March 17, 2018

Life Insurance Policy Settlement Option

Often times people spend a lot of time on determining what type of life insurance they want and how much of it. But an important topic that is often overlooked is life insurance policy options.  Policy options give the life insurance contract flexibility to meet the needs of the insuring public. Of particular value are the settlement, nonforfeiture, and dividend options available under a life insurance contract.

Settlement Options

At one time, life insurance policy proceeds were paid only in the form of a lump-sum cash payment. This often created as many problems for the beneficiary as it solved. A beneficiary who is the sudden receipient of a large amount of cash may not know what to do with it or how to invest it. Or they may irresponsibly go on a spending spree and broke in a short time. To avoid situations such as the insurance industry developed methods by which the settlement could be paid in forms other than a lump sum. Many policyowners don’t even realize that an alternative exists! When a settlement option is chosen, the proceeds of the policy are left with the company. The insurance company invests the proceeds and guarantees that the funds will earn interest. The advantages of a settlement option are clear:

  • The insurer invests the money, relieving the beneficiary from the task of managing and investing the funds
  • The money is “safe” with the insurance company
  • Interest earnings are guaranteed

The beneficiary can receive the proceeds in a manner that best suits their needs unless the policyowner specifies an irrevocable settlement option. Without the irrevocable option, the beneficiary can choose one of the frequently used optional modes of settlement:

  • Interest only
  • Fixed-Period installments
  • Fixed-Amount installments
  • Life income

Under the interest only option, the life insurance company keeps the proceeds of the policy for a limited time and invests them for the beneficiary, paying the earned interest as income to the beneficiary. The policy option can allow the beneficiary to withdraw some portion of the principal or it can be set that they cannot until a certain number of years have been reached. Money left with a company will go to either the deceased beneficiaries estate or the secondary beneficiary named in the policy.

Under the fixed period option, the beneficiary receives a regular income for a specified period (i.e. 10,20,30 years). Under this option, the principle gradually decreases to zero. The amount that the beneficiary receives will depend on the principal amount, the interest earned on the principal, and the length of time.

Under the fixed amount option, the payee receives payments but the length of time is not specified. The payments continue until the combination of principal and interest has been exhausted.

The life income option provides for payment of installments for the entire lifetime of the payee. Just as with an annuity, there are at least four distinct methods in which these installments can be paid:

  • straight life, in which the payee receives a specified income for as long as they live
  • refund annuity, in which an income is paid for the lifetime of the payee and to the second payee if the first payee dies before receiving an amount equal to the full proceeds
  • life income certain, in which the payee receives installments for life and a second payee receives the the payments if the first payee dies within a certain period of time 5,10, or 20 years
  • joint and survivor life income, in which two payees are recipients of the income of the lifetime of the first payee and the surviving payee the recipient of income of a lesser amount

Withdraw Provision

Usually a withdrawal provision is used in conjunction with settlement options. Under this provision, the proceeds of a policy are held by the insurance company and earn interest, the insured has the right to withdraw the funds left on deposit with the insurer at any time. the beneficiary may withdraw only a limited amount each year.