Common Life Insurance Provisions

Insurance contracts, like most contracts, have common provisions.

Misstatement of Age

If the age of the insured was misstated when the policy was initiated, then the face value of the policy will be adjusted to the amount that the paid premiums would have bought if the true age was given.

Major Contract Clauses: Entire Contract, Incontestable Period, and Suicide

Unlike many other insured events, death is certain, and, thus, the insurance company must pay the death claim eventually as long as the owner of the policy keeps it in force. Life insurance would have little benefit for the insured if the insurance company could somehow get out of the contract, after collecting premiums for many years, by canceling it before the death rate increased significantly, or by changing the policy in other ways, such as changing the company's bylaws or charter, or by contesting that there were mistakes in the application. There are 2 major contract provisions that prevent the insurer from canceling the insurance unilaterally: the entire contract clause and the incontestable clause.

The entire contract clause states that the contract and the application for life insurance constitutes the entire contract. The contract cannot make any reference to other documents, or anything else, such as the corporate bylaws or charter, that can change the terms of the contract without the insured knowing about it. The insurance company cannot change the terms of the contract unless the insured consents to the change.

The insurer can cancel the contract within the 1^st 2 years of the policy if it discovers a material misstatement in the application. After 2 years, the incontestable clause prevents the insurer from canceling the contract even for a material misrepresentation. For if the insured dies, the decedent cannot contest any objections the insurer may raise to deny payment of the death claim to the beneficiary. Therefore, the incontestable clause gives the insurer 2 years to discover any material misrepresentations; afterwards, it must pay the death claim. As a further means of preventing the insurer from denying the payment of a claim because of any misrepresentation of fact, all information provided by the insurance applicant are considered representations rather than warranties.

The only situations under which an insurer will be allowed to deny payment of a claim, or to cancel the policy during the incontestable period is when the insurance applicant had no insurable interest in the insured, or if the insured committed a major fraud, such as having someone else take the physical examination, or the beneficiary murders the insured.

Life insurance policies also have a suicide clause stipulating that if the insured commits suicide within 2 years (1 year for some policies), then the insurance company will only refund the premiums. Afterward, the insurance company will pay the claim. Paying for suicide is justified because the insured would be considered mentally ill. The 2-year waiting period is to provide against adverse selection. If immediate payment was provided, someone determined to commit suicide could take out a life insurance policy, then commit suicide. The presumption is that most people who really want to commit suicide will not wait 2 years so that the beneficiary can collect the death payment.

There is also a legal presumption against suicide. If the insurer wanted to deny payment because of suicide, the burden of proof would be on the insurer to prove that it was a suicide.

Premium Payments

Premiums are usually paid annually, but they can be paid semi-annually, quarterly, or monthly for those policies that require the regular payment of premiums. However, if the policyholder elects to pay an annual premium in smaller, more frequent amounts, then there is usually a small interest charge added.

Change-of-Plan Provision

Most life insurance contracts allow the policyholder to change the type of life insurance to provide for changing conditions or different desires. If the change is to a policy requiring greater reserves, then the policyholder must pay the difference; if the required reserve is less, then the insurer refunds the difference to the policyowner.

In any policy change that increases the pure insurance component, which is the net amount at risk for the insurer, the policyowner must provide evidence of insurability.

Assignment

A life insurance policy can be transferred to another party, and such transference is called an assignment. The insurance company must be notified of the assignment; otherwise, the death claim will be paid to the beneficiary. An absolute assignment transfers all rights to the policy to the new owner. A collateral assignment assigns certain rights to a creditor to serve as collateral for a loan to the policyowner. The policyowner retains all other rights. When the insurance company is notified, then a new contract is formed between the insurance company and the assignee, and the assignee has a superior claim on the proceeds of the policy over the beneficiary, but only to the extent of satisfying the repayment of the loan.

Grace Period

If the policyowner fails to pay a premium on time, then the insurance company will send him a notice. The policyowner will have a grace period of at least 31 days to pay the premium. If the premium is not paid, then the policy lapses, or is no longer in force. Most insurance contracts lapse in the 1^st couple of years. If the lapsed policy is a cash-value policy, then the insured will lose quite a bit of money because most of the initial premiums go to paying sales commissions and other expenses of acquiring a policy.

Reinstatement

If the policy lapses, then most contracts provide a reinstatement provision that allows the policyholder to reinstate the policy under certain conditions. The policy can only be reinstated if the policy was not surrendered for its cash value, and it is reinstated within a certain time limit, typically 3 to 5 years. To reinstate the policy, the policyholder must provide evidence of insurability; pay all overdue premiums + interest; and any policy loan must be repaid or reinstated with interest.

Although the owner of a lapsed policy can simply buy another policy, there are several advantages to reinstating the lapsed policy: the premium will be lower because it was bought at a younger age; cash values and, possibly, dividends will be greater; and acquisition expenses will be avoided by reinstating the policy.

If the holder of a lapsed policy purchases a new policy instead, then the periods for suicide coverage and the incontestable period will not begin for 2 years; whereas with a reinstated policy, the old periods apply and may have already expired. The insurer does, however, have another 2 years to contest any new facts in the reinstatement application, but not any facts contained in the original application.

Exclusions and Restrictions

Compared to most insurance policies, life insurance policies have few exclusions or restrictions. However, there may be some restrictions if the cause of death was from war, hazardous occupations or hobbies, aviation deaths other than as a passenger on a commercial airline, or traveling or living in a dangerous country.