Life Insurance: Contract Provisions, Options, and Taxation
What the exam tests
Life questions cluster around four ideas: insurable interest and underwriting, policy types, contract provisions, and the options attached to cash value and death proceeds. Know the difference between term (pure protection, no cash value, renewable/convertible), whole life (level premium, guaranteed cash value, dividends if participating), universal life (flexible premium, current interest, two death-benefit options: Option A level and Option B increasing), and variable life (separate account, securities-licensed producer, prospectus required, no guaranteed cash value). Annuities are the mirror image of life insurance: a lump sum or stream of premiums converted to income, with accumulation and annuity (payout) periods.
Provisions candidates misread
- Incontestability: generally two years; after that the insurer cannot contest for misstatement, but it may still contest for nonpayment of premium or lack of insurable interest.
- Suicide clause: typically two years, after which the death benefit is paid.
- Grace period: typically 30 or 31 days; the policy stays in force and an unpaid premium may be deducted from the claim.
- Reinstatement: usually within 3–5 years with evidence of insurability and payment of overdue premiums plus interest.
- Misstatement of age or sex does not void coverage; the benefit is adjusted to what the premium would have purchased.
Traps
Confusing nonforfeiture options (cash surrender, reduced paid-up, extended term) with settlement options (lump sum, interest only, fixed period, fixed amount, life income). Also: dividends are a return of premium, not taxable until they exceed basis; policy loans are not taxable but reduce proceeds; death benefits are generally income-tax free to the beneficiary but may be in the insured's estate if incidents of ownership are retained.
Worked example
Stated age 40, actual age 45, face $100,000. Premium per $1,000 at 40 is $20, at 45 is $25. Benefit = $100,000 × (20 ÷ 25) = $80,000.
Rule of thumb: read every question asking who gets paid, how much, and when - the answer usually turns on one provision.