March 17, 2018

Life Insurance Nonforfeiture Options

Many years ago, life insurance policies were structured so that if the owner allowed the policy to lapse, they simply forfeited (gave up) the excess amounts paid in as premium. Today, most laws operate with the standard nonforfeiture law that prescribes any cash value accumulation must be made available to the policyowner if they stop making premium payments.

The amount of cash value and the rate at which it accumulates depends on the type of policy and may vary from company to company. But, in most states, a permanent policy at least has some cash value by the end of the third year. There are three common nonforfeiture options:

  • Cash surrender value
  • Extended term insurance
  • Reduced paid-up insurance

The policyowner can receive the cash accumulation as a cash payment but the life insurance protection will cease. The cash surrender value is the amount entitled to the owner at the time of surrender before maturity. The cash value is determined by a formula established by law. A portion of each premium payment is allocated to the policy reserve, which is a fixed liability of the insurance company. The balance of the premium is used to cover certain expenses such as acquisition costs, administration expenses, and agent’s commissions. The life insurance contract is heavily loaded with expenses initially, thus there is no cash value in the early years of the policy.

With the extended term option, the policyowner can use the policy’s cash value accumulation as a single premium to purchase paid-up term life insurance in an amount equal to the original policy face amount. The length of the term life insurance depends on the net cash value. Typically, the extended term nonforfeiture option goes in to effect automatically if the owner isn’t available to make a choice of simply fails to exercise an option.

With reduced paid-up option, the policyowner essentially uses the cash value of a present policy to purchase a single premium insurance policy at attained age rates for a reduced face amount. There are some important things to keep in mind before choosing this option:

  • Once the face amount of protection has been determeind, it remains the same for the duration of the contract. the new policy will build cash values for the policyowner
  • No further premiums need be paid on the reduced policy- it’s paid up because of a single premium policy
  • the new protection is computed at the attained age of the insured
  • A full share of expense loading is usually not included in the premium on the reduced coverage because the cost of setting up the overage is greatly reduced

Please note that reduced paid-up policies are of the same type of insurance as the original policy, except all riders, including those for disability and accidental death, are eliminated.

Of the three nonforfeiture options for life insurance discussed here, the extended term option provides the most life insurance protection the quickest. And it is important to remember that if a cash value option is chosen, the policyowner looses all life insurance protection.

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