It’s not a pleasant subject, but we need to discuss the suicide clause found in most life insurance policies. It ties in with an insurance concept called adverse selection so let’s take a more in-depth look at how the suicide clause works in life insurance.
First, let’s look at the definition of a standard suicide clause found in most policies. Essentially, the clause states that if the insured passes away by committing suicide in the first two years of the policy, the life insurance company will not pay the benefit according to the policy. The two year window starts from the official effective date of the life policy. This is one more reason the effective date of your life insurance policy is important. You’ll notice that the other similar clause, the contestability clause also has a two year window as well.
It sounds a bit morbid and unfair to penalize someone after such a tragic event. Why do the life insurance companies have a suicide clause in their policies to begin with? This is where adverse selection and insurance plans come into play. Adverse selection is when an insurance plan attracts excessive risk…more than average for a given type of insurance. If a person were in a state of complete despair and contemplating suicide, he/she might take out a life insurance policy. Without the suicide clause, life insurance policies might attract this excessive risk and the cost of life insurance for everyone would increase significantly for everyone. Keep in mind that life insurance inherently deals with large amounts of money. Potentially very large amounts of money. The reason term life insurance rates are so low is that the probability of triggering the benefits is relatively low. Any adverse selection such as that associated with suicide could significantly impact rates by shifting the probability higher. The protection against adverse selection differs from all other types of death in that people have an inherent motivation to avoid triggering the benefits. Whether it’s serious illness or severe accident, all people have a motivation to avoid these.
Suicide is different. Obviously, a person has to be in a very seriously depressed or altered state of mind to even contemplate suicide but the fact that he/she causes the death changes the entire equation. The two year clause is there to offset this potential adverse selection from blowing apart the life insurance product apart. The two year window of the clause takes into account an impulsive purchase of life insurance while contemplating suicide. Other mental illness issues that may affect mortality rates (with or without the risk of suicide) should be brought to light during the underwriting process and especially during the questioning part of the paramedical exam.
As hard as the subject matter is, it’s important to understand that you, the life insurance shopper benefits from this clause by keeping term life rates affordable. Without this clause, you could be paying much more in premiums. As a core component of insurance, a policy holder should not be able to control or trigger benefits to their advantage. This is the reason for the suicide clause in life insurance.