Accelerated Death Benefit

An accelerated death benefit is a life insurance provision that pays part of the policy's death benefit to the insured while they are still alive, on certification that they are terminally or chronically ill. It reduces the amount payable at death by what was advanced, so it moves money forward in time rather than creating any. Washington's Office of the Insurance Commissioner describes the mechanism from the regulator's side: the provision "allows for an early, discounted benefit payment to terminally ill policyholders," and "a doctor must certify that policyholders have less than 24 months to live."

The statutory phrase comes from the tax code. Section 101 of the Internal Revenue Code, which excludes life insurance death benefits from income, carries a subsection headed "Treatment of certain accelerated death benefits," and it is that subsection, section 101(g), that makes the early payment tax-free on the same terms as a payment at death. So the benefit is a contract provision, but what makes it worth having is a federal tax rule, and the rule has conditions the contract language does not always make obvious.

The two routes, and the asymmetry between them. Section 101(g)(1) treats two categories of payment as though they were paid by reason of the insured's death: amounts received under a life insurance contract on the life of a terminally ill individual, and amounts received on the life of a chronically ill individual. For the terminal route, section 101(g)(4)(A) defines a terminally ill individual as one "who has been certified by a physician as having an illness or physical condition which can reasonably be expected to result in death in 24 months or less after the date of the certification." Nothing in the statute conditions that payment on what the money is spent on. The insured may use it for medical bills, a mortgage, travel, or anything else.

The chronic route is different, and the difference is the single most consequential fact about this benefit. Section 101(g)(3)(A)(i) provides that the treatment does not apply to a payment received by a chronically ill insured unless "such payment is for costs incurred by the payee (not compensated for by insurance or otherwise) for qualified long-term care services provided for the insured for such period." So the chronic side is, for tax purposes, a reimbursement mechanism: the money has to be matched to unreimbursed care costs. A page or a sales conversation that applies the costs-incurred condition to both routes, or that applies the 24-month certification to the chronic route, has the statute wrong in a way that changes what a claimant can safely do with the money.

Two qualifications on the chronic route. Section 101(g)(3)(C) provides that a payment "shall not fail to be described in subparagraph (A) by reason of being made on a per diem or other periodic basis without regard to the expenses incurred during the period to which the payment relates," so a per diem design is not disqualified merely for being a per diem. Section 101(g)(3)(D) then points to section 7702B(d) for a limitation on how much of a periodic payment gets the treatment. That limitation is not a cap on benefits and is frequently described as though it were; the mechanics are set out on the hybrid long-term care material, which owns them. What belongs here is the boundary: section 7702B(d)(1) states expressly that a payment is not taken into account "if the insured is a terminally ill individual (as defined in section 101(g)) at the time the payment is received." The per diem limitation therefore reaches the chronic route only, which is consistent with its sitting inside section 101(g)(3), a paragraph headed "Special rules for chronically ill insureds."

What it costs the policy, and what the insurer actually pays. Accelerating reduces the death benefit, and usually by more than the amount received. The insurer is paying early on money it expected to pay later, so it discounts for the time value and often charges an administrative fee, and some contracts reduce the death benefit by a lien plus accrued interest rather than by the cash paid. Where a policy loan is outstanding, the acceleration typically has to address it first. None of that is hidden, but it is in the rider form rather than in the illustration, and the number a claimant needs is the reduction in the death benefit per dollar received.

Two boundaries worth naming. Section 101(g)(5) switches the whole subsection off for a business-owned policy: it does not apply to an amount paid to a taxpayer other than the insured where that taxpayer has an insurable interest "by reason of the insured being a director, officer, or employee" or by reason of the insured being financially interested in the taxpayer's business. And section 101(g)(2) places viatical settlements, in which the policy itself is sold to a licensed settlement provider, inside the same subsection. Selling a policy and accelerating it are different transactions with different consequences for the beneficiary, and they have their own pages.

The insured, or the policy owner, files a claim with the insurer supported by a physician's certification meeting the contract's definition. The insurer determines the maximum it will accelerate, usually a stated percentage of the face amount subject to a dollar ceiling, calculates the discounted amount it will pay, deducts any administrative charge, and settles any outstanding policy loan. The death benefit is then reduced, either by the amount advanced plus charges or by a lien that accrues interest, depending on the contract. The remaining coverage stays in force on the contract's ordinary terms.

A hypothetical, to show what the reduction looks like. Suppose a policy carries a $400,000 death benefit and its rider permits acceleration of up to 50 percent of the face amount, so $200,000. The insurer discounts that for early payment and charges a $250 administrative fee, and the claimant receives $178,000. The death benefit is reduced by the full $200,000 accelerated, leaving $200,000 for the beneficiary. The claimant received $178,000 and the beneficiary lost $200,000, so the effective cost of the acceleration was $22,000, or 11 percent of the amount accelerated. The figures are invented for the arithmetic, and the discount, the percentage limit and the fee are all set by the individual rider.

Two things follow from that. The first is that the number worth asking for is the reduction in the death benefit per dollar received, because the discount is the whole cost and it is the figure least often volunteered. The second is that the family's own arithmetic has to include the beneficiary: accelerating is a decision about how the same money is divided between the insured's remaining years and the people who outlive them.

Pros

• It converts a policy into money at the moment a household's costs spike and its earnings usually stop.
• For a terminally ill insured the statute imposes no restriction on how the money is used, so it can cover a mortgage or ordinary living costs rather than medical bills alone.
• It is frequently included in modern policies at no separate premium, so the option costs nothing until it is exercised.
• Payments meeting the section 101(g) conditions are treated as though paid by reason of death, which is a favorable rule rather than a neutral one.

Cons

• It is an advance, not additional coverage, so every dollar taken is a dollar the beneficiary does not receive, and usually more than a dollar.
• The insurer discounts the payment for early settlement and may add a fee, so the effective cost is real and is often not stated as a rate.
• On the chronic illness route the money is tax-favored only where it is for unreimbursed qualified long-term care costs, which is a restriction most people do not expect.
• Receiving a lump sum can affect eligibility for means-tested benefits, which is a reason to check before claiming rather than after.
• The subsection does not apply to an amount paid to someone other than the insured where that person's insurable interest arises from the insured's role as a director, officer or employee, which removes the tax treatment from a business collecting on a policy covering its own people.