Remember, a life insurance policy is a unilateral contract. This means that one party to the life contract (the insurer) makes a promise (to pay the policy benefits) that is conditioned upon the performance of an act (payment of the premium) by the other party (usually the policyowner). Since payment of the initial premium is a condition that must be fulfilled before the contract comes into existence, we will examine that requirement in detail.

For the vast majority of life insurance policies, the premiums are normally paid by the policyowner. (Several different methods of premium payment are available to policyowners. These methods�for example, cash, check, and automatic transfer�are discussed later in this chapter.) When the premiums are paid by someone other than the policyowner, however, a few special questions arise.

If the insured and the policyowner are not the same person, payment of the premiums by the insured does not give the insured any rights in the insurance contract whatever. The insured is the object of the insurance contract and is vital to its creation and continuation, but he or she is not a party to the contract.

Depending on the relationship between the insured and the policyowner, if the insured pays the premiums, there may be gift or income tax consequences to consider. If the insured is a sole proprietor and the policyowner is an employee of the insured, the payment of premiums by the insured may be treated as compensation to the insured. If there is no employment relationship between the two parties, payment of the premiums may be a gift from the insured to the policyowner subject to federal gift taxation.

Payment of insurance premiums by a revocable beneficiary does not give that beneficiary any additional rights in the contract beyond those accorded by designating that person as a beneficiary. Since the policyowner can change a revocable designation at any time, it is described as a defeasible interest (also known as a mere expectancy). However, if the beneficiary can produce evidence indicating a promise by the policyowner to pay all or a portion of the insurance proceeds to the beneficiary in exchange for the beneficiary�s payment of the premiums, the courts will enforce such an agreement. In such a case, the courts will direct the insurer to pay the proceeds to the beneficiary even if the policy- owner has changed the beneficiary designation to another person.

If a trustee is both owner and beneficiary of a life insurance policy that has been transferred to or purchased by the trust, the trust document will normally have a provision either requiring or permitting the trustee to pay the premiums on the policy. This gives the trustee a fiduciary responsibility to see that the premiums are paid. If the trustee is not the owner of the policy but is merely designated as beneficiary of the policy in trust, there is usually no duty imposed on the trustee to see that premiums are paid. This is clearly the case if the trustee is merely a revocable beneficiary of the policy. Nevertheless, the terms of the trust define the trustee�s responsibilities with respect to all property interests the trustee possesses on behalf of the trust.

If a person is designated as an irrevocable beneficiary, payment of the premiums on the policy for the policyowner still does not increase that person�s interest in the policy beyond that granted by the beneficiary designation. To the extent that payment of premiums by an irrevocable beneficiary continues the policy in force, however, the irrevocable beneficiary has acted to protect the rights acquired under the beneficiary designation. Individuals may elect to pay premiums or not as their own self-interest dictates. Trustees must act in accordance with the provisions of the trust and with state law governing their management of trust assets.

Life insurance policies are frequently assigned by their owners to other persons for various purposes. The assignment may be as collateral for a loan, or it may be an absolute assignment. Payment of premiums by an assignee has different consequences, depending on which type of assignment has been made. If the policy has been assigned as collateral, the terms of the collateral assignment document define whether the assignee has any duty to pay premiums. The standard American Bankers Association (ABA) collateral assignment form does not give the assignee any duty to pay premiums. It provides as follows:

A person who receives an insurance policy as the result of an absolute assignment becomes the owner of the policy. Thus an absolute assignee, like the initial policyowner who assigned the contract, has no duty to pay any premiums because the life insurance policy is a unilateral contract. Of course, if the premiums on the policy are not paid after the assignment, the policy will be likely to lapse.

At one time it was common for insurance companies to acknowledge receipt of the initial premium by automatically inserting language to that effect in the insurance contract. This is no longer the case because of statutes and court decisions adverse to the insurers. Insurance companies used to print that language in the contract because they assumed that the policy would not be issued unless they had, in fact, received the initial premium. However, circumstances frequently arose where companies issued policies without first receiving the initial premium and insurance agents delivered the policies without collecting the initial premium. Usually, the premium was collected in short order, and the policy was treated by all parties as a contract for insurance. But in some of these cases, the insured died before the initial premium was collected. Because the premium had not been paid, the insurance companies denied the ensuing claim for the death benefit on the logical ground that the contract did not exist because the applicant had not provided the full consideration (application and premium). Some courts held, however, that by delivering the policy, the insurers had waived their right to demand payment prior to delivery. Thus the contract was in effect.

Today, a majority of the states have established a rule of law that if an insurance policy with such a provision has been delivered to the policyowner, there is a conclusive presumption that the policy is in effect, even if the available evidence suggests that the initial premium has not been paid. It is important to understand that the presumption is conclusive only as to the fact that the policy is in effect, not that the premium has actually been paid. In most jurisdictions, the insurer will be permitted to establish that the premium has not been paid and be allowed to collect the premium due (by deducting it from the death benefit, for example), but the insurer will not be permitted to challenge the validity of the contract.

Modern insurance contracts do not contain this language. Thus it is clear that an insurance contract is an evolving document. Its terms change in response to adverse court decisions, new legislation, and competitive pressures. With respect to the relationship between premium payment and the insurer�s obligation to pay policy benefits, language such as the following two examples is common:

For policies with these types of provisions, possession of the policy by the owner or beneficiary will still create a presumption that the initial premium has been paid. However, that presumption is rebuttable�meaning that if the insurer can provide evidence that the initial premium has not been paid, the presumption will be overcome and the policy will be void.

The terms of the application and the insurance contract governing the payment of the initial premium will be binding on the policyowner and the insurer. However, the insurer in some circumstances may be held to have waived the requirements of those documents. For example, as explained above with respect to the presumption that the initial premium has been paid, the acts of the insurer or its agent may be interpreted as a waiver by the insurance company of the requirements for timely payment of the initial premium. This might happen if the agent delivers a policy, does not collect the initial premium and advises the policyowner that a later payment of the initial premium will be acceptable. In such a case, the insurer may find itself bound by a contract (and obligated to pay a death benefit) even though it has not yet received the initial premium.

One solution to this problem is to avoid contract language acknowledging receipt of the initial premium. To further avoid this possibility, both the insurance application and the policy now usually have a provision limiting the agent�s authority to alter the terms of the contract. Such language is contained in the application so that the policyowner will be put on notice prior to the delivery of the policy that the agent�s power is limited.

In the Application. A typical limitation provision in the application states as follows:

In the Policy. A typical limitation provision in the policy stipulates as follows:

These provisions are designed to put the applicant on notice that the agent does not have the authority to waive the timely payment of the initial premium or to change any other requirement in either document. If these provisions had existed in the application and policy referred to in the above example, the insurance company would probably not have been bound by the contract. This result would be appropriate because the initial premium (part of the required consideration for the contract) was not paid at the time of delivery. If both the application and policy had contained a notice to the applicant and the policy-owner that the agent did not have the authority to waive that requirement, it is likely that the courts would enforce the contract language as written in those documents and deny the claim for coverage.