Standard Life Insurance Contract Definitions
Life insurance policies are not standardized, but they do have many similarities. The most fundamental of all definitions is the distinction among the owner of the policy, the insured, and the beneficiary. Often, the owner of the policy is the insured, or the beneficiary can own the policy, or they can be 3 separate parties.
Owner and Insured
The owner of a life insurance policy is the one who has the rights stipulated in the contract. These include the right to:
- name a beneficiary
- surrender the policy for its cash value
- transfer ownership
- receive participating dividends
The insured, who is often the owner of the policy, is the person whose death causes the insurer to pay the death claim to the beneficiary, who can be a person, trust, estate, or business. Although the owner has the right to name the beneficiary, whether the owner can change the beneficiary depends on whether the beneficiary designation is revocable or irrevocable.
The beneficiary is named in the policy to receive the proceeds of the death claim. Specific types of beneficiaries include primary and contingent beneficiaries; specific and class beneficiaries; and revocable and irrevocable beneficiaries.
The primary beneficiary (aka direct beneficiary) is the beneficiary to receive the proceeds of the life insurance policy when the insured dies. However, if the primary beneficiary dies before the insured, then the contingent beneficiary will receive the proceeds. If the life insurance proceeds are paid in installments, and the primary beneficiary dies before receiving all of the installments, then the contingent beneficiary will receive the remaining installments.
Minor children should never be named beneficiaries, because they lack the legal capacity to receive the insurance proceeds. Either a will should specify a guardian who can receive the life insurance proceeds on behalf of the children, or the life insurance should be paid into a trust for the children.
Life insurance proceeds should not be paid into an estate, because it will be subjected to probate and its associated costs and delays, and possibly estate taxes and claims of creditors.
A specific beneficiary is a named beneficiary, whereas a class beneficiary is a named group of people such as the children of the insured, or other such designation, meaning that the policy proceeds will be divided equally among the group. However, members of the entire class should be unambiguously identifiable; otherwise, there could be legal problems, and the money may not be distributed as the owner of the policy intended. For instance, does the children designation include illegitimate children, half-children, and step-children?
Most life insurance policies provide for a revocable beneficiary, giving the policyowner the right to change beneficiaries at any time before the insured's death, and without the consent of the beneficiary.
The policyowner cannot, however, change an irrevocable beneficiary without the beneficiary's consent. However, if an irrevocable beneficiary dies before the insured, then the policyowner generally has the right to name a new beneficiary. Most irrevocable beneficiary designations result from legal proceedings, such as a divorce decree.
Sometimes the insurance company is not sure who the rightful beneficiaries are, either because the designation of the beneficiaries was unclear, or because they cannot be found. To prevent legal liability by paying a wrong party, the insurance company may use an interpleader: an equitable legal proceeding effected by transferring the proceeds to a court, and letting the court determine the rightful beneficiaries.
Paying Life Insurance Proceeds into a Trust
Often, the beneficiaries are minor children, or mentally handicapped or elderly adults who cannot manage their own financial affairs. In these cases, it is best to pay the money into a trust managed for their benefit by the trustee, often the trust department of a bank. This will prevent the money from being squandered or invested unwisely, or having it taken away from gullible beneficiaries. It also offers the greatest flexibility in payment options, because the trustee can disperse the money to the beneficiaries as needed. For instance, money can be saved for college, and more can be paid out as needed when the children attend college, for instance.