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Question

Difficulty: HardInitial Premium and Premium Receipts

An independent contractor submits an application for a $750,000 key person life insurance policy on October 12. At the time of application, the contractor pays the full initial annual premium and the producer issues a conditional receipt. The policy requires an extensive medical examination, which the applicant successfully completes on October 19. On October 22, the contractor is fatally injured in an auto accident. Three days later, the insurer's underwriting department processes the medical exam results and determines that, due to pre-existing hypertension, the contractor was insurable but only at a substandard risk classification requiring a premium surcharge. How will the insurer handle the death claim?

  1. The claim will be denied and the initial premium refunded, because the applicant was not insurable at the standard classification applied for.Answer
  2. B
    The claim will be paid in full, because coverage became retroactively effective on October 19 once the required medical exam was completed.
  3. C
    The claim will be paid, but the death benefit amount will be mathematically reduced to account for the required substandard premium surcharge.
  4. D
    The claim will be paid in full, because the issuance of the receipt established immediate binding coverage on October 12.

Answer

The insurer will deny the claim and refund the premium because the conditions for retroactive coverage under a conditional receipt were not met.
For a conditional insurability receipt to provide coverage prior to policy delivery, two conditions must be met: the required medical exam must be completed, AND the applicant must be found insurable at the standard or preferred rate they applied for. Because the underwriting department determined the applicant was a substandard risk, the insurer would have been required to make a counteroffer. Therefore, the strict conditions of the receipt were not met, no contract was formed, and the insurer's only obligation is to return the initial premium.

Step-by-Step Solution

1
Identify the type of receipt issued at the time of application.
A conditional receipt was issued when the premium was paid.
The type of receipt determines the rules for when coverage becomes effective.
2
Determine the trigger requirements for a conditional receipt.
Coverage becomes effective on the date of application or medical exam (whichever is later), provided the applicant is found insurable at the rate applied for.
Conditional receipts hinge entirely on the applicant meeting the standard underwriting criteria as requested in the application.
3
Evaluate the underwriter's findings against the receipt's conditions.
The applicant was evaluated as a substandard risk requiring a premium surcharge, meaning they were not insurable at the standard rate applied for.
A substandard rating requires the insurer to issue a counteroffer, which legally constitutes a rejection of the original application.
4
Conclude the insurer's liability at the time of death.
Because a counteroffer would have been required, no contract was in effect when the applicant died. The insurer is only liable to refund the premium.
The conditions of the conditional receipt were not satisfied prior to the applicant's death.

Key Concept

Conditional Receipt Rules and Substandard Risk
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Topics

Initial Premium and Premium Receipts

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