Legally, life insurance is a contract, governed principally by state law.
A life insurance contract promises to pay a specified amount of money to a designated beneficiary when the insured person dies. The contract is between the insurance company and the policyowner, who pays premiums in exchange for the promised death (and other) benefits. Frequently the policyowner is the person insured, but someone other than the insured may own the policy.
In return for its promise to pay death and other benefits under the contract, the insurance company charges a premium to provide adequate funds to pay death benefits when they come due and to cover insurance company expenses and profits. (Ultimately, though, the death benefit paid by the insurer on any given policy may significantly exceed the total of the premium(s) paid by the policyowner.)
Although state laws vary, life insurance contracts are issued with a number of standard provisions. Keep reading to find out 15 legal issues that should be addressed in most life insurance policies, from the 6th Edition of "The Tools & Techniques of Life Insurance Planning" (2015, The National Underwriter Company).
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1. A typical life insurance policy should spell out who the parties to the contract are.
A life insurance policy is a legally enforceable contract issued by the insurer in consideration of the application and the payment of premiums. The essence of that contract is that:
If the insured dies while this policy is in force, we will pay the Sum Insured to the Beneficiary, when we receive at our Home Office due proof of the Insured's death, subject to the provisions of this policy.
There are four parties to the life insurance contract:
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- The insurer;
- The insured;
- The applicant-policyowner; and
- The beneficiary.
See also: Do you know these annuity terms?
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2. A typical life insurance policy should explain the need for an insurable interest by the policyowner in the life of the insured.
Insurable interest is a key principle in life insurance law. It is the requirement imposed by law (and by insurers) to prevent a "gaming" or "wagering" by one party on the life of another through insurance. Simply put, to insure the life of an individual, the applicant must have an insurable interest, i.e., a greater concern in the insured's living than dying.
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3. A typical life insurance policy should describe the legal form and contents of the contract.
The life insurance policy is highly consumer protection oriented and unique in the law of contracts. In legal parlance, it is an "aleatory, unilateral contract of adhesion."
Aleatory means that the insurer's promise to pay the policy proceeds is conditioned upon an uncertain event (i.e., the insured's death within the term of the contract).
Unilateral describes the fact that the insurance company is the only party to the contract which makes a legally enforceable promise. (The policyowner's payment of premiums is technically a "condition precedent" to the insurer's liability.) The insurer promises to pay a specific dollar amount if the insured dies while the policy is in force. Note that the policyowner makes no promise to continue paying premiums and there is no way the insurer can require the policyowner to continue paying premiums.
Adhesion is a legal recognition that the policyowner was not in a position to negotiate with the insurer on the terms of the contract and the resulting document is not evidence of the normal "give and take" negotiation and bargaining found in a standard contract. The insured may adhere to the terms of the policy but cannot change them. Furthermore, the legal terms of the life insurance contract and underlying mathematical assumptions make it difficult for the policyowner to understand. For these reasons, courts will not insist that the policyowner meet the same degree of strict compliance to the terms of the life insurance contract as it might in the case of the typical agreement. Because the insurance contract is a "take it or leave it" agreement in which the insurer selects all wording and there is no negotiation of the terms, ambiguities are typically interpreted in the policyowner's (and beneficiary's) favor and against the insurer.
For these reasons, many courts have adopted one or more theories that have made it possible to construe insurance policy language strictly against the insurer. But because the life insurance contract is one requiring a great deal of reliance on the statements of the insured and/or applicant-owner, honesty — rather than reliance on the leniency of the courts — should be the watchword in the contractual process.
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4. A typical life insurance policy should describe the insured's rights to name and change the beneficiary.
A beneficiary is a person (or entity) named (or designated such as by a check off) by the policyowner to receive the death benefits under a life insurance policy at the death of the insured. A revocable beneficiary is one whose potential receipt of the proceeds can be cut off, or revoked, at any time by the policyowner. An irrevocable beneficiary is one whose interest in the contract cannot be changed or reduced by the policyowner without his consent of the beneficiary. Such a beneficiary has a vested right to the death benefit as soon as he or she is named irrevocably.
Within reasonable limits, the policyowners can change the beneficiaries as often during lifetime as they want – and name anyone else they want as beneficiaries — subject to the procedures specified in the policy.
A policyowner can, and should, name more than one beneficiary.
5. A typical life insurance policy should limit the insurer's right to contest or challenge the validity of the contract after (usually) two years, even if the policyowner made a material or fraudulent misrepresentation in acquiring the policy.
The incontestable clause typically is stated as follows:
We will not contest the validity of this Policy, except for nonpayment of premiums, after it has been in force during the Insured's lifetime for two years from the policy date. This Provision does not apply to any rider providing disability or accidental death benefits.
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6. A typical life insurance policy should provide a one-month grace period for the payment of premiums.
The policyowner's payment of the premium is a "condition precedent" to the insurer's duty to pay a death claim. So nonpayment of premiums will cause a life insurance policy to lapse. Even an insured in a coma or a person legally adjudicated mentally incompetent must pay premiums in a timely manner or the coverage will end. The insured's rights under the contract end if the specified premium is not paid at the dates specified in the contract.
See also: Premium financing is dead. Or is it?
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7. A typical life insurance policy should limit the insurer's obligation to pay death benefits if the insured commits suicide (usually) within two years of policy issue.
Suicide is the intentional killing of oneself. The following verbiage is common for a life insurance policy:
If the insured commits suicide, while sane or insane, within two years from the Policy Date, our liability will be limited to the amount of the premiums paid, less any debt and partial surrenders, and less the costs of any riders.
If the insured commits suicide, while sane or insane, within two years from the effective date(s) of any increase in insurance or any reinstatement, our total liability shall be the cost of the increase or reinstatement.
