Traditionally, insurance can be classified according to risks covered in three primary categories:
(1) life insurance;
(2) fire and casualty insurance; and
(3) marine and inland insurance.
Insurance companies were initially limited by statute to writing insurance in only one of these three categories. As restrictions were relaxed, companies began writing multiple-line insurance, which included insurance in every line except life insurance. Eventually, companies expanded to write all-lines insurance to include all categories of insurance. In this module, we will look at life insurance.[1]
Types of Life Insurance Policies
Life insurance is a contract under which the insurer promises to pay proceeds upon the death of the insured. Life insurance policies fall into one of two categories: (1) term insurance or (2) whole life insurance. Term insurance is purchased for a specified duration and the designated beneficiary collects the proceeds only if the insured dies within the term. If the insured survives the term, the policy will lose all of its value. There are also variations on term life insurance. Credit insurance uses proceeds to pay off an insured’s debt. Another variation is term deposit insurance. This type of insurance allows the first premium to set up a “deposit” or a small cash value. If the policy is kept in force for the length of the term, the deposit plus interest is returned to the insured. If the insured dies before the end of the term, the face value plus the deposit is paid to the beneficiary.[2]
Whole life insurance is also referred to as “permanent insurance.” It has two components: it is both a policy of insurance and a savings plan. Part of each premium covers the cost of the insurance and the remainder goes into a savings component of the product. The amount of the savings is called the policy’s cash value or surrender value. An insured may also borrow against the cash value or cash the policy out and receive the surrender value. In some whole life insurance policies, also sometimes referred to as either straight life insurance or ordinary life insurance, the insured either pays a premium for a lifetime or until he reaches a certain age and, if the insured lives to the designated age, the policy is terminated, and the insured receives the cash value in a lump sum.[3]
A limited-payment life policy features high premiums for a set number of years in the foreseeable future or until a planned event, such as retirement, wherein a lump sum is paid out to the insured. The advantage is that premiums need not be paid for life. The disadvantage is that if the insured dies before the planned event such as retirement, the insured will have paid high premiums for insurance that could have been procured at a cheaper rate.[4] Endowment life insurance policies require premium payments until a specified age at which time the policy holds an “endowment.” The insured has the option of either taking the cash value in a lump sum or having the cash value paid back in an annuity. Universal life insurance is similar to whole life insurance in that it provides a death benefit and has a cash value, while also allowing for an insured to borrow against the cash value. However, with a universal life insurance policy, the insured pays interest, either providing a sum certain death benefit or an increasing death benefit as the policy’s cash value increases. Also, with universal life, the policyholder may vary the death benefit, the premium and timing of the premium, as well as make partial withdrawals from the cash value of the polices.[5]
Variable universal life insurance also has a cash value and allows for the insured to invest the premiums, minus the cost of the insurance, in investment accounts which operate akin to mutual funds. The death benefit has two parts: a minimum guaranteed death benefit, unaffected by the performance of investments, and a variable component linked to investments.[6] Industrial life insurance got its name from its purchasers who were urban, industrial or blue-collar workers. It provides modest coverage in the amount necessary to cover burial expenses. These types of policies generally have facility of payment clauses allowing someone who has incurred medical or burial expenses on behalf of the insured to be paid immediately, avoiding delay that may otherwise be required to have an administrator of the estate appointed.[7]
Mutual life insurance is another name for participating life insurance policies. Life insurance policies may be participating or non-participating. A participating life insurance policy arises when the insured pays a premium slightly larger than the expected loss plus administrative expenses. If the insurance company’s loss experience is lower than expected, the excess of the insured’s premiums over that which is necessary to pay claims and for administrative expenses is returned to the insured in the form of a dividend. In other words, a participating policy is one in which dividends based upon the company’s earnings are paid by the company to the policyholders. A nonparticipating policy is one in which no dividends are paid out to the policyholders.[8]
Insurable Interest Requirement
The insurable interest doctrine was first adopted by the courts and later enacted into statutes. An insurable interest in life insurance is the policy owner’s interest in the life of the insured, such as their being closely related by blood. Spouses and parents or children are certainly considered related to each other by blood. However, beyond spouses and parent-child relationships, courts may vary in the proximity of the family relationship that is required in order to support the insurable interest. The more remote the family relationship, the more a party must show some sort of economic interest to substantiate an insurable interest.[9] Where the insured is not related to the policy owner, an economic interest in the continued life of the insured must be shown, such as that the insured is a business partner or employee of the policy holder. In determining where there is an insurable interest, the courts ask whether there is a sufficiently close relationship to establish that the policy holder is naturally interested in the life of the insured. Without a family relationship, the courts ask whether the policy owner derives economic benefit from the insured’s living.
The purposes of requiring an insurable interest are (1) discouraging the use of insurance as a device for gaming or wagering; and (2) removing the incentive for procuring insurance only to, actively or passively, cause the death of the insured. If an insurer is found to knowingly sell life insurance to a party lacking an insurable interest, and the policy holder contributes to the death of the insured, the insurer could face civil liability.[10] If a person who is not the policyholder, but is named as a beneficiary of the policy, encourages the insured to take out a policy on the insured’s life and pays the premiums, some courts may view the policy as a wager and find it void as against public policy even if the insured was the policy holder.
In Country Life Insurance Co. v. Marks,[11] John and Debbie Marks insured Connie Romig’s life at her insistence as a close family friend, whom they affectionately referred to as “Aunt Connie” and who helped support the couple and their children financially. When “Aunt Connie” died, the court initially ruled that the couple did not have an insurable interest in her life. On appeal, however, the Eighth Circuit Court of Appeals found that there was an insurable interest based upon her status as a benefactor even though there was no family relationship by blood or operation of law. A divorce may terminate the insurable interest one spouse has in the other based upon a family relationship. However, the divorce decree or settlement agreement does not terminate a spouse’s right as a designated beneficiary under an existing policy. Moreover, divorce decrees may require payment of alimony, maintenance or child support, which may create an economic interest that can serve as the pecuniary interest needed to establish the insurable interest requirement. In other words, this may be the reasoning behind why an insured may, in fact, designate an ex-spouse as a beneficiary. Alternatively, a divorce order or settlement may require one spouse to purchase an insurance policy to benefit the other spouse or the children, and this certainly creates an insurable interest.[12]
Most courts have held that a life insurance policy, once properly purchased, may be freely assigned without the recipient holding an insurable interest in the insured. For example, a family member may purchase a life insurance policy on another family member and then sell it. Absent a clause within the policy expressly forbidding the assignment of the policy, courts have even upheld assignment without the consent of the insured. However, note that in many states, the Statute of Frauds requires that assignment of life insurance policies must be in writing.[13]
Beneficiaries
A beneficiary is the person who, although not a party to the contract, is entitled to receive the insurance proceeds. A beneficiary can be an individual, company, estate or trust. Under all modern life insurance policy forms, the policy holder has the power to change the beneficiary without the beneficiary’s consent. The owner of the policy, not the beneficiary, has access to the cash value of the policy, to take out loans against the cash value or to assign the policy. The beneficiary has the expectation of receiving proceeds, but not a vested right.
The primary beneficiary is the person who will receive the death benefit assuming that she is alive at the time of the insured’s death. The contingent beneficiary is the person who will receive the death benefit if the primary beneficiary is not living at the time of the insured’s death. There may be multiple beneficiaries that receive pro rata shares of the proceeds. If there is no designated beneficiary, the insured’s estate receives the proceeds.[14] While the insured may generally change the beneficiary, other laws such as community property rules and divorce decrees sometimes limit the policy owner’s ability to make changes.
While insurance companies are free to set forth the procedural requirements to change beneficiaries, under the substantial compliance rule, a change in beneficiary is effective if the owner substantially complies with the procedures specified by the insurance company. The test involves two elements: (1) the owner must have clearly intended to change the beneficiary; and (2) the owner must have acted affirmatively to do substantially all that he could to demonstrate the intention to change the beneficiary.[15]
In Occidental Life Insurance Co. v. Row,[16] Mary Allie owned a life insurance policy issued on the life of her husband, Ernest. After Mary died, Ernest told the insurance agent to change the beneficiary to his daughter, but before the formalities could be completed, he also died. The court ruled that his intent was clear and that he would have finished completing all the steps necessary to designate his daughter as the beneficiary had he lived. Therefore, his daughter was entitled to receive the proceeds as beneficiary. Likewise, in Connecticut General Life Insurance Co. v. Gulley,[17] Balsley was insured under a group life insurance policy issued by his employer. He wished to change the beneficiary from his wife to his daughter. He left a change of beneficiary form with his daughter saying he would return to retrieve it. He died before retrieving it, though. After his death, his daughter mailed in the form to the insurance company. The Seventh Circuit Court of Appeals ruled that it was the insured’s intent to change beneficiaries and although he did not complete the process he had substantially complied. Therefore, the daughter would inherit as the beneficiary.
In Engelman v. Connecticut General Life Insurance Co.,[18] the Connecticut Supreme Court took substantial compliance even farther, applying it where the forms had never been completed. Ella Ryder was the primary beneficiary and her nephew the contingent beneficiary on her husband’s life insurance policy. Upon the death of her husband, her relationship with her nephew began to deteriorate. She sent a letter to the insurance company, asking to change the beneficiary from her nephew to another beneficiary. The insurance company sent her a change of beneficiary form, but it was never completed. The court ruled the “substantial compliance” test requires only that an insured show the intent to change the beneficiary and take substantial affirmative action to effectuate the change, but not necessarily everything possible. Therefore, the change was effective.[19]
Suicide
Most life insurance policies exclude coverage for suicide which occurs within a specified time after the policy is issued. Sometimes, issues arise as to whether the death was a suicide or an accident, leaving coverage to be determined based upon a determination of how death came about. For example, in a Florida case, an insured who was depressed after the break-up of his marriage played Russian roulette and died as a result. The court found this to be suicide rather than accident. Because it was also within two years of the issuance of the life insurance policy, the beneficiaries were not entitled to the proceeds of the policy.[20] The courts have also found that an attempt to save oneself after initially starting the suicide process does not prevent the death from being classified as a suicide. This is generally referred to as the rule of the Estate of Tedrow.[21]
Life insurance policies are generally paid regardless of the manner of the insured’s death. Some policies, though, provide for additional proceeds if the death is the result of an accident. Many life insurance policies provide for double-indemnity[22] if the insured’s death is the result of an accident. An accident occurs when the event happens suddenly, unexpectantly with without intent, causing the death. Many polices limit double indemnity by limiting coverage if multiple causes played a role. For example, when a death is caused by a fall related to a disease such as a brain tumor, some courts have ruled that the death is the result of the disease, and not the accidental fall. Other courts, however, have ruled falls to be accidents if the fall is the dominant cause of the death.
In Arata v. California-Western States Life Insurance Co.,[23] an insured suffering from hemophilia slipped and fell, eventually dying of internal bleeding. The court ruled the event to be an accident, allowing beneficiaries to collect the increased benefits. Conversely, in Carroll v. CUNA Mutual Insurance Society,[24] the insured died of a massive hemorrhage caused by the accidental rupture of a preexisting cerebral aneurysm. The courts ruled the preexisting aneurysm was the predominant cause of the insured’s death and therefore the additional accidental death proceeds were not available to the beneficiaries.[25]
The issues that may arise with life insurance policies, be they determining an insurable interest or applying the substantial compliance rule or determining the cause of death, demonstrate the importance of gathering and analyzing all the facts surrounding the circumstances of the case.
In our last module, we’ll discuss insurance defense litigation and the process by which insurance disputes are settled in court.
[1] John F. Dobbyn, Insurance Law in a Nut Shell (Thomson West, 1981) Pg. 6-7.
[2] Robert H. Jerry II and Douglas R. Richmond, Understanding Insurance Law (Carolina Academic Press 2018).
[3] Id at 35-36.
[4] Id at 36.
[5] Id at 37.
[6] Id at 38.
[7] John F. Dobbyn, Insurance Law in a Nut Shell (Thomson West, 1981) Pg. 11.
[8] Id at 12.
[9] Id at 253.
[10] Robert H. Jerry II and Douglas R. Richmond, Understanding Insurance Law (Carolina Academic Press 2018).
[11] 592 F.3d 896 (8th Cir. 2010).
[12] Robert H. Jerry II and Douglas R. Richmond, Understanding Insurance Law (Carolina Academic Press 2018)
[13] John F. Dobbyn, Insurance Law in a Nut Shell (Thomson West, 1981) page 242.
[14] Robert H. Jerry II and Douglas R. Richmond, Understanding Insurance Law (Carolina Academic Press 2018).
[15] Id at 291.
[16] 271 F.Supp. 920 (S.D.W. Va. 1967).
[17] 668 F.2d 325 (7th Cir. 1982).
[18] 690 A.2d 882 (Conn. 1997).
[19] Robert H. Jerry II and Douglas R. Richmond, Understanding Insurance Law (Carolina Academic Press 2018).
[20] C.M.Life Ins. Co. v. Ortega, 562 So. 2d 702 (Fla. Dist. Ct. App. 1990).
[21] 558 N.W. 2d 195 (Iowa 1997).
[22] A clause or provision in an insurance policy providing additional payment (often double) if the death is the result of an accident. See, 2 The Law of Life and Health Insurance § 5.24 (2018)
[23] Estate of Tedrow v. Standard Life Ins. Co., 50 Cal. App. 3d 821 (1975).
[24] 894 P.2d 746 (Colo. 1995).
[25] Robert H. Jerry II and Douglas R. Richmond, Understanding Insurance Law (Carolina Academic Press 2018) at page 409.