Insurance is a highly-regulated industry
We can credit our favorite kite-flying forefather, Benjamin Franklin, for playing a major role in founding the life insurance industry in the United States in the 1700s1 but it was not until the mid-19th century that the regulatory framework for the industry was created.2 Insurance regulations were developed to protect consumers in three main areas: the financial solvency of insurance companies, the products they sell, and market conduct and prevention of unfair trade practices.2
Almost all regulations that life insurance companies must follow are state laws rather than federal laws. Each state has a state insurance department, which means that a life insurance company that operates in each state must adhere to the governing laws of every state they operate in.3
The National Association of Insurance Commissioners (NAIC) is the U.S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia, and five U.S. territories. NAIC acts as a forum for the creation of model laws and regulations, but generally, each state decides whether to pass these model laws and regulations. States are allowed to make changes during the enactment process but the model laws and regulations are widely adopted.2
Extenuating Circumstances
Life insurance is a contract,
wherein you agree to pay the insurance company the policy premiums, and the insurance company agrees that, upon your death, it will pay the death benefit you have selected to your designated beneficiary if the benefit is payable according to the provisions of the policy. Like any other legal contract, life insurance policies have rules and provisions depending on the type of policy you buy.
Sometimes, people stop paying premiums on their life insurance. For some policies, the policy terminates after a grace period but if the policy has cash value, state law prevents insurance companies from terminating the policy and keeping the cash value.4
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A non-forfeiture option
(or clause) is a provision included in certain life insurance policies stipulating that the policyholder will not forfeit the value of the policy if the policy lapses after a defined period due to missed premium payments. The nonforfeiture clause may also become available when the holder of some life insurance policies surrenders (actively cancels) the policy.5 Carefully weigh the consequences of canceling your original policy, which also cancels the death benefit of the policy.
Whole life insurance policies generally have three standard payout options in the non-forfeiture clause.
Cash Surrender Value
If the policyholder chooses the cash surrender option, the insurance company pays the cash value to the policy owner as a lump sum. At that point, the policy is canceled and can’t be reinstated; the insurer’s responsibility under the contract ends. Most states allow insurance companies up to six months to pay the cash surrender value.6Extended-Term Option
This option allows the policy owner to use the cash value from their policy to place the policy on extended term insurance. This option also helps the policy owner to quit paying premiums for the original policy.5 The length of time the new policy will be in force will depend on the cash values available from the policy.5 A policy converted to term insurance may be reinstated under the reinstatement provision of the contract provided the term has not expired.4Reduced Paid-Up Insurance
Choosing this option means the policy’s cash value is used to buy a paid-up policy of the same type as the policy that lapsed. The policyholder pays no further premiums. The new policy will have a reduced death benefit but will retain a cash value that will grow throughout the life of the policy at a reduced rate.5
If the policyholder doesn’t select an option, the insurance company will have a default option contained in the policy’s language. The Extended Term Option is often the insurance company’s default option.
There are other non-forfeiture options, but not all insurance companies make these options available.
Single-Premium, Immediate Annuity
Some insurance companies will also allow the policy owner to convert the policy to an annuity, which will pay the policy owner an amount for the rest of his/her life. That amount is based on the cash value of the lapsed or surrendered policy and the policy owner’s age.4Automatic Premium Loan
An automatic premium loan is a provision in a life insurance policy with a cash value that allows the insurer to automatically deduct the premium amount overdue from the policy value. The insurance company makes a loan against the policy’s cash value for paying the overdue premiums provided the cash value is more than or equal to the premium amount due.7
If you find yourself in a situation where you cannot or no longer wish to pay the premiums on a life insurance policy with a cash value, using one of the non-forfeiture options may be a good choice for you. Keep in mind that non-forfeiture options may adversely impact some coverage; for example, reducing the face amount or canceling the policy completely. Your insurance agent can help you weigh the pros and cons so you can decide what is best for you.
- Insurance Information Institute, Insurance 101 (Accessed January 12, 2021)
- NAIC, State Insurance Regulation (Accessed January 12, 2021)
- Life Insurance Law, Life Insurance Laws by State (Accessed January 12, 2021)
- thisMatter, Dividends and Non-Forfeiture Options (Accessed January 13, 2021)
- Corporate Finance Institute, Nonforfeiture Clause (Accessed January 13, 2021)
- Quizlet, Policy Nonforfeiture Options (Accessed January 13, 2021)
- Corporate Finance Institute, What is an Automatic Premium Loan? (Accessed January 26, 2021)
Categories: insurance, life insurance