to pay the policy proceeds conditions upon the an uncertain event • Unilateral contract • The insurance company is the only party to the contract which makes a legally enforceable promise • Contract of Adhesion • The insurance contract is a “take it or leave it” agreement • Insurer selects all wording • No negotiation of the terms • Ambiguities are usually interpreted in the policyowner;s favor and against the insurer

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Grace period • Gives the policyowner an additional period of time(typically 31 days) after due date of premium during which the policy remains inforce • Death during grace period • Full death benefit paid less premium that was due and not paid • Incontestable clause • After 2 years from the policy date (during the insured’s life) • Company barred from challenging validity of contract

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Incontestable clause (cont'd) • Why? • Clause allows a reasonable time for discovery by the insurer • Avoids long, expensive and uncertain litigation for the policyowner • Difficult to collect evidence from years, even decades ago • Exceptions • Fraudulent impersonations • Lack of insurable interest • Procurement of the policy with intent to murder

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Suicide clause • Proceeds will not be paid if insured commits suicide • Within 2 years from the policy date • Whether sane or insane • Insurer will returns premiums paid, less any debt or partial surrenders • Presumption is that the insured did not commit suicide • Insurer must demonstrate death did not occur by accident • Accidental death benefits will not be paid as a result of an insured’s suicide • Suicide is a deliberate act • Conversions to permanent insurance do not re-start clock

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Misstatement of age adjustments clause • Proof of age not required at time of application • At death, a death certificate is required • Proceeds of the policy will be adjusted • To proceeds that would have been purchased at the correct age • Dividend Clause • Dividends are influenced by insurers experience with 3 factors • Mortality • Excess by which actual morality expenses were greater or less than the expected

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Dividend Clause (cont'd) • Dividends are influenced by insurers experience with 3 factors (cont'd) • Interest • Excess by which actual interest earning were greater or less than the expected • Expenses • Excess by which actual business expenses were greater or less than the expected • Dividends are payable to and legally the property of the policyowner • Dividend options • Policyowner chooses how dividends will be applied to policy

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Dividend Clause (cont'd) • Dividend options (cont'd) • Take dividends in cash • Have dividends reduce premium • Dividends purchase paid-up additions • Dividends accumulate with interest • Dividends purchase one-year-term insurance equal to the cash value • Insurer’s allowed to specify what will happen if the policyowner does not specify which dividend option they want

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Nonforfeiture provisions • Define options for the policyowner with respect to the cash surrender value • Cash surrender • Policyowner surrenders policy for its cash surrender value • Extended Term Insurance • Cash value is applied as a single “Premium” to create an extended term policy • No additional premiums required • Death benefit remains the same • Since the death benefit is the same, only the term for time for which coverage will last will change • If the insured dies after the term ends – no benefits • Good choice for some with a shortened life expectancy

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal Form and Contents of The Contract • Nonforfeiture provisions (cont'd) • Reduced paid-up insurance • Cash used as a single premium to pay-up the contract for the life of the insured • Amount of coverage is reduced to what a net single premium in the amount of the policies cash value would purchase at the attained age of the insured • Policy has both cash values and loan values and is more flexible than extended term insurance • Good choice for insured in good to excellent health, but does not want to continue paying premiums

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Policy lapse and reinstatement clause • Policy “Lapses” when premium are not paid by the end of the grace period • A lapsed policy can be resuscitated to put the insurer back in a position prior to the lapse • Reinstatement conditions • Applies for reinstatement • Provides evidence of insurability • Pays all back premiums plus interest

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Policy lapse and reinstatement clause • Why reinstate? • Annuity purchase rates rates in original contract more favorable than what's currently available • More favorable policy loan rates in original policy than what’s currently available • More favorable interest and mortality assumptions in original policy than what’s currently available • Premiums lower that what’s currently available in new policies • Simpler and quicker than applying for a new contract • On a new contract suicide and incontestable clause start anew

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Legal form and contents of the contract (cont'd) • Policy lapse and reinstatement clause • Why one might not reinstate? • New contract have superior features and benefits • Larger outlay to reinstate than to buy a new contract • Rates for new policy may be lower than for original policy • Naming & changing a beneficiary • Beneficiary is the person designated by the policyowner to receive the death proceeds • Revocable – Can be changed anytime by the policyowner • Irrevocable – requires consent of the original beneficiary before it can be changed to another beneficiary

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Naming & changing a beneficiary (cont'd) • Limitations • Beneficiary must have insurable interest if policyowner is someone other than insured • Community property state requires consent of spouse to change beneficiary if policy purchased with community property funds • Insured minor change change beneficiary upon reaching majority • Employer cannot be named as beneficiary for group term insurance • Beneficiaries named as part of a divorce decree cannot be changed without their consent • Legally adjudicated incompetent cannot change beneficiary • Uniform Simultaneous Death Act(USDA) • Proceeds distributed as if insured survived beneficiary

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Naming & changing a beneficiary (cont'd) • Primary beneficiary • First in line to receive proceeds • Secondary beneficiary • Receive proceeds in the event they outlive the primary beneficiary • Per Capita class of beneficiaries • “By the head” distribution • Proceeds split according to the number of beneficiaries in the class • If there are three children, then each gets 1/3rd

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Naming & changing a beneficiary (cont'd) • Per Stirpes Class of beneficiaries • “By the branches” distribution • Proceeds are first divided among the class • If 2 out 3 children survive, the proceeds are split 3 ways with the deceased child’s children splitting the share the deceased child would have had • Trustee should be named as beneficiaries involving minors

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Modes of settlement (death proceeds) • Lump sum payable in cash • Leave proceeds with insurer and receive annual payments • Fixed-years installments • Fixed amount installments • Life Income Options • Straight Life • Life income with period certain • Life refund annuity • Joint and survivor annuity

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Modes of settlement (death proceeds) (cont'd) • Issues and considerations (Electing a non lump sum settlement option) • Advantages • No separate charge made by the carrier • No other commercial institution can pay a life income • Both principal and minimum interest rate are guaranteed • Disadvantages • Alternative investments may product higher returns • A trust may prove more flexible • The trust may be more responsive to the beneficiary needs and circumstances

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Policy loans • Insured can access the cash value for policy loans • Loan does not require re-payment • In fact, the interest due can be borrowed as well. • Cash values must be sufficient • At death, loan balance is deducted from the total death proceeds • Automatic policy loan provision • Advances the insurer makes under the policy clause to pay premium in the event the insured does not pay by the end of the grace period • If loan value insufficient to pay annual premium, then they will pay a semi-annual, quarterly or monthly premium

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Assignments • A Life insurance policy can be transferred to another person or entity • It is a piece of property • Lifetime transfers • Absolute assignment • Transfers all policyowner's rights irrevocably • Collateral assignment • Assigns as much of the death proceeds as necessary to secure a lenders rights • Insurance company must be notified in writing by the policyowner

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Waiver • Intentional voluntary surrender of a known right • Rights that cannot be waived by the insurer • Rights that protect a party to the contract as well as the public • Example – Insurer tries to demand that the applicant have an insurable interest in the insured • Rights that would create coverage were none previously existed • Rights to receive a sum of money cannot be waived • Types of Waivers • Express – Surrender of a legal right expressly declared by written or orals words of an insurance agent • Implied – Conduct infers the intention to forego a legal right

Legal Aspects of Life Insurance Chapter 5 Tools & Techniques of Life Insurance Planning • Waiver (cont'd) • Types of Waivers (cont'd) • Waiver by silence – Where insurer has legal duty to speak, but fails to do so • Estoppels • Legal way of arriving at a fair and just result • Insurer through words or conduct mislead policyowner • Action or inaction results in policyowner loss • Example – Agent tells applicant to ignore that one fainting spell because the insurance company is only concerned with long- term history of fainting • The result – Insurer denies death benefit claim on the grounds that the fainting was not admitted on the application • The insurer is “estopped” from claiming misrepresentation, because the insurance agent’s comments induced the applicant into taking action

Legal Aspects of Life Insurance