Lecture Nineteen-twenty Life Insurance Contractual Provisions, and buying Life Insurance

1. Lecture Nineteen-twentyLife Insurance Contractual Provisions, and buying Life Insurance Northwest University Huixia Liu

2. Learning Objective • Explain the incontestable clause, suicide clause, and grace period provision • Identify the dividend options that are found in participating policies • Explain the non-forfeiture options that are found in cash-value policies • Describe the various settlement options for the payment of life insurance proceeds • describe the rules to follow when purchasing life insurance Northwest University Huixia Liu

3. Main Contents • Life insurance contractual provisions • Dividend options • Nonforfeiture options • Settlement options • Additional life insurance • Determining the cost of life insurance • Rate of return on saving component • Shopping for life insurance Northwest University Huixia Liu

4. Case • Scott, age 36, and Michelle, age 34, are married and have two small children. Michelle is the owner and beneficiary of a $500,000 life insurance policy on Scott’s life. Three years after the policy was purchased, Scott committed suicide because of chronic depression and the bankruptcy of his business. Because Scott deliberately caused his own death, Michelle was concerned that the insurer might deny payment of the claim. Michelle's life insurance agent, however, assured her that the claim would be paid in full. Northwest University Huixia Liu

5. Questions ? • Do you think Michelle could receive Scott’s life insurance payment • In the preceding case, Michelle’s financial security was affected by a contractual provision in a life insurance policy dealing with suicide. Northwest University Huixia Liu

6. Life Insurance Contractual Provision • Life insurance contracts contain dozens of contractual provisions that affect the insured and beneficiary and payment of the death proceeds. • Some contractual provisions are mandatory and must be included in every life insurance policy. Other provisions are optional. Northwest University Huixia Liu

7. Life insurance contractual provisions Life insurance policy contain numerous contractual provisions as follows: • Ownership Clause • Entire-contract Clause • Incontestable Clause • Suicide Clause • Grace Period • Reinstatement Clause • Misstatement of Age or Sex Clause Northwest University Huixia Liu

8. Life insurance contractual provisions • Beneficiary Designation • Change-of-Plan Provision • Exclusive and Restrictions • Payment of Premiums • Assignment Clause • Policy Loan Provision • Automatic Premium Loan Northwest University Huixia Liu

9. Life insurance contractual provisions • Ownership Clause (保单所有人条款） • The owner of a life insurance policy can be the beneficiary, a trust, or anther party. • In most cases, the applicant, insured, and owner are the same person • The policyowner possesses many rights as the following: Northwest University Huixia Liu

10. Life insurance contractual provisions • Naming and changing the beneficiary • Surrendering the policy for its cash value • Borrowing the cash • Receiving dividends, • Electing settlement options • Designate a new owner and inform the insurer. The policy will be endorsed. Northwest University Huixia Liu

11. Life insurance contractual provisions • Entire-contract Clause （完整合同条款） • The life insurance policy and attached application constitute the entire contract between the parties. • All statements in the application are considered to be representations rather than warranties • No officers of the insurer can change the policy forms unless the policyonwer consents to the change. Northwest University Huixia Liu

12. Life insurance contractual provisions • Incontestable Clause（不可抗辩条款） • The insurer has two years in which to discover any irregularities in the contract. • The insurer cannot contest the policy after it has been in force two years during the insured’s lifetime, the death claim must be paid even if it is a material misrepresentation, concealment, or fraud when the policy was first issued. The following cases are exceptional: • The beneficiary murdering the insured • someone else take a medical examination • An insurable interest does not exist at the inception of the policy Northwest University Huixia Liu

13. Life insurance contractual provisions • Suicide Clause(自杀条款）] • If the insured commits suicide within two years after the policy is issued, the face amount of insurance will not be paid; there is only a refund of the premiums paid. • If the insured commits suicide after two years since the policy is issued, the policy proceeds are paid Northwest University Huixia Liu

14. Life insurance contractual provisions • Grace Period（宽限期条款） • A period during which the policyowner has a period of 31-61 days to pay an overdue premium. • The insurance remains in force during the grace period. If the insured dies within the grace period, the overdue premiums is deducted from the policy proceeds. Northwest University Huixia Liu

15. Life insurance contractual provisions • Reinstatement Clause(复效条款） • A policy may lapse if the premium has not been paid by the end of the grace period, or if an automatic premium loan provision is not in effect. The reinstatement provision permits the owner to reinstate a lapsed policy. Northwest University Huixia Liu

16. Life insurance contractual provisions • Reinstatement Clause(复效条款） • The following requirements must be fulfilled: • Evidence of insurability is required • All overdue premiums plus interest be paid • Any policy loan must be repaid or reinstated. • Not have been surrendered for it cash value • Must be reinstated within a certain period ( 3-5years in US, within 2 years in China) Northwest University Huixia Liu

17. Life insurance contractual provisions • Misstatement of Age or Sex Clause(年龄或性别误报条款） • If the insured’s age or sex is misstated, the amount payable is the amount that the premiums paid would have purchased at the correct age and sex. Northwest University Huixia Liu

18. Life insurance contractual provisions • Beneficiary Designation （指定受益人） • the party named in the policy to receive the policy proceeds. • The principal types of beneficiary designations are as follows: • Primary and contingent beneficiary • Revocable and irrevocable beneficiary • Specific and class beneficiary Northwest University Huixia Liu

19. Life insurance contractual provisions • Change-of-Plan Provision(改变保障计划条款） • Life insurance policies may contain a change-of-plan provision that allows policy-owners to exchange their present policies for different contracts. The purpose of this provision is to provide flexibility to the policy-owner. Northwest University Huixia Liu

20. Life insurance contractual provisions • Exclusive and Restrictions （除外或限制责任） • A life insurance policy contains very few exclusions and restrictions，such as suicide within first two years, war death, aviation death, etc. Northwest University Huixia Liu

21. Life insurance contractual provisions • Payment of Premiums (保费支付) • Life insurance premiums can be paid annually, semiannually, quarterly, or monthly. • If the premium is paid other than annually, the policyowner must pay a carrying charge(分期付款的利息) due to the true interest rate Northwest University Huixia Liu

22. Life insurance contractual provisions • Assignment Clause(转让条款)A life insurance policy is freely assignable to another party. There are two types of assignments: • An absolute assignment（绝对转让） • a collateral assignment （担保物的转让） Northwest University Huixia Liu

23. Life insurance contractual provisions • Policy Loan Provision（保单贷款条款） • Cash-value life insurance contains a policy loan provision that allows the policy-owner to borrow the cash value. The interest rate is stated in the policy. Northwest University Huixia Liu

24. Life insurance contractual provisions • Automatic Premium Loan（自动保费贷款） • The automatic premium loan provision can be added to most cash-value policies. Under it, an overdue premium is automatically borrowed from the cash value after the grace period expires, provided the policy has a loan value sufficient to pay the premium. • Interest is charged on the premium loan at the stated contractual rate. Northwest University Huixia Liu

25. Dividend Options • Life insurance policies frequently contain dividend options. If the policy pays dividends, it is known as a participating policy（利益）分享保险单/分红保单). • Policy dividends are generally derived from three sources: • the difference between expected and actual mortality experience; • excess interest earnings on the assets required to maintain legal reserves; • the difference between expected and actual operating expenses. Northwest University Huixia Liu

26. Dividend Options There are several ways in which dividends can be taken: • Reduction of premiums • Accumulate at interest • Paid-up additions • Term insurance (fifth dividend option) • Other uses of dividends Northwest University Huixia Liu

27. Dividend Options • Paid-up additions (额外购买缴清保单） Under the paid-up additions option, the dividend is used to purchase a small amount of paid-up whole life insurance. Northwest University Huixia Liu

28. Dividend Options • Term insurance (fifth dividend option) Some insurers offer a fifth dividend option by which the dividend is used to purchase term insurance. Two forms of this option are typically used. • to purchase one-year term insurance • to use the dividend to purchase yearly renewable term insurance. Northwest University Huixia Liu

29. How to select the best dividend Option ? ? • There is no one best dividend option. The best dividend option is the one that is best for you in terms of your financial circumstances, needs, and objective. • If your income is limited or if premium payments are financially burdensome, the dividend can be paid in cash or used to reduce the next premium. • If you are substandard in health or uninsurable, then the paid-up additions option is appropriate. • If income-tax considerations are important, you should not use the interest option because the interest i5 taxable. Instead, the paid-up additions option would be more appreciate. Northwest University Huixia Liu

30. Why How to select the best dividend Option • because the dividend becomes the legal reserve under the paid-up addition, and interest accumulations on the legal reserve are not axed as current income to the policy-owner. • If your objective is to have a paid-up policy at retirement, then the paid-up additions option is desirable, if you need additional life insurance, the fifth dividend option can be used if it is available, in short, no single dividend option is best for all insured. Each insured must choose an option suited to his or her situation. Northwest University Huixia Liu

31. Non-forfeiture Options(不丧失或不没收选择权） • Most cash-value policies have the provision that the insurers pay the cash surrendered value or a non- forfeiture value. • There are three non-forfeiture options or cash surrender options: • Cash value • Reduced paid-up insurance（减额缴清保险） • Extended term insurance Northwest University Huixia Liu

32. Settlement Options (人寿险赔款方式选择） Settlement options, or optional methods of settlement, refer to the various ways that the policy proceeds can be paid other than in a lump sum. The most common settlement options are as follows: • interest option • fixed period option • fixed amount option • life income option Northwest University Huixia Liu

33. Settlement Options (人寿险赔款方式选择） • interest option Under it, the policy proceeds are retained by the insurer, and interest is periodically paid to the beneficiary. The beneficiary can be given withdrawal rights, by which part or all of the proceeds can be withdrawn. Northwest University Huixia Liu

34. Settlement Options (人寿险赔款方式选择） • fixed period option Under it, the policy proceeds are paid to a beneficiary over some fixed period of time. Payment can be made monthly, yearly, etc. Both the principal and interest are systematically liquidated under this option. Northwest University Huixia Liu

35. Settlement Options (人寿险赔款方式选择） • fixed amount option Under the fixed-amount (installment-amount) option, a fixed amount is periodically paid to the beneficiary. The fixed-amount option provides considerable flexibility. Northwest University Huixia Liu

36. Settlement Options (人寿险赔款方式选择） • Life income options Death benefits can also be paid to the beneficiary under a life income option. The cash surrender value can also be disbursed under a life income option. The major life income options are as follows: Life Income (installment payments to the beneficiary while he or she is alive) • Life Income with Period Certain • Life Income with Refund • Joint-and-Survivor Income Northwest University Huixia Liu

37. How to Buy Life Insurance Northwest University Huixia Liu

38. Buying Life Insurance Jennifer, age 30, is divorced and has a son, age 2. she wears $55,000 as sales representative for a national oil company. Jennifer wants to update her life insurance program. Recently, a life insurance agent present her with several proposals. Although Jennifer is a careful shopper, she does not know how to evaluate the plans offer to her. Could you Tell Jennifer How to buy life insurance? ? ? Northwest University Huixia Liu

39. Buying Life Insurance • Determining the cost of life insurance • Rate of return on saving component • Shopping for life insurance Northwest University Huixia Liu

40. Buying Life Insurance • Determining the cost of life insurance • The cost of life insurance is a complex subject. In general, cost can be viewed as the difference between what you pay for a life insurance policy and what you get back. Northwest University Huixia Liu

41. Buying Life Insurance • When determining the cost of life insurance, four major factors must be considered: • Annual premium • Cash values • Dividends • Time value of money • Two widely used cost methods are: • The traditional net cost method • Interest-adjusted cost method Northwest University Huixia Liu

42. Buying Life Insurance • The traditional net cost method Under this method, the annual premiums for some time period are added together. Total expected dividends to be received during the same period and the cash value at the end of the period are then subtracted from the total premiums to determine the net cost of life insurance. Examples This method has some defects.Examples Northwest University Huixia Liu

43. Buying Life Insurance • Interest-adjusted cost method Under this method, the time value of money is taken into consideration by applying an interest factor to each elements of cost. There are two principal types of interest-adjusted cost indexes: • The surrender cost index • The net payment cost index Examples Northwest University Huixia Liu

44. Buying Life Insurance • Rate of return on saving component • Another important consideration is the rate of return earned on the saving component of a traditional whole life insurance policy • Liton yield • Yearly rate-of-return method • Examples Northwest University Huixia Liu

45. Buying Life Insurance • Shopping for life insurance • A good life insurance program involves seven steps, as illustrated in the following Exhibit. Northwest University Huixia Liu

46. Shopping for life insurance Determine whether you need life insurance Estimate the amount of life insurance you need Decide on the best type of life insurance for you Decide whether you want a policy that pays dividends Shop around for a low-cost policy Consider the financial strength of the insurer Deal with a competent agent Northwest University Huixia Liu

47. Summary • Life insurance contracts contain dozens of contractual provisions that affect the insured and beneficiary and payment of the death proceeds. The most popular provisions are: the ownership clause, the entire-contract clause, the incontestable clause, the suicide clause, the grace period. • A dividend represents a refund of part of the gross premium. Dividends are paid in several ways, such as cash, reduction of premium, accumulate at interest, paid-up-additions, term insurance. Northwest University Huixia Liu

48. Summary • There are three non-forfeiture or cash surrender options: cash value, reduced paid-up insurance, extended term insurance. • There are enormous cost variation among similar life insurance policies. • Life insurance experts typically recommend several rules to follow when shopping for life insurance: determine whether you need life insurance, estimate the amount of life insurance, decide on the best type of insurance for you, decide whether you want a policy that pays dividends, shop around for a low-cost policy, consider your financial strength, deal with a competent agent Northwest University Huixia Liu

49. Review Questions I. Briefly explain the ownership clause and entire-contract clause in a life insurance contract. 2. Describe the incontestable clause and explain why it appears in a life insurance policy. 3. Explain the requirements for reinstating a lapsed life insurance policy. 4. If the insured's age is misstated, can the company refuse to pay the policy proceeds? Explain. 5. Describe the various beneficiary designations in tire insurance. 6. Can a life insurance policy be assigned to another party? Explain. 7. Are dividends to policy-owners guaranteed? Explain. 8. Explain the non-forfeiture or cash surrender options that are found in cash-value life insurance. Northwest University Huixia Liu

50. Review Questions 9. Identify the various settlement options for the payment of life insurance proceeds. 10.Explain the definition of total disability that is found in a typical waiver-of-premium provision.. 11. Describe the traditional net cost method for determining the cost of life insurance. 12. Describe the rules that should be followed when shopping for life insurance 13. Should cost be the only factor to consider when a life insurance policy is purchased? Explain. Northwest University Huixia Liu