144
CHAPTER 16
Standard Life Insurance Contract Provisions and
Options
I. SUGGESTED CLASSROOM TIME: 110–130 MINUTES
II. CHAPTER OVERVIEW
This chapter contains a large number of new terms for the student to learn. The
terminology of life insurance becomes much more interesting when the reasons for the
various provisions, e.g., reinstatement, extended term option, fixed period option, and
waiver of premium, are stressed. Numerous examples illustrating these features are found
III. LECTURE OUTLINE
A. Introduction—discuss the parts of life insurance contracts. No standardized life
insurance contracts exist. However, states have created a minimum set of required
provisions to protect the consumer and provide a fairer transaction. In addition, the
language of the provisions must meet certain requirements, and if the contract does
not, the language is automatically changed to meet the minimum intent of the law.
1. Insured, Owner, and Beneficiary
a. Insured— The person whose death causes the life insurance company to pay a
1. Revocable versus irrevocable beneficiaries
2. Primary versus contingent beneficiaries
3. Interpleader
Chapter 16 /Standard Life Insurance Contract Provisions and Options 145
B. General Life Insurance Policy Provisions—mandated by the New York State Insurance
Code
1. Grace period: A 31-day period after premium due date in which a missed
premium can be paid without penalty. The policy lapses when the insured fails to
2. Reinstatement: A provision allowing an insured whose policy is under a
nonforfeiture option (assuming cash values have not been withdrawn) to reinstate
3. Incontestable clause: Makes the contract secure from claims by insurer that
contract was not valid—usually after two years. Purpose: Adds security to contract
4. Entire contract provision: No incorporation by reference in the contract is
allowed and the contract and all attachments is the entire document. No oral
evidence is allowed.
5. Misstatement of age provision: Does not allow insurer to void policy upon
6. Annual apportionment of divisible surplus: Requires insurers to pay
dividends annually if they are earned. This feature is associated with participating
7. Suicide and other restrictive provisions
a. Suicide clause: Precludes payment if death of an insured is due to suicide in the
first few years of a policy. Purpose: control of the moral hazard. After two years,
146 Chapter 16 /Standard Life Insurance Contract Provisions and Options
8. Dividend options: Participating life insurance
a. Can take the dividend in cash; nontaxable since considered a return of excess
9. Nonforfeiture options: Gives the owner a choice if a policy that has cash value
is lapsed
10. Policyholder loan provision: Gives the owner the right to borrow the cash
value at a predetermined interest rate. If not paid at death, reduces the face
amount paid to beneficiary.
11. Settlement options:
a. Cash (face amount of policy plus any paid up additions or dividends left on
deposit)
12. Available riders and options:
a. Guaranteed insurability: Allows owner to acquire more insurance at
predetermined times, regardless of health. Often this is a very desirable option.
b. Waiver-of-premium: Allows owner to omit premium payments if he or she
Chapter 16 /Standard Life Insurance Contract Provisions and Options 147
IV. ANSWERS TO REVIEW QUESTIONS
1. Define the terms insured, owner, and beneficiary. The insured is the subject
of the insurance, and when the insured dies, the event causes the life insurance
2. Give the reasons for a life insurance policy containing each of the
following provisions:
a. Grace period
b. Reinstatement
c. Incontestable clause
d. Entire-contract clause
e. Misstatement-of-age clause
f. Annual apportionment of divisible surplus
g. Loan
a. Grace period: Sometimes people forget to pay premiums or make a mistake
b. Reinstatement provision: Sometimes people change their minds after a paid–
c. Incontestable clause: The provision precludes an insurer from denying payment
on the grounds of fraud or misrepresentation when the policy was applied for after
d. Entire-contract clause: This provision makes the application and the policy the
148 Chapter 16 /Standard Life Insurance Contract Provisions and Options
e. Misstatement-of-age-clause: If an insurer would not issue the same contract at
the same rate had the truth been known, a case for material misrepresentation has
f. Annual apportionment provision: This provision was designed to eliminate
the possibility for abuse associated with the tontine system; it is clearly a
requirement meant to protect the insurance consumer. A tontine is a scheme where
g. Loan provision: In policies with savings values, the loan provision guarantees
the insured the right to borrow these savings at a predetermined rate of interest.
3. What is a lapsed life insurance policy? What are some possible causes of
lapsing? Is a lapsed policy a problem or benefit to the insured? To the
insurer? A lapsed policy is a policy abandoned by an insured, usually because of non–
payment of premiums. Lapsed policies are serious problems to both insureds and
Chapter 16 /Standard Life Insurance Contract Provisions and Options 149
4. Give some reasons why an insured might prefer to reinstate an existing
policy rather than begin a new one. There are several reasons why reinstating an
old life insurance contract is advantageous over starting a new one. After meeting the
5. Does the incontestable clause mean an insured always “gets away with”
fraud against the insurer? Is the purpose of the incontestable clause to
protect the insured from fraud? Does the incontestable clause encourage
fraud? The incontestable clause does not create a situation in which all fraud is
6. What will an insurer do if it learns that an applicant misstated his or her
age on a life insurance application? Buster Brown knowingly tells the
insurer his age is 28 when he is actually 38. What effect will this lie have
on his insurance contract? When an insured misstates her/his age on an
7. Describe some of the differences between participating and
nonparticipating life insurance. Which plan should a consumer purchase?
The participating insurance plan has the following features: 1) A relatively large initial
150 Chapter 16 /Standard Life Insurance Contract Provisions and Options
8. Are participating dividends guaranteed? Participating dividends are not
9. Identify four dividend options.
1) Dividends may be taken as a cash payment.
10. Describe the three typical nonforfeiture options. Why do insurers offer
nonforfeiture options? Illustrate the three nonforfeiture options in the
case of John Brahms, who currently has a policy with $24,000 of cash
value. John is 38 years old. The typical nonforfeiture options include surrendering
the policy for cash, receiving term insurance with an equal face amount for a period of
Chapter 16 /Standard Life Insurance Contract Provisions and Options 151
11. Do insureds have a legal right to a loan secured by their cash value?
Describe some circumstances when a policyholder loan provision is
advantageous to the insured, but a disadvantage to the insurer. Policy
owners have an unlimited right to a loan secured by the cash value of their life
12. What is an automatic premium loan? The automatic premium loan (APL) option
13. Explain five different settlement options. Give an example where each
alternative might be useful. With the cash settlement option (the default option)
the face amount is paid to the beneficiary in one lump sum and all contract obligations
terminate. The fixed amount option pays an amount periodically until the proceeds are
14. Describe the benefits provided by the guaranteed-insurability and waiver-
of-premium options. The guaranteed insurability option provides the owner the
right to purchase limited amounts of additional life insurance at predetermined times,
152 Chapter 16 /Standard Life Insurance Contract Provisions and Options
15. What are some objections to the double-indemnity option? What is the
justification for this option? Critics object to the double-, triple-, etc., accidental
V. ANSWERS TO OBJECTIVE QUESTIONS
1. In a life insurance policy the owner is the party
2. The policy provision that allows premiums to be paid after the due date is called
3. The effect of the incontestable clause is to
4. Which of the following alternatives is not a typical dividend option?
5. The settlement option that pays a monthly amount until death is an annuity called the
Chapter 16 /Standard Life Insurance Contract Provisions and Options 153
6. The person who receives the proceeds of a life insurance policy is called the
7. If an insured voluntarily gives up the life insurance contract, the policy is
8. If an insured misstates her age, then the insurer
VI. IDEAS FOR INSTRUCTORS AND TEACHING METHODS
1. One method of teaching the ideas relating to the life insurance contracts is to teach by
case example. One source of legal cases addressing the various aspects of contract
2. Split the class into groups. Have the students go to the law section of the library, and
have them look up court cases relating to the contractual features of the life insurance
3. Have students discuss the legal, moral, and ethical considerations in paying the face
4. Have the class analyze the provisions of the life insurance contract relative to providing
cash for a terminally ill person. Does the insurance contract meet the needs of the
person before death? After death?
154 Chapter 16 /Standard Life Insurance Contract Provisions and Options
5. Through the use of the standard policy provisions, have the class discuss whether a
whole life insurance policy meets the needs of a family through the early adult years,