Life Insurance Policy Evaluation

The process of acquiring a life insurance policy requires meeting certain conditions imposed by the law and the issuing insurance company. Further, while policies are approved by state insurance departments, in accordance with laws and regulations that are intended to protect consumers, they are complicated and contain many variations. The following is a summary of some of the pertinent laws and policy provisions with which a prospective policyholder should be familiar before beginning the process of acquiring coverage.

Insurable interest. The acquisition of a policy starts with determining that the prospective purchaser has an insurable interest in the life to be insured. That is because, without an insurable interest, the policy would be unenforceable under the law. This is based on public policy considerations that are designed to prevent people from being insured for no purpose other than their being killed for the death proceeds.

An insurable interest is found to exist where the prospective purchaser can reasonably expect to receive financial gain from the proposed insured’s longevity or can expect to suffer financial loss from his death. In that regard, a prospective insured is deemed to have an insurable interest, for an unlimited amount, in his own life with the right to name anyone he chooses as beneficiary. Insurance companies, however, limit the amount of coverage they will issue to a figure that is not unreasonably large, relative to the insured’s financial situation and earning capacity.

Relationships based on marriage and close blood ties that presumably involve pecuniary interests also serve as a basis for finding an insurable interest. This is also true of debtor creditor relationships, with the understanding that the amount of coverage must bear some reasonable relationship to the amount of debt. In addition, many other business relationships provide a basis for insurable interest as long as there is a substantial economic tie between the parties such as between an employer and an employee or the partners of a partnership.

Generally, an insurable interest only needs to exist when the contract is issued unless state law or the policy provides otherwise. This means that the contract will continue to be valid and enforceable even if the insurable interest later ceases. An exception to this rule exists in those states that also require an insurable interest between the insured and the beneficiary, where the interest must go on.

Policy application. Acquiring a life insurance policy begins with completing a policy application. That document, which generally becomes a part of the contract, requires that the proposed insured accurately provide information on his medical, personal and family history as well as employment and lifestyle. Information on other life insurance in force or applied for is also required.

Depending upon the law of the governing jurisdiction, the contract may be void or voidable by the insurer if the applicant does not accurately disclose all material information called for. In that regard, a fact may be considered material if its disclosure would have affected the insurer’s willingness to issue the policy under the same terms or for the same premium. The applicant’s intentions may also be relevant but the courts tend to liberally interpret situations in favor of the applicant.

Incontestable clause. This is a clause in life insurance contracts that prevents the insurer from voiding the contract on grounds of concealment, material misrepresentation or fraud after a certain period of time (usually two years). If the insured lives or dies within the contestable period, the insurer can contest the contract but not thereafter. The purpose of this provision is to give finality to an arrangement upon which the beneficiaries depend and which becomes increasingly difficult for them to defend with the passage of time.

Suicide clause. This provision typically states that the insurance company will terminate the contract and return the premiums if the insured commits suicide within one or two years of the original application date. In such cases the burden of proofs with the insurer and it usually represents a difficult challenge.

Contract interpretation. The courts’ general leaning in favor of policy owners extends to interpreting policy provisions. Further, some jurisdictions even give effect to the policyholders’ reasonable expectations, where they conflict with the policies’ explicit terms. All this seems to be a reflection of the fact that life insurance policies are written by the life insurance companies, without the bargaining or input from purchasers that characterizes most contract relationships.

Jurisdiction. Contracts are generally governed by the laws of the jurisdictions in which they are made, as evidenced by the locations of the parties, their relationships and actions within the jurisdiction in question. In that regard, when it comes to life insurance, state laws, courts and insurance departments do not take lightly jurisdictional issues with regard to those domiciled within their borders. This means that for a particular state’s law to apply to an insurance policy, the parties should have significant contact with that jurisdiction through domicile, employment or business activities. Consequently, merely crossing borders with the intention of executing an application for a policy within a jurisdiction for the sole purpose of gaining some advantage under that state’s law is likely to lead to disappointment.

Effective date of insurance. Applications may be submitted with or without payment of the first premium. If the application is sent in without a premium, it is considered to be an invitation for the insurer to make an offer to contract by issuing the policy. The applicant may then accept the offer and put the coverage in effect by accepting the policy upon delivery and paying the requisite premium.

Alternatively, if the applicant submits the first premium with the application, some form of receipt may or may not be given in return. If no receipt is given, the policy will not take effect until it is issued and delivered to the policy owner. More often, however, a receipt is given and results in some form of temporary insurance, for a limited amount, until the actual policy is delivered.

Grace period. This policy provision requires the insurance company to accept premiums for a certain period after they are due, without requiring evidence of insurability. The contract remains in effect during the grace period, which is typically from 3 1 to 61 days, depending on the type of contract. The purpose of the provision is to protect the policy owner from the consequences of an unintentional lapse of the policy. The insurer is also protected, however, to the extent that it is permitted to deduct the premium plus interest from any death proceeds, if the insured dies during the grace period.

Reinstatement clause. This type of provision gives the policyholder the right to reinstate a policy after it has lapsed, for a certain period, if he meets certain requirements. Generally,. this means that he has to provide evidence of insurability and pay the overdue premiums.

Nonforfeiture provision. This kind of provision only applies to cash value policies and gives the policyholder, who chooses to terminate his contract, the options of applying the cash surrender value to:

Give the policyholder cash.
Provide a reduced paid-up policy of the same type.
Provide extended term insurance for the original face amount.