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Difficulty: HardInitial Premium and Premium Receipts

On April 5, David, an architect with a history of type 2 diabetes, submits an application for a $500,000 whole life insurance policy. He pays the initial annual premium and the producer issues a conditional insurability receipt. A required medical examination is completed on April 9. On April 14, before the insurer's home office finishes reviewing the file, David is fatally injured in an automobile accident. Upon post-mortem underwriting review, the insurer determines that David was insurable, but only as a substandard risk requiring a higher premium surcharge than the standard rate initially collected. Based on these circumstances, what is the insurer's financial obligation regarding the claim?

  1. The insurer will only refund the initial premium paid, because the conditional coverage never took effect since David was not insurable at the applied-for rate.Answer
  2. B
    The insurer will pay the $500,000 death benefit, because the conditional receipt established retroactive coverage that began on the date of the medical examination.
  3. C
    The insurer will pay the full death benefit, because the producer's acceptance of the premium check created an unconditional binding contract.
  4. D
    The insurer will deduct the required premium surcharge from the death benefit and pay the balance, because initial consideration was already exchanged.

Answer

The insurer will only refund the initial premium paid, because the conditional coverage never took effect since David was not insurable at the applied-for rate.
Under a conditional insurability receipt, coverage becomes effective on the date of the application or medical exam (whichever is later) strictly on the condition that the applicant is found to be insurable at the rate applied for. Because David was classified as a substandard risk requiring a higher premium, the original condition was not met. The insurer's decision represents a counteroffer. Since David died before he could accept the new policy terms and pay the additional premium, no insurance contract was ever formed, and the insurer's only obligation is to return the initial premium.

Step-by-Step Solution

1
Analyze the type of receipt issued and its conditions.
A conditional insurability receipt was issued, which provides coverage retroactive to the application or medical exam date ONLY IF the applicant is found insurable at the rate applied for.
Understanding the specific trigger for a conditional receipt is necessary to determine if coverage was active.
2
Determine the applicant's insurability status at the time of underwriting.
The underwriter determined David was a substandard risk, meaning he did not qualify for the standard premium rate initially collected.
This establishes whether the condition outlined in the receipt was met.
3
Apply the rule for counteroffers in life insurance underwriting.
Because David required a higher premium, the insurer's determination acts as a counteroffer rather than an acceptance. Since David died before the counteroffer could be delivered and accepted, no contract was formed.
A contract requires an offer and acceptance; a counteroffer voids the original conditional terms.

Key Concept

Conditional Receipts and Substandard Risk Counteroffers
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Topics

Initial Premium and Premium Receipts

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