Parties to a Life Insurance Contract

A life insurance contract involves several parties, each with distinct rights and responsibilities. Understanding these roles is essential for the exam and for properly structuring policies for clients.

The Four Primary Parties

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The Insurer

The insurer (insurance company) is the party that:

• Issues the policy
• Collects premiums
• Pays claims according to the policy terms
• Invests premium dollars
• Assumes the mortality risk

Key Insurer Obligations

• Pay death benefits promptly when claims are valid
• Maintain adequate reserves
• Comply with state insurance regulations
• Act in good faith

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The Policy Owner

The policy owner (also called the policyholder) is the person or entity that owns all rights in the policy.

Owner's Rights

The policy owner has the right to:

Owner vs. Insured

The policy owner and insured are often the same person—but not always. Common situations where they differ:

Insurable Interest Requirement

When the owner and insured are different, the owner must have an insurable interest in the insured's life at the time of application. Insurable interest exists when the owner would suffer financially if the insured died.

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The Insured

The insured is the person whose life is covered by the policy. If the insured dies while the policy is in force, the death benefit is payable.

The Insured's Role

• The insured's age, health, and lifestyle determine the premium
• The insured must consent to the coverage (in most cases)
• The insured may or may not be the policy owner
• The insured may or may not be the premium payer

Consent Requirements

In most states, the insured must provide consent when:

• Someone other than the insured applies for the policy
• The beneficiary is someone other than a close family member or business partner

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The Beneficiary

The beneficiary is the person or entity designated to receive the death benefit when the insured dies.

Types of Beneficiaries

Primary Beneficiary

The primary beneficiary is the first in line to receive the death benefit. If living when the insured dies, they receive the full benefit.

Contingent (Secondary) Beneficiary

The contingent beneficiary receives the death benefit only if the primary beneficiary dies before the insured or is otherwise unable to receive the benefit.

Tertiary Beneficiary

Some policies allow a tertiary (third) beneficiary as an additional backup.

Beneficiary Designation Table

Classes of Beneficiaries

Exam Tip: Naming "My estate" as beneficiary is generally discouraged because proceeds become subject to probate and creditors' claims.

Revocable vs. Irrevocable Beneficiaries

Key Point: Most beneficiary designations are revocable by default unless specifically made irrevocable.

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Third-Party Ownership

Third-party ownership occurs when someone other than the insured owns the policy. This arrangement is common in:

Common Third-Party Ownership Scenarios

Irrevocable Life Insurance Trust (ILIT)

An ILIT is a trust that owns life insurance on the grantor's life. Benefits include:

• Death benefit not included in insured's taxable estate
• Provides liquidity for estate without increasing estate taxes
• Protects proceeds from creditors
• Provides professional management of proceeds

Assignment of Life Insurance

Assignment is the transfer of some or all policy rights from one party to another.

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Special Situations

Minor Beneficiaries

If a minor is named as beneficiary:

• Proceeds cannot be paid directly to the minor
• A guardian or custodian must be appointed
• Consider using a trust instead

Common Disaster Clause

A common disaster clause (or survivorship clause) requires the beneficiary to survive the insured by a specified period (often 30-60 days) to receive the benefit. If both die in the same accident and the beneficiary doesn't survive the required period, proceeds go to the contingent beneficiary.

Per Stirpes vs. Per Capita

When naming a class of beneficiaries (like "my children"), the owner should specify:

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Key Takeaways

• The four parties to a life insurance contract are the insurer, policy owner, insured, and beneficiary
• The policy owner controls the policy and holds all ownership rights
• The owner and insured can be different people (requires insurable interest)
• Primary beneficiaries receive the death benefit first; contingent beneficiaries receive it if the primary cannot
• Revocable beneficiaries can be changed; irrevocable beneficiaries must consent to changes
• Third-party ownership is common in business and estate planning
• ILITs keep proceeds out of the taxable estate
• Consider using trusts rather than naming minors as beneficiaries directly