A policy lapses when the policyowner does not pay premiums by the end of the grace period. (A policy expires when it has run past its grace period with premiums unpaid and has exhausted any benefits available under the nonforfeiture option or when the policyowner has allowed the policy to lapse by not paying the next premium due and then decides to cash in the policy.)
However, policyowners can resuscitate a lapsed policy if the insured meets certain tests and the policyholder puts the insurer back to the financial position it would have been in had the policyowner never allowed the policy to lapse.
Almost all states require that life insurance contracts contain a clause allowing reinstatement—a restoration and, according to most courts, a continuation of the original contract.
Such a clause might read as follows: This policy may be reinstated at any time by a request, in writing and submitted to the Company’s Home Office within five years from the date of default in premium payments, unless the policyowner has surrendered the policy for its cash value, if the policyowner:
1. applies for reinstatement;
2.provides evidence of insurability satisfactory to the insurer;
2. pays all overdue premiums with interest at a rate not exceeding 6 percent per year compounded annually; and
3. pays or reinstates any policy indebtedness with interest at a rate not in excess of the applicable policy loan rate or rates determined in accordance with the policy’s provisions.
There are many reasons why this reinstatement provision can be quite valuable. When compared to newly-issued policies at the insured’s attained age, the original policy may have more favorable:
1. annuity purchase rates (as applied to payouts under the settlement options or nonforfeiture options);
2. policy loan rates;
3. mortality or interest assumptions; and
4. lower premium payments.
1. A new policy would take a considerable amount of time to start to build up cash values and dividends.
2. The process of reinstatement is often quicker and simpler than applying for a new contract.
3. Typically, the suicide clause does not run anew from the date of reinstatement but instead starts to run from the original date of the contract. (This assumes the reinstatement was not procured with the intention of committing suicide and also assumes the reinstatement clause itself did not start another suicide period to run.)
4. On a new contract, the incontestable and suicide clauses start anew.
Of course, reinstatement may always not be the appropriate course of action for a particular client. Reasons for applying for a new policy rather than reinstating an older one include:
1. Insurers now may have a type of policy that was not available when the policyowner applied for the original coverage and the new coverage may be more appropriate than the old.
2. Reinstatement often requires a large outlay because the policyowner must not only pay all unpaid premiums but also interest for the period of time that has elapsed since the past premiums were due.
3. Rates for new insurance may be lower than the rates charged per thousand of death benefit on the original coverage.
Insurers are usually more liberal than state law requires them to be with respect to policy reinstatement. But to prevent those who are ill or at greater risk from selecting against the insurer (this is called adverse selection), state statutes and policy provisions uniformly require that the insured must be insurable—to the insurer’s satisfaction— at the date of reinstatement. Were it not for such a provision, former insureds who have become uninsurable would uniformly seek to become insureds again and by doing so adversely affect the mortality experience of the insurer.
Merely completing the application for reinstatement is not sufficient to restore the policy’s benefits. The insured and policyowner must meet all the conditions of reinstatement before the insurer becomes liable to pay anything other than any nonforfeiture benefits that already existed before the application for reinstatement. So if the proposed re-insured dies after signing the reinstatement form but before satisfying all the requisite tests, the insurer is not liable to pay the policy death benefit.
However, once all of these conditions precedent to the insurer’s liability are met (such as full compliance with all the contractual terms including insurability and payment of back premiums and interest), if the insured then dies from a cause such as an accident unrelated to insurability before the reinstatement is approved, most courts will hold that the reinstatement holds and dates back to the time the application and back premiums were tendered to the insurer.
An unreasonable delay on the insurer’s part may be held to bar the insurer from declining coverage.
Can a reinstated policy be contested? Most courts have held that for other purposes the reinstated contract should be considered the exercise of a contractual right under the original policy, i.e., a continuation of the original. This follows the ordinary meaning of the term “reinstatement,” that is “to restore to the former state or position.” But for purposes of contestability, a new period applies—but solely to statements made in the reinstatement application. In other words, the incontestable clause runs anew as to fraud or misrepresentations in the application for reinstatement. Generally, the same contestable period that applied to the original contract applies to the reinstatement.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM