Life Insurance: Policy Variations, Riders, Provisions and Options

Edward J. Metzen and Eunice Lieurance
Department of Consumer and Family Economics

Life insurance policy variations, riders, provisions and options may make buying insurance more confusing, but at the same time they allow you to tailor an insurance program for your particular situation. Becoming acquainted with some of the most common variations will help you develop a life insurance plan to best meet your needs.

Note
Each of these variations is available at a price.

Policy variations

Family Policy
Coverage on all family members is included in one contract. Usually this type provides whole life insurance on the primary insured person and term insurance on the spouse and children. All children are covered, even if born or adopted after the policy is issued. The premium does not change if any of the children die or if more children are born or adopted. If the insured dies, the insurance on the surviving spouse and children remains in force without further premium payments.
Family Income Policy
This is designed to provide a surviving family with a specific monthly income for a specific time period after the death of the insured. It may be sold as a rider on a cash value policy or as a separate policy. If sold as a separate policy, the insured buys a policy that guarantees a monthly income for a guaranteed income period. The period of the guarantee begins with the date the policy is purchased and is in force only for the specified number of years. So it is, in effect, a form of decreasing term insurance. Payments are made to the beneficiary for the remainder of the specified period following the death of the insured. If the insured dies during the family income period, the proceeds of the whole life coverage are held at interest until the end of the family income period. Then the proceeds are paid to the beneficiary. In the meantime, the interest on the proceeds provides part of the family income payments and the proceeds from the decreasing term insurance rider provide the rest.
Family Maintenance Plan
Typically, this policy (or rider) consists of a whole life policy plus level term insurance (instead of decreasing term as used in the family income policy). The level term insurance provides income for a stated number of years beginning at the insured's death, provided this occurs within the period designated in the policy. The face value of the whole life portion is also paid to the beneficiary.
Credit Life
This type of life insurance is decreasing term insurance and is offered when a person buys on credit or takes out a loan, such as a mortgage. The intent of the policy is to pay off the loan, plus interest, if the policyholder dies. Credit life tends to be over-priced compared with conventional life insurance products. A well-planned, overall life insurance program should cover present as well as foreseeable debts. If you need more life insurance to cover a debt, you should compare the cost of decreasing term policies before purchasing a credit life insurance policy from a lender.
Universal Life
Universal life combines term insurance with tax sheltered annuities. The return on the annuity is tied to short-term money market instruments and changes periodically. Flexibility, one of the key characteristics of universal life, exists in both premiums and death benefits. The premiums are specified at the beginning of the policy. However, the policyholder has a great deal of premium flexibility during the policy lifetime. The premium payment in a particular year may be reduced to any level. This is possible because the cash amount in the annuity fund can be used to pay all or part of the premium for one or more years, so long as there is enough cash value to cover the necessary premium payment. This, of course, reduces the amount of money in the annuity fund. The death benefit or face value of the policy is set at the beginning of the policy. But, the policyholder can change the death benefit upward or downward. If it is shifted upward, the policyholder may have to meet insurability requirements. Also, the premium will increase unless the policyholder wants to reduce the amount of each premium payment that goes into the annuity fund. The policyholder may also reduce the death benefit to the minimum established at the time the policy was purchased. Additionally, extra money may be added to the annuity fund by increasing the premium but not the death benefit. Cash may be withdrawn from the annuity fund without being treated as a loan. However, the policy's face value and cash value (annuity fund) are reduced by the amount withdrawn.
Variable Life
In a variable life policy, the portion of premium payments that would be placed in a savings plan in other types of cash value policies is instead placed in an equity investment fund. The policy owner can determine the kind of investment -- a choice among a variety of mutual funds, for example. The policy owner can also change the choice of investments one or more times each year, depending upon the provisions of a particular company. Unlike the savings element of other policies, the value of the investment portion of a variable life policy will increase or decrease like the market value of any other equity (ownership) investment. Because of this market risk, the policy amount payable at death, and the amount available for a policy loan, vary over time depending on the performance of the investments. A minimum death benefit (face amount) is usually guaranteed, but the cash surrender value is not. The premium remains the same over the duration of the policy.
Variable Universal Life
This type of policy combines the flexible premium option of universal life with the variable life concept.
Survivor Life
Survivor life (sometimes known as survivor joint life) covers two lives with one policy. The policy is paid up at the first death, but the face value is not paid until the second death.
Joint Life
Joint life is a policy that covers two lives. The policy pays off when the first dies. It costs less than two separate policies for the same amount. A policy that offers contingent coverage is similar to joint life but can be written on more than two lives.
Single Premium Life
With a single premium, usually $5,000 or more, the insured has a paid-up insurance policy. Some of the premium money pays for a minimal amount of protection, but most goes to an investment account. In most policies, the interest starts building up immediately, tax deferred. The face value (death benefit) depends upon the age of the insured when the policy is purchased and the amount that may have been borrowed from it. Whole life and variable life are the two most common types of insurance sold as single premium life policies. In a single premium, whole life policy, the return rate on the investment portion is fixed and may be adjusted periodically. Many policies have guaranteed minimum returns. A single premium variable life usually does not guarantee a rate of return because returns are based on the performance of the investments.
"Living" Insurance
In recent years, a new type of life insurance has become available. Basically, this is a whole life plan that will pay a portion of the face value if the insured suffers a catastrophic illness and needs the money. Although each plan is different, generally the plans will pay a portion of the face value if the insured is confined to a nursing home or diagnosed as being terminally ill. Many companies offer this provision as a rider to other policies at an additional cost. These policies should not be purchased as a form of health insurance. They were created for the terminally ill who have no other means of paying medical bills. Payouts prior to death, of course, reduce the amount available to survivors and may reduce the terminally ill person's opportunity for being eligible for Medicaid.

Policy riders

Riders provide a means of adding benefits or special features to a policy in order to meet a policyholder's specific needs.

The four most frequently sold riders are:

Waiver of Premium
This rider frees the policyholder from the obligation to pay premiums on the policy when he or she is disabled for a long period of time (this time period is specified in the rider). The benefits in the contract continue uninterrupted until the policyholder recovers and resumes payment of premiums. The extra cost for this rider is sometimes built into the basic premium; more often it is optional at an extra cost. The clauses for this rider vary considerably from company to company and must be read carefully. Especially important is the definition of "totally disabled," the age requirement for eligibility, and the waiting period before the rider takes effect.
Guaranteed Insurability
This option permits the insured to purchase additional life insurance at certain specified dates without evidence of insurability. This option generally ends when the insured reaches a certain age and is available only with cash value policies.
Accidental Death Benefit (multiple indemnity)
This rider provides that double (or triple or quadruple) the face amount of the policy is payable if the insured's death is caused by an accident. Usually death must occur within 90 days after injury and prior to a specified age for this rider to be effective. From an economic standpoint, there seems little justification for the multiple indemnity provision. The economic impacts of death by accidental means are no greater than those resulting from death by natural causes. In fact, the spouse would likely have less expense in the case of a sudden accidental death than if the insured died of an extended illness.
Disability Income Protection
Some life insurance companies allow disability income benefit guarantees, based on the face amount of the policy, to be added to cash value life insurance policies for an extra premium. This rider provides benefits that are payable if the insured becomes totally disabled beyond a specified waiting period (usually six months). The amount of the income payment often is 1 percent of the face amount of the policy per month.

Provisions and clauses

Policy Loan (cash value insurance)
This provision in a life insurance contract allows the policyholder to take a loan up to an amount that, with interest, will not exceed the cash value (loan value) of the policy at the next anniversary date. The rate of interest that can be charged is stated in the contract. When a loan is outstanding against a life insurance policy, the death benefit due the beneficiaries will be reduced by the amount of the loan.
Automatic Premium Loan (cash value insurance)
This provision guarantees that if a policyholder fails to pay a premium when due, the premium will automatically be paid out of the policy loan value. Many life insurance companies do not include this provision in the policy except at the policyholder's request. There is generally no charge for this provision, so it's a good idea to be sure it is included as it's easy to overlook a premium payment.
Renewability Provision (term insurance)
This provision guarantees that a company will renew the policy at the end of its term without evidence of insurability.
Convertibility Provision (term insurance)
This provision gives the insured the right to convert a term policy to a cash value policy, paying the higher premium rate for the age at which the insured converts.
Beneficiary Designation
The person (or persons) named by the insured to receive the death benefits from the insurance policy is called the beneficiary. The beneficiary designation is termed revocable if the insured reserves the right to change the beneficiary. If the insured does not reserve the right to change the beneficiary, the designation is irrevocable. It is usually advisable to name a secondary beneficiary in case the first (primary) beneficiary dies before the insured. If no secondary beneficiary is named, the proceeds normally would go to the insured's estate.
Assignment Clause
A life insurance contract is personal property and, as such, is freely transferable (assignable) by the owner to someone else, providing the policy does not state otherwise. The right to assign a life insurance policy can be a valuable one in both personal and business transactions.
Grace Period
This is a period (commonly 31 days) after the premium for a life insurance policy is due during which the policy remains in full force even though the premium has not been paid. This provision protects the policyholder against inadvertent lapse of the policy.
Reinstatement Clause
This provision gives the insured the right to reinstate a lapsed policy within a specified period (usually three years after default in premium payment), subject to furnishing evidence of insurability and payment of back premiums.
Incontestability Clause
This clause provides that after a life insurance contract has been in force a certain length of time (normally two years) the insurer agrees not to deny a claim because of any error, concealment, or misstatement on the part of the insured.
Suicide Clause
Life insurance contracts generally contain a clause stating that if the insured commits suicide during a certain period of time after the policy date (often two years), the insurer is liable only to return to the beneficiary the premiums paid (with or without interest), but not to pay the death benefit. After the stipulated period, suicide becomes a covered risk and is treated like any other cause of death.
Delay Clause
This permits an insurance company to postpone payment of the cash (loan) value of a policy, if necessary, for up to six months after it has been requested by the policyholder. Insurers, by law, must include this provision in their contracts. This provision is designed to protect the insurer against losses that might develop from excessive demands for cash loans in times of economic crises. Only during the most severe economic circumstances would this clause be invoked by the company.

Nonforfeiture provisions options

Nonforfeiture provisions are available when the insured stops making premium payments on a policy with a cash value.

Cash Surrender Value
When the policyholder surrenders a policy for its cash value, life insurance protection ceases and the insurer has no further obligation under the policy.
Reduced Paid-Up Life Insurance
This option permits the policyholder to elect to use the cash value to purchase paid-up insurance of the same type as the original policy, but for a reduced face value. One situation in which this option is appropriate is when a policyholder is approaching retirement and wants to stop paying premiums but still wants some insurance coverage to remain in force for the rest of his/her life.
Extended Term Life Insurance
This option allows the policyholder to exchange the cash value of a policy for term insurance for the full face amount of the original insurance contract. The duration of the term coverage depends on the face value of the policy, the amount of cash value available, and the age of the insured when this option is exercised.

Settlement options

Settlement options are applicable under three conditions:

When the insured dies and the policy proceeds are payable to the beneficiary
When an endowment policy matures
When the insured decides to let a cash value policy lapse and withdraws the cash value

Options

Lump Sum
This option allows the recipient to receive the proceeds from the life insurance in one payment. Thus, if the policy is for $100,000, the beneficiary simply receives the $100,000 as a single payment.
Interest Option
Under this option, the funds are left with the insurer and interest is paid to the beneficiary. The principal stays with the insurer until requested by the beneficiary.
Fixed Payment or Amount Option
With this option, the funds are left with the insurance company and periodic payments of a specified amount are made to the recipient until principal and interest are exhausted.
Fixed Period or Time Option
The funds are left with the insurance company and paid to the recipient in periodic payments, including both principal and interest, over a specified period of time.
Annuity Option
Under this option, the beneficiary elects to have the proceeds paid for the rest of his/her life, or for the lifetime of one or more beneficiaries. Once payments begin, the option cannot be changed.
Joint and Last Survivor Life Income Option
This is one variation of the annuity option. Under this option, the proceeds are paid during the lifetimes of two or more recipients. This option can be set up to have the same income continue to the death of the second person or the annuity payments may be higher while both are alive and reduced upon the death of the first deceased.

When considering an option other than the lump sum option, look at how much the life insurance proceeds could earn in alternative, secure investments before making the choice.

Dividend options

Participating insurance is a form of insurance on which the owner receives dividends -- a patronage refund, essentially. When a policy dividend is due, the policy owner has several choices regarding how it will be used.

Cash Dividends
This option is most frequently used when a policy is paid-up; the insured receives periodic cash payments of dividends.
Application to Premiums
This option is a convenient one for the policyholder and involves leaving the dividends with the company to help pay future policy premiums.
Addition to Cash Surrender Value
With this option, dividends are left with the insurer to increase the cash surrender value of the policy by accumulating at a minimum guaranteed rate of interest. If the insurer earns more than the guaranteed rate, dividend accumulations may participate in the excess earnings.
Paid-Up Additions
This option uses the dividends to buy paid-up insurance at net single premium rates. The amount of the additional coverage depends on the amount of the dividend and the age of the insured person.
Term Insurance Additions
The dividend is used to purchase one-year term insurance at net rates. The amount of one-year term insurance that can be purchased with dividends is again dependent on the amount of the dividend and the age of the insured, and is generally limited to the amount of cash value in the policy.

GH3426, reviewed October 1993