10 timely life insurance riders

By Stephan R. Leimberg, Robert J. Doyle Jr., Keith A. Buck

September 02, 2013 at 02:00 AM

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In addition to the many required legal provisions of a life insurance contract, many life insurance contracts include special provisions, permit special endorsements, and/or allow special riders to be attached to the basic contract. The purpose of these provisions and riders often is to enhance the flexibility and fit of the policy to the policyowner's needs. However, in some cases, they serve to restrict the policyowner's options and to limit the insurer's exposure. Also, some of the standard policy provisions, such as the dividend provision, the nonforfeiture provision, the policy-loan provisions, and the settlement provisions, usually include default options that policyowners may request the insurer

To select the policy or insurance package with the most favorable combination of features one must know not only the options available, but also something about how those options may differ among companies and contracts. As a starting point, here are ten riders you should know about.to replace with other options. However, the options are not uniform among contracts; some companies offer a more restrictive list of choices than others or include other limiting features or provisions.

1. Term rider

The most common and familiar rider is the term insurance rider. When purchasing insurance, buyers may add virtually any form of term insurance — increasing, decreasing, or level — to a base permanent policy. The principal advantage to the insured of using a term rider is that the insurer issues the additional insurance on a net cost basis, without some of the fees typical of new issues. Policyowners frequently use such riders when they have a temporary need above their long-term base need or when the policyowners cannot afford to pay the premiums for a permanent policy for the full amount of insurance they need, but still wish to assure coverage for the full amount of their need.

Two of the critical elements people seeking insurance should investigate are the current term rates charged by the prospective companies as well as these companies' maximum guaranteed term rates. Some companies guarantee that their current term rates will never increase. However, their current term rates may be higher than those of companies who reserve the right to increase term rates, subject to a maximum, if their experience so dictates. Also, if prospective insureds anticipate that they may wish to convert term riders in the future, they should check the companies' conversion charges, which may vary widely.Term riders normally provide that the policyowner can change the rider to a separate policy or convert it into a permanent form of coverage within a specified period or before a specified age without evidence of insurability. Companies differ with respect to the length of the period of coverage they will permit under the term rider. For instance, some companies limit both the coverage period and the conversion period to the insured's age 65 or younger; others will permit coverage and conversion to later ages, such as age 75 or older.

2. Accelerated death benefit (ADB) rider

Accelerated death benefit riders, also called living benefit or advanced death benefit riders, are a relatively recent innovation with many variations. In general – for policies with this rider – insurers will pay part or all of the policy face amount of coverage in advance on the diagnosis of certain dread diseases or in the event of circumstances significantly affecting the insured's longevity and quality of life, such as a major organ transplant or entering a nursing home.

In most cases, once insureds meet the conditions necessary to trigger accelerated payments, they can elect to receive benefits in a single lump sum or as a series of installment payments. However paid under the option, the amount of money insureds may receive generally is more than they would realize by surrendering the policy for cash or by taking a policy loan. Insureds usually do not have to use amounts they receive under the option to pay medical or nursing home expenses. Rather, they generally may use these amounts in any manner they desire.The amount that companies may pay in advance varies by company and circumstance. The percentage of the face amount of coverage that policies may pay out in advance ranges from 25 percent to 100 percent. In those policies with high percentage-of-face payouts, the limits may depend on the reason for payout. For example, policies may make about 70 percent to 85 percent of the death benefit available under the nursing home option and 90 percent to 98 percent under the terminal illness option. The insurers reduce the advanced death benefit amount by actuarial computation to reflect the earlier and determinable payout. Among the factors that affect the actual amount available are the face amount of death coverage, the insured's actual future mortality, outstanding policy loans, current interest rates, future scheduled premiums, and administrative charges.

The policyowner may make the ADB election with respect to less than the total available insurance, provided the minimum election is for at least a specified amount, typically $25,000, and at least a specified amount of death benefit, such as $25,000, remains in force. When policyowners elect to receive an advanced payment of only a portion of the total benefit, the insurer reduces the life policy proportionately as to death benefit, premium, and value.

3. Disability waiver of premium rider

The waiver-of-premium rider is a form of disability insurance that provides that the basic policy (and often other riders) will continue in force if the insured becomes disabled and incapable of paying premiums. However, if policyowners have taken loans against their policy cash values, interest is still due on the loans. If interest on the policy loans is drawn from policy cash values (rather than paid in cash by the policyowner) and loan balances and interest charges are large relative to the net cash value, the policy could still lapse if the interest charges deplete the net cash value to close to zero.

Waiver of premium riders differ among companies and polices with respect to the period of coverage, the waiting period needed to qualify, and the definition of total disability.

Period of coverage

If the insured becomes disabled after age 60, about half the companies' provisions provide no waiver of premium benefit. Of those companies that do provide a waiver of premium benefit for disabilities occurring after age 60, most will waive premiums only to age 65, although some specify a period equal to the longer of a specified minimum number of years or to age 65 or 70. For example, the rider may specify that if disability occurs after age 60, premiums will be waived for two years or until the insured is age 65, whichever is longer.In the event of disability, the insurer essentially pays the premiums for the policyowner/insured for a specified period of time that varies from company to company. If disability occurs before age 60, most companies will waive premiums for as long as the disability continues or until the policy would otherwise terminate or endow. Some policies become paid up at age 65. If the waiver of premium rider is in effect at the time a policy becomes paid up, the insurer would not require the insured to resume premium payments even if he should overcome his disability.

Waiting period

Most companies use a waiting period of six months before insureds qualify for disability waiver of premium benefits. However, some companies use a shorter period of four months or less.

Definition of total disability

The definition of total disability varies widely and may be more or less liberal. It is therefore critical when shopping for a policy to determine which definition insurers are using in the policies one is considering.

A majority of the insurers use what advisers generally consider the most liberal definition:

Inability to perform one's own job for two years, then any job for which reasonably suited by education, training, and experience.

A sizable minority of insurers use a somewhat less liberal definition:

Inability to perform any job for which reasonably suited by education, training, and experience.

A few insurers use a very limiting definition of total disability:

Inability to perform any job for pay or profit.

Many insurers use a duration-varying definition of disability where, for instance, they will use the most liberal "own job" definition for the first 2 to 5 years of disability and then switch to the somewhat less liberal "job for which reasonably suited" definition. Some insurers may even switch again at a later date to the "inability to perform any job" standard. Given the many possibilities or combinations of disability definitions and time frames when the insurers use the various definitions, persons seeking to buy insurance with a waiver of premium rider should review the specifics of the rider carefully.

Most insurers' definitions also include conditions that are presumptive of total disability. Typically insurers presume the "loss of use of" or less liberally, the "loss of" two body members such as an arm and a leg, or of sight, to constitute total disability qualifying for waiver of premium. Some companies even include total loss of hearing as a presumptive condition. A minority of insurers include no presumptive conditions in their definition of total disability.

4. Long-term care rider (LTC)

Some life insurance issuers offer life insurance with a long-term care rider available for an additional charge. Essentially, an LTC rider is a variation of the accelerated death benefits rider. Persons who buy a policy with this rider can pay the premium in a single lump sum or by making periodic payments. In any case, the policies with the LTC rider provide policyowners with a death benefit that they can also use to pay for long-term care related expenses, should they incur them.

The insurer bases the amount of death benefit and the long-term care allowance on the insured's age, gender, and health at the time the policyowner buys the policy. The appeal of this combination policy lies in the fact that either policyowners will use the policy to pay for long-term care expenses or their beneficiaries will receive the insurance proceeds at the insureds' death. In either case, someone will benefit from the premiums policyowners pay.

Accelerated benefits rider – An accelerated benefits rider makes it possible for policyowners to access the death benefit to pay for expenses related to long-term care. The insurer reduces the death benefit by the amount used for long-term care expenses, plus a service charge. If policyowners need long-term care for a lengthy period of time, they will eventually deplete their death benefit. Policyowners also can use this same rider if they have a terminal illness that may require payment of large medical bills. Because (as described above under the accelerated death benefits rider) accelerating the death benefit can have unfavorable tax consequences, one generally should not exercise this option before consulting a tax professional.Insurers add the long-term care benefit to the life insurance policy by either an accelerated benefits rider or an extension of benefits rider.

Example: Policyowner pays a single premium of $50,000 for a universal life insurance policy with a long-term care accelerated benefits rider. The policy immediately provides approximately $87,000 in long-term care benefits or $87,000 as a death benefit. If the insured incurs long-term care expenses, the accelerated benefits rider allows the insured to access a portion, such as 3 percent ($2,610), of the death benefit amount ($87,000) each month to reimburse some or all of the long-term care expenses. The insurer will continue payments until total payments exhaust the total death benefit amount of $87,000 in about 33.3 months. Whatever the policyowner does not use for long-term care will be left to heirs as a death benefit. (The hypothetical example is for illustration purposes only and does not reflect actual insurance products or performance. Guarantees are subject to the claims-paying ability of the issuer.)

Typically, qualifying for payments under a long-term care rider is similar to the qualifying for payments under most stand-alone long-term care policies. Insureds must be unable to perform usually 2 or 3 of the activities of daily living (bathing, dressing, eating, getting in or out of a bed or chair, toilet use, or maintaining continence) or suffer from a severe cognitive impairment.

An elimination period may also apply: policyowners pay for the initial cost of long-term care out-of-pocket for a specific number of days (usually 30 to 90, but sometimes longer) before they can apply for payments under the policy. As with all life and long-term care insurance, the insurance company will require prospective insureds to answer some health-related questions and to submit to a physical examination before they issue a combination policy.

Deciding whether a combination policy is the right choice depends on a number of factors.

First, a combination policy is almost never a good choice if the prospective insured does not need both life insurance and long-term care coverage.

Second, one should ask how much life and long-term care one needs and whether no one combination policy can adequately satisfy these needs. A long-term care rider may not provide as many features as a stand-alone long-term care policy. For example, the combination policy may not cover assisted living or home health aides. It also may not provide an inflation adjustment, an important feature considering the rising cost of long-term care. Given the greater flexibility of tailoring two distinct policies to meet the needs and also the inherently greater range of choices and flexibility with stand-alone long-term care policies, more often than not, a two-policy approach will better fit one's needs.

Third, when it comes to long-term care, nobody can ever be sure how long he or she might need long-term care coverage. The critical question is: will the long-term care part of a combination policy provide sufficient coverage even if one adds an EOB rider?

Fourth, keep in mind that accelerated death benefits that the insurer pays for whatever reason deplete the face amount of the life insurance. The combination policy may be a risky proposition if one wants to maintain the level of the death benefit payable to heirs with a reasonably high probability.

Finally, the tax benefits offered by a qualified long-term care policy may not apply to the long-term care portion of combination policies, which could result in taxation of long-term care benefits received from the policy.

5. Accidental death benefit rider (ADB)

Many insurers offer an accidental death, or double indemnity, rider that – for a small additional premium – provides some multiple of the base face amount (typically double) if death is accidental. Most experts feel there is little use for this coverage, because the insurance need is rarely tied to the means of death. In fact, a nonaccidental death rider, if it were available, would be a better option, because death benefit needs are likely to be higher if death occurs after a prolonged and expensive illness than if it occurs suddenly as a result of an accident.

If policyowners purchase such a rider, they must take care to determine what the policy means by using the term "accidental" death. Insurers use two different clauses: the "accidental means" and the "accidental death" type clauses. Most companies now use the accidental death clause which provides that when death occurs as a result of accidental bodily injury, the insurer pays the accidental death benefit.

Whatever merit an ADB rider may have, it is virtually useless if the insurer uses the accidental means clause to determine when they will pay the ADB. A person probably would be better off taking a chance spending the additional premium amount on the lottery.If the contract uses the accidental means clause, both cause and result must have been accidental. The insurer will not pay the ADB if death is accidental but did not occur as a result of an accidental means or cause. For instance, if a person dies as a result of falling down his stairs, it is an accidental death, but it might not qualify for the ADB if the means were not also accidental (he intended to go down the stairs). Only if the fall resulted from an accidental means (he tripped on his child's roller skate), would the insurer pay the ADB.

Companies differ with respect to the minimum and maximum ages of coverage under the ADB rider. Some companies do not specify either minimum or maximum ages. Those that do, set age 1 or 5 as the minimum age and most set age 70 as the maximum age, although some set earlier maximum ages, such as age 65 or 60. Companies also differ with respect to the period of time after an accident during which death must occur for the insured to be paid the ADB. Most companies limit the period of time to 90 days, but some set the period at 120 or 180 days or 1 year. A few companies allow payment as long as the rider is in force.

Finally, some companies offer a curious limited ADB rider that pays a multiple benefit if death occurs on a common carrier, such as an airline, bus, taxi, or train. Some contracts include school buses and private passenger automobiles and/or will pay the ADB if death occurs as a result of being struck while a pedestrian. Once again, unless one has a gambling nature and spends a lot of time on common carriers in high-risk areas, the policyowner would be better off using the premium dollars spent on such an ADB rider buying additional coverage that will pay off regardless of the cause or means of death.

6. Additional purchase option (guaranteed insurability rider)

Most commonly, insurers sell permanent policies with attached additional purchase options (APOs) or guaranteed insurability options (GIOs) on the lives of younger insureds. The APO gives the younger insureds who cannot afford the premiums for large face amounts the option to purchase additional insurance without evidence of insurability at specified times in the future or upon the occurrence of certain life events. The traditional pattern provides regular options every three years usually beginning with age 25 and ending at age 40. However, some companies start options earlier and/or may continue the options at regular or specified intervals to age 65.

Most companies also provide alternate purchase options and dates based on the occurrence of certain critical life events that would normally warrant additional life insurance coverage. Most companies allow exercise of the option in case of marriage or birth, with multiples for multiple births. Some companies also will allow exercise if and when the insured adopts a child. In most cases, the exercise of an alternate purchase option will preempt exercise of the next regularly-scheduled purchase option.

A sizable minority of insurers automatically include a disability waiver of premium (or policy charges if a UL policy) in their new policies if the original policy included it . Many other insurers will include the disability waiver of premium (or policy charges), if requested. However, there is a great diversity in the conditions for the disability waiver of premium (or policy charges) benefit in new policies issued under an APO. The waiver may be automatic, but only if the original policy is whole life or premiums are payable to an advanced age, such as age 95. In other cases, the insurer will include the waiver if the policyowner requests it but then only if the premium on the new policy is equal to or less than that of the whole life policy. In some cases, the disability waiver of premium (or policy charges) benefit is available only if the insured is not already totally disabled at the time the insurer issues the new policy. In other cases the insurer will include the waiver if the policyowner requests it and the company consents.The option amounts generally are scheduled on the specifications page of the contract and usually are equal to or less than the original face amount of coverage. In some cases, companies also specify a minimum purchase amount, such as $5,000 or $10,000.

In virtually all cases, insurers require the new policy to be a type of whole life or endowment policy. However, a few companies permit the insured to purchase term insurance.

In addition to the traditional APO for young insureds, some companies now offer special APOs or GIOs in other circumstances. For example, some companies offer a GIO for the survivor to a joint life contract. Also, some companies offer GIOs or APOs with policies issued to fund business buy/sell agreements. This permits the policyowners to increase necessary coverage as business values increase.

7. Disability income rider (DIR)

The disability income rider provides both a waiver of premium (or a waiver of policy charges) and a supplementary income if the insured becomes totally disabled. The definition of total disability is the same as that used for purposes of the waiver-of-premium or waiver of policy charges riders. Customarily, the policies express the disability income benefit as a specified percentage of the face amount payable monthly. The common percentage is 1 percent. For example, if the face amount of the policy is $50,000, the DIR will pay $500 per month in the event the insured becomes totally disabled.

As with regular disability income insurance policies, insurers generally place maximum limits on the amount of disability income they will issue to some stated figure, such as $1,000 per month. Also, through coordination of benefits provisions, they may further limit the amount of disability income they will issue and pay based on the total amount of income payable on all other disability income policies on the insured. As a general rule, insurers are reluctant to issue disability income policies when aggregate disability income payments may exceed 65 percent to 80 percent of the insured's net earned income.

The additional premium companies charge for a given disability income benefit varies among companies, but generally will be higher for policies issued by the companies that use the most liberal definition of total disability (as described above for the waiver of premium) and lower for those that use the most restrictive definition. Regardless of the definition used, the DIR generally will only pay if the insured is totally disabled and the disability is presumed to be permanent. Therefore, advisers generally do not consider the DIR to be the most suitable form of disability income insurance. For insureds who need disability income protection, insurers generally will tailor comprehensive disability income policies (independent of their life insurance policies) to fit their needs better and more cost effectively.Commonly, disability must continue for a 6-month waiting or elimination period before benefit payments commence, although a few companies use a 4-month waiting period. As with the waiver of premium or waiver of policy charges riders, if the insured overcomes the disability, disability income payments cease and the insured must commence paying premiums on the life insurance policy once again. However, in those cases where the disability ceases after age 65 and when the waiver of premium or policy charges provision pays-up the policy at age 65, insurers require no further premium payments.

8. Cost of living rider (COL)

Some companies guarantee the term rates for the COL additions, while others do not.The COL rider typically is a term insurance rider providing automatically increasing coverage each year, or every few years, equal to the increase in the cost of living as measured, normally, by the Consumer Price Index (CPI). The insurer bills policyowners for the additional coverage with the regular notice for the base policy. The insurers require no evidence of insurability; however, if policyowners reject the additional coverage at any time by nonpayment of the additional premium, they usually will have to provide evidence of insurability in order to receive future COL adjustments. Once the insurer increases coverage, the new level of coverage remains in effect, even if the owner later rejects increases or the CPI declines.

In the case of adjustable life products, the COL increases typically are part of the readjusted base policy, rather than term additions, and insurers adjust the premiums accordingly. In universal life policies, insurers may increase the face amount of coverage for COL adjustments without the need for the policyowner to pay additional premiums if the policy has sufficient cash value to support the higher death benefit at the current premium level.

9. Extension of benefits rider (EOB)

Policyowners can add extension of benefits riders to their policies with accelerated death benefit (ADB) riders to increase their coverage beyond their policies' death benefits under the various forms of the ADB riders including benefits covering terminal, chronic, or critical illnesses and long-term care expenses. This rider differs from company to company as to its specific application.

Continuing from the example above under the long-term care rider section, if a policy's extension of benefits rider increases the long-term care benefit (the death benefit–$87,000–remains the same) to three times the death benefit ($261,000), the monthly amount available for long-term care increases to $7,830. On the other hand, if the extension of benefits rider extends the length of time the monthly long-term care benefit is available, then the monthly payments ($2,610) are extended for an additional 24 to 36 months beyond the initial number of months (33.3) available.Depending on the issuer, the extension of benefits rider either increases the total benefit amount available for terminal, chronic, or critical illnesses or for long-term care expenses (while the death benefit remains the same) or lengthens the number of months over which the insurer will pay benefits. In either case, benefit payments will reduce the available death benefit of the policy. However, some companies still pay a minimum death benefit even if the total of all accelerated benefit payments exceeds the policy's death benefit amount.

10. Change of plan provision

Many policies provide a change of plan provision that gives the policyowner the privilege of exchanging the policy for some other contract issued by the company. In essence, this feature is an in house IRC Section 1035 exchange provision. In term contracts this generally is the conversion option that allows the policyowner to exchange a term contract for some form of permanent cash-value contract. In permanent cash value contracts, the privilege normally is to change to some other form of cash-value contract. In general, the insurer permits the exchange without evidence of insurability if the new plan is a higher-premium, higher cash value type of policy. Also, the new policy generally must have the same policy date and the same underwriting class and issue age as the original policy.

Policy exchange fees also vary widely. In some contracts, the insurers treat the new policy as a new issue with new issue charges and commissions. In other cases, the insurers issue the new policy at net cost, that is, without new issue fees and commissions. These companies levy only a minimal charge to cover the administrative and clerical costs of handling the paperwork.Despite these commonalities, the companies' change of plan provisions operate in diverse ways. In some contracts, the insurers allow certain types of exchanges only with the approval of the company. In a few other companies' contracts, policyowners may exchange virtually any type of policy for any other type, including permanent for term, with evidence of insurability but otherwise without the need for approval by the company. In many contracts, the change of plan clause states that the new policy may not have any riders attached, even if the old policy included certain riders, unless the company agrees. Although in most cases companies permit existing riders to continue in the new policy, some companies' change of plan clauses specifically state that riders may continue in the new policy without the need for special approval by the company.

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