Life Insurance Policies: How Payouts Work

Life insurance is a popular part of long-term financial planning. But to effectively incorporate this tool into your portfolio, you must understand how and when life insurance payouts are delivered to beneficiaries. This includes understanding how quickly benefits will be paid and designing the policy with the payout option that works best with your estate planning.

Typically life insurance benefits are paid when the insured has died, and the beneficiaries file a death claim with the insurance company, submitting a certified copy of the death certificate. Many states allow insurers 30 days to review the claim. Then they can pay it, deny it or ask for additional information.

Most insurance companies pay within 30 to 60 days of the date of the claim, says Chris Huntley, founder of Huntley Wealth & Insurance Services.

“There is no set time frame," adds Ted Bernstein, owner of Life Cycle Financial Planners, LLC, a firm in Boca Raton, Fla. "But insurance companies are motivated to pay as soon as possible after receiving bona fide proof of death, to avoid steep interest charges for delaying payment of claims."

Several situations can result in later payment of a claim. If the insured died within the first one to two years after the policy was issued, beneficiaries could face delays of six to 12 months. The reason: the one- to two-year contestability clause, says Huntley. “Most policies contain this clause, which allows the carrier to investigate the original application to ensure fraud was not committed. As long as the insurance company cannot prove the insured lied on the application, the benefit will normally be paid,” says Huntley. Most policies also contain a suicide clause that allows the company to deny benefits if the insured commits suicide during the first two years of the policy.

Another scenario that could delay payment, not surprisingly, is when “homicide” is listed as the cause of death on the death certificate. In this case, a claims representative may communicate with the detective assigned to the case to rule out the beneficiary as a suspect. “If the beneficiary is a suspect, the benefit will be held until charges are dropped or he/she is acquitted of the crime,” says Huntley.

Since the inception of the industry more than 200 years ago, the payout to the beneficiary was always a lump-sum payment of the proceeds. The default payout option of most policies remains a lump sum, says Richard Reich, President, Intramark Insurance Services, Inc. 

Modern life insurance policies have seen a monumental improvement in how payouts can be delivered to the policy’s beneficiaries, says Bernstein. These included an installment-payout option, or an annuity option, in which the proceeds and accumulated interest are paid out regularly over the life of the beneficiary.

These choices give the policy owner the opportunity to select a pre-determined, guaranteed income stream of between 5 and 40 years. “For income-protection life insurance, most life insurance buyers prefer the installment option to guarantee the proceeds will last for the necessary number of years,” says Bernstein.

Traditionally, life insurance policies only pay out at the time of the policy holder’s death. “However, some life insurance companies have designed policies that allow their policyholders to draw against the face value of the policy in the event of a terminal, chronic or critical illness. These policies enable the policyholder to be the beneficiary of their own life insurance policy,” says Bernstein.

The term for this is accelerated death benefit. (For related insight, take a closer look at accelerated benefit riders.) Talk with your insurance agent about whether this option makes sense for you.

The life insurance company should be contacted as soon as possible following the death of the insured to begin the claims process. The claims representative will request paperwork to process the claim.

The beneficiary of the insurance policy must obtain a certified copy of the death certificate. This can usually be obtained through the county in which the named insured dies. If the insured died in a hospital or nursing home, the institution may have completed the certificate, says Luke Brown, a retired insurance lawyer in Tallahassee, Fla.

“The death certificate has to be submitted to the insurance company address listed in the policy along with a statement of claim, which is sometimes called a "request for benefits," signed by the beneficiary,” says Brown.

Policies owned by revocable or irrevocable trusts must ensure that the insurance company has a copy of the trust document identifying the owner and the beneficiary, adds Bernstein.

Life insurance policies provide both policyholders and their loved ones' peace of mind that financial difficulties may be avoided in the event of a person’s death. To expedite the claims process, and avoid errors and delays, Reich stresses that accuracy is essential when submitting any documentation or communicating with the life insurance company. “A person’s life insurance agent can help make sure that the claim form is filled out correctly and help answer questions throughout the process,” he says. (For more insight, read about how life insurance proceeds are taxed.)