Life Insurance Payouts Before Death? What You Need to Know about the Catastrophic Illness Rider

A benefit sometimes included with an ADB rider, but which insurers also offer separately, is the catastrophic illness rider. When buyers add a catastrophic illness rider to a life insurance policy (usually requiring them to pay an additional premium), a portion (usually 25 to 50 percent) of the face amount is payable upon diagnosis of specified illnesses. The named illnesses differ among insurers but typically include organ transplantation.

As insurers pay benefits under either a catastrophic or terminal illness rider, they reduce the face amount of the basic policy an equal amount. Also, an interest charge applies in some policies. Insurers reduce cash values either in proportion to the death benefit reduction or on a dollar-for-dollar basis.


Some life insurance issuers offer life insurance with a long-term care rider available for an additional charge or as a provision of the base policy. Essentially, an LTC rider/provision is a variation of the accelerated death benefits rider. Persons who buy a policy with this rider/provision can pay the premium in a single lump sum or by making periodic payments. In any case, the policies with the LTC rider/provision provide policyowners with a death benefit that they can also use to pay for long-term care related expenses, should they incur them.

The insurer bases the amount of death benefit and the long-term care allowance on the insured’s age, gender, and health at the time the policyowner buys the policy. The appeal of this combination policy lies in the fact that either policyowners will use the policy to pay for long-term care expenses or their beneficiaries will receive the insurance proceeds at the insureds’ death. In either case, someone will benefit from the premiums policyowners pay.

Insurers add the long-term care benefit to the life insurance policy by either an accelerated benefits rider or an extension of benefits rider.

Accelerated benefits rider – An accelerated benefits rider makes it possible for policyowners to access the death benefit to pay for expenses related to long-term care. The insurer reduces the death benefit by the amount used for long-term care expenses, plus a service charge. If policyowners need long-term care for a lengthy period of time, they will eventually deplete their death benefit. Policyowners also can use this same rider if they have a terminal illness that may require payment of large medical bills. Because (as described above under the accelerated death benefits rider) accelerating the death benefit can have unfavorable tax consequences, one generally should not exercise this option before consulting a tax professional.

Example. Policyowner pays a single premium of $50,000 for a universal life insurance policy with a long-term care accelerated benefits rider. The policy immediately provides approximately $87,000 in long-term care benefits or $87,000 as a death benefit. If the insured incurs long-term care expenses, the accelerated benefits rider allows the insured to access a portion, such as 3 percent ($2,610), of the death benefit amount ($87,000) each month to reimburse some or all of the long-term care expenses. The insurer will continue payments until total payments exhaust the total death benefit amount of $87,000 in about 33.3 months. Whatever the policyowner does not use for long-term care will be left to heirs as a death benefit. (The hypothetical example is for demonstration purposes only and does not reflect any actual insurance products or performance.)

Typically, qualifying for payments under a long-term care rider is similar to qualifying for payments under most stand-alone long-term care policies. Insureds must be unable to perform usually two or three of the activities of daily living (bathing, dressing, eating, getting in or out of a bed or chair, toilet use, or maintaining continence) or suffer from a severe cognitive impairment.

An elimination period may also apply: policyowners pay for the initial cost of long-term care out-of-pocket for a specific number of days (usually thirty to ninety, but sometimes longer) before they can apply for payments under the policy. As with all life and long-term care insurance, the insurance company will require prospective insureds to answer some health-related questions and to submit to a physical examination before they issue a combination policy.

Deciding whether a combination policy is a right choice depends on a number of factors.

First, a combination policy is almost never a good choice if the prospective insured does not need both life insurance and long-term care coverage.

Second, one should ask how much life and long-term care one needs and whether no one combination policy can adequately satisfy these needs. A long-term care rider may not provide as many features as a stand-alone long-term care policy. For example, the combination policy may not cover assisted living or home health aides. It also may not provide an inflation adjustment, an important feature considering the rising cost of long-term care. Given the greater flexibility of tailoring two distinct policies to meet the needs and also the inherently greater range of choices and flexibility with stand-alone long-term care policies, more often than not, a two-policy approach will better fit one’s needs.

Third, when it comes to long-term care, nobody can ever be sure how long he or she might need long-term care coverage. The critical question is: will the long-term care part of a combination policy provide sufficient coverage even if one adds an EOB rider?

Fourth, keep in mind that accelerated death benefits that the insurer pays for whatever reason deplete the face amount of the life insurance. The combination policy may be a risky proposition if one wants to maintain the level of the death benefit payable to heirs with a reasonably high probability.

Finally, the tax benefits offered by a qualified long-term care policy may not apply to the long-term care portion of combination policies, which could result in taxation of long-term care benefits received from the policy.

In the case of chronically ill individuals, the income-tax exclusion applies only if the case meets detailed requirements. For example, the payee must use payments for costs incurred by the payee (not compensated for by insurance or otherwise) for qualified long-term care services provided for the insured for that period. Under the terms of the contract, the payment must not be a payment or reimbursement of expenses reimbursable under Medicare (except where Medicare is a secondary payor, or the arrangement provides for per diem or other periodic payments without regard to expenses for qualified long-term care services).

The income-tax exclusion may not apply to amounts paid to a taxpayer other than the insured in certain circumstances. The exclusion is denied if the noninsured payee has an insurable interest in the insured’s life because the insured is a director, officer, or employee of the payee, or because the insured is financially invested in any trade or business conducted by the payee.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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