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When a policy is delivered, the Free-look (also called "Right to Examine") provision allows the new owner to review the contract for a specified number of days. If the new policy owner decides not to keep the policy, they may return it to the insurer as long as this is accomplished within a specified number of days from the delivery date. If the new policy owner decides to take this course of action and return the policy to the insurer, they will receive a full return of premium. The free-look provision is also known as the "right to examine" provision. This provision allows the policy owner to return the policy for a full premium refund without providing a reason. A free-look provision must be included in all forms of life insurance, except for flight or aviation insurance.
Mandatory free-look periods vary in each state, but they're generally within 10 days of the delivery date. Depending on the state, additional requirements may apply for variable policies or senior applicants. The free-look period begins when the policy owner receives the policy. Most insurers require policy owners to sign a dated delivery receipt upon receiving their policy, and this receipt triggers the start of the free-look period. To receive a premium refund, the policy must be returned within the specified number of days from the date it is received.
For example, if a policy is delivered to the new owner on January 25, the 10-day free-look period begins on January 25 and ends 10 days later. In this case, the free-look period ends on February 4. To arrive at the correct answer, the day after the policy is delivered (January 26) should be counted as day one.
The "mode of premium" provision states that premiums must be paid to an insurer or its representative for coverage to be provided and allows policy owners to select the mode (frequency) of premium. Insurers vary in the payment modes they offer. Policy owners can choose from the available options.
Some policy owners may choose to pay annually. Those who do will save the most money (i.e., have lower premiums) because annual premium payments result in lower administrative and maintenance costs for the insurer. These savings are typically passed to policy owners. The other methods for paying premiums include quarterly, semiannual, or monthly. Since insurers incur substantially higher administrative and maintenance costs when premiums are paid monthly, it is considered the costliest method.
Grace periods are standard in many other financial products, such as consumer loans, mortgages, and credit card payments. In a life insurance policy, the grace period is meant to protect the policy owner from an unintentional policy lapse. A grace period is the time following the premium due date during which coverage does not lapse even if the premium has not been paid. This period is generally 30 days, or one month, unless otherwise required by state law. Coverage remains in effect for the days following the due date. Additionally, some states may have specific laws governing grace periods for senior policy owners.
The insurer offers this grace period because it wants to keep business "on the books." If the insured dies during the grace period and before a premium has been paid, the death benefit will be paid less a pro rata share of the owed premium. A primary purpose of the grace period, as well as the reinstatement and automatic premium loan provision, is to keep a life insurance policy in force even when a premium payment is late. Keeping the policy in force prevents the life insurance company from requiring the insured to prove their insurability again and prevents the insurer from charging a higher rate for the insured's increased age.
If a policy lapses because premiums are not paid, many life contracts allow reinstatement, generally provided it is requested within three years of the lapse. However, the request is not the predominant factor. The insurer will require proof of insurability or good health, and all outstanding back premiums (plus interest) must be paid to the insurer before reinstatement is granted.
A principal reason for a policy being reinstated is that the contract owner wants to "reinstate" the initial premium rate as well as the coverage limit. Other than an insured's coverage being reinstated, the most crucial advantage of reinstating an insurance policy is that the policy's premium will continue to be based on the insured's age at the time of the initial application (i.e., the applicant's original age).
Whenever a policy is reinstated, a new two-year contestable period begins for statements made on the reinstatement application. However, there's no new suicide exclusion. A policy cannot be reinstated if it was surrendered (i.e., given up by the policy owner).
The following provisions are associated with the cash value of a whole life insurance policy. There are two primary types of cash value provisions — those involving policy loans and those involving policy surrender. Provisions for a policy loan allow a policy owner to use the cash value of a life insurance policy without surrendering the policy. Provisions for policy surrender allow the policy owner to surrender the policy without losing all of its equity.
The excess interest provision in life insurance means that the cash value will increase faster than the guaranteed rate if the insurer earns a greater return than the guaranteed rate. Therefore, the excess interest provision allows interest that exceeds the policy's guaranteed rate of interest to be credited to the cash value account.
Excess interest can be applied using either the index-linked method or the portfolio method.
Permanent or whole life insurance builds cash value. The policy loan provision, which is required in all whole life policies, states that the policy owner has the right to access their equity at their discretion. This provision, which is supported by the previously reviewed owner's rights provision, permits the owner to receive an advance against the cash value buildup of the whole life policy.
A policy "loan" cannot be "called" by the insurance company and can be repaid at any time by the policy owner. Additionally, policy loans don't require credit checks, proof of income, or other things commonly associated with taking out a loan. Remember, the policy owner is essentially borrowing funds from the insurer and using the cash value as collateral. Technically, the policy owner is making a collateral assignment of cash value that equals the amount borrowed. Typically, the only qualification for a policy owner to take out a policy loan is that the policy must have accumulated cash value available to secure the loan (i.e., act as collateral). However, if the policy contains an irrevocable beneficiary, the policy owner must secure permission from the irrevocable beneficiary to borrow against the cash value.
The maximum loan value of a whole life policy is generally its cash value, less any projected interest. Therefore, policy owners may make withdrawals or partial surrenders in amounts that don't exceed the cash value, less the interest. Although the loan doesn't need to be repaid, any outstanding policy loans or interest at the time of the insured's death will reduce the policy's face amount. Additionally, if the policy owner later chooses to surrender the policy for cash, the cash value available to the policy owner is reduced by the amount of any outstanding loan, plus interest. Other surrender options (i.e., extended term or reduced paid-up) would also take any outstanding policy loans into account when determining the term period or reduced face value. Taking a loan permits the person to keep the whole life policy in force and use the borrowed funds when cash is needed.
Keep in mind that while policy owners may be borrowing "their money," the insurance companies planned to use that money as an investment to return an estimated amount of interest. This estimated interest is a crucial component for an insurance company to fulfill its obligations.
Policy loans reduce the amount of funds that an insurer has to invest and, accordingly, reduce the interest that the insurance company can accumulate. Policy owners are required to pay interest on these loans to offset the interest the insurance company would have earned if the funds were invested.
The automatic premium loan (APL) provision is an optional financial safety mechanism in permanent life insurance policies, designed to prevent unintentional policy lapses. Think of it as an automated backup system that kicks in when traditional premium payments fail.
When a policyholder misses a premium payment and the grace period expires, the APL automatically initiates a loan against the policy's cash value to cover the missed premium. This mechanism offers a critical advantage to policy owners by preventing an accidental policy lapse without active intervention. It provides peace of mind at no additional charge. Of course, an APL provision only works if there is sufficient cash value. Also, it creates a policy loan and, over time, could deplete the policy's cash, ultimately leading to a policy lapse.
Individual Uses: The primary advantage of a policy loan is that it provides the policy owner with ready cash without having to apply for or qualify for a loan. Whether it's to pay debts, pay for emergencies, pay for education expenses, or to be used for a business purpose, a policy owner may use the cash value for any reason when they need cash. The cash value may also be used as collateral to secure another loan with a lending institution.
Business Uses: Businesses may take out life insurance to safeguard against a number of different risks. As the policy's cash value grows, the company may take a policy loan for any reason it deems necessary. Business policy loans are subject to the same rules as individual policy loans regarding structure, interest, and repayment. The original purpose for the company's decision to take out the policy may be significantly impacted if the policy proceeds are reduced due to an outstanding loan.
In general, policy loans may be taken out of an individual whole life policy without any tax implications as long as the policy remains active. However, this changes if the policy lapses or is surrendered, and there is an outstanding loan greater than the total premiums paid. When a policy with an outstanding loan is lapsed or surrendered (before the insured's death), any gains (i.e., the amount received via policy loan that exceeds the premiums paid) will be taxed as ordinary income. Additionally, interest paid to the insurer on a policy loan is not tax-deductible. Tax implications for policy loans that are taken on business-owned life insurance are beyond the scope of this course.
While not often used, insurers typically have the right to defer a policy loan or the payment of the cash value (in most states, this can be for up to six months after its request). This right to defer is designed to protect an insurer if a large number of policy owners decide to make withdrawals at the same time. However, this right to defer doesn't apply to death benefit claims or automatic premium loan payments.
Even if the policy doesn't contain an automatic premium loan provision, if the policy owner informs the insurer that they want to borrow against the policy's available cash value to pay the premium, the company cannot defer the loan.