What is an example of Nonforfeiture?

UPDATED: Apr 20, 2022Fact Checked

• A nonforfeiture clause can be found in a permanent life insurance policy, long-term disability, and long-term care insurance policies
• It was created to protect the insured in case the policyholder stops paying premiums
• Policyholders can choose from four different life insurance nonforfeiture options: cash surrender value, extended-term insurance, loan value, and paid-up insurance

For those who hold a permanent life insurance policy, nonforfeiture options are available to protect the insured.

Life happens and sometimes insurance policies need to be surrendered or premiums cannot be consistently paid. Insurance companies want you protected no matter what happens. Read the article to learn more about the meaning of nonforfeiture in an insurance policy.

Find out if you qualify for a life insurance nonforfeiture option. Enter your ZIP code and get a free quote today.

What is a nonforfeiture option in an insurance policy?

For an insured party to have the ability to receive full or partial benefits or a partial refund of premiums after a lapse in their policy, they must have a nonforfeiture clause within their insurance policy.

Under the clause, the insured may have to return some portion of the total premiums paid, the cash surrender value of the policy, or a reduced benefit based upon premiums paid before the policy lapsed.

A nonforfeiture clause can be in a permanent life insurance policy, long-term disability, and long-term care insurance policies.

The clause was created to protect the insured in case the policyholder stops paying premiums. State law forbids companies from keeping the accumulated cash value and canceling the policy should a policy expire.

How does the nonforfeiture option work?

The nonforfeiture benefit becomes available when the policyholder decides to surrender the policy.

Life insurance policyholders can choose one of four nonforfeiture benefit options: cash surrender value, extended term insurance, loan value, and paid-up insurance.

1. Cash Surrender Value
   • Within six months of the policyholder surrendering the policy, they will be able to receive the accumulated portion of a permanent life insurance policy’s cash value. Depending on the age of the policy, the cash surrender value could be less than the actual cash value.
2. Extended-Term Insurance
   • The extended-term nonforfeiture option allows the policyholder to use the cash value to purchase a term insurance policy with a death benefit equal to that of the original whole-life policy. This allows the policyholder to stop paying the premiums but not forfeit the equity of their policy.
3. Loan Value of Policy Loans
   • The option of a policy loan is not like a regular loan — it does not need to be paid back. Any money that is taken out will be deducted from the death benefit that goes to the policyholder’s beneficiaries. You will be charged between 5% and 9% interest on the loan.
4. Paid-Up Insurance
   • The policyholder will be allowed to receive a lower amount of fully paid whole life insurance, excluding commissions and expenses. The age of the insured will determine the face value of the new policy. The new death benefit will be less than that of the lapsed policy.

If the policyholder does not make a selection, the terms of the policy will generally stipulate which option would go into effect if the policy lapses or is surrendered.

In short, the policyholder has options if they cannot continue to pay the premiums.

The cash surrender guarantees the policyholder their accumulated cash value.

If the policyholder decides on the extended-term insurance option, they are guaranteed the current death benefit of the whole life policy for a set time with no premium payment required.

The reduced paid-up option guarantees a lesser whole life death benefit remains in force for the rest of the insured’s life with no premium payments required.

It will also continue to build up a cash value through the accumulation of guaranteed interest. Also, the payment of dividends continues if the dividend option is set to paid-up additions.

It is important to note the option to exercise a nonforfeiture benefit only exists if the whole life policy has cash value — some policies have no cash value for the first few years.

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Are there other life insurance nonforfeiture options?

There are two other life insurance nonforfeiture options. But unlike the four options mentioned above, these two are not made available by all insurance companies.

The first is a single-premium, immediate annuity option. The policyholder will be able to convert their policy to an annuity, which will pay the policy owner an amount for the rest of their life. The amount is based on the cash value of the lapsed or surrendered policy and the policy owner’s age.

The other option is an automatic premium loan. The cash value will allow the insurer to automatically deduct the premium amount overdue from the policy value. This is the insurance company making a loan against the policy’s cash value.

The nonforfeiture benefit is available only for permanent life insurance policies. If you have a term life insurance policy or universal life insurance policy and you’re looking for a nonforfeiture option, then your best step to take is a 1035 exchange option.

As long as you are in good health and under the age of 80, you may exchange your term insurance policy for another term insurance policy with a level premium, or a permanent life insurance policy with a level premium. The only stipulation is that the insured of the old policy is the same person insured under the new policy.

Find nonforfeiture options in your life insurance policy. Enter your ZIP code and get a free quote today.

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The three nonforfeiture options can easily be remembered with the acronym C-E-R and they are as follows:

1 – Cash Surrender – If the owner of the policy selects this nonforfeiture option, the policy will be canceled and the insurer will mail a check to the policy owner.  If the policy owner elects cash surrender there will be no further life insurance coverage, and they may have to pay ordinary income tax if they receive more money than they paid into the policy in premiums.

2 – Extended Term – If this option is selected by the policy owner, the cash value from their original policy will be used to purchase a term policy that will have the same face amount (amount of insurance protection) as the original policy.  If this option is selected, there is no additional premium due from the owner of the policy and they will have the same amount of coverage as they had in the original policy, but only for a limited time.  Remember, term insurance is temporary.  Term life insurance is NOT permanent.

3 – Reduced Paid-up – If this nonforfeiture option is selected by the policy owner, the cash value from their original policy is used as a single premium to purchase them a paid-up whole life policy.  There are two things you need to know about this selection for your licensing exam.  First, the amount of coverage under this new policy is reduced.  Second, this new whole life policy will provide permanent coverage.

What is a nonforfeiture values policy?

Any policy which accumulates cash value is a nonforfeiture values policy.  In fact, the cash values in a policy are sometimes referred to as nonforfeiture values.  You need to know which policies will accumulate a cash value.  Term insurance has NO cash value.  In turn, term insurance has no nonforfeiture values.

However, policies such as whole life and endowments do accumulate cash value, which means they both have nonforfeiture values.  Usually, the cash value will begin to accumulate in a policy after the first three years, however, single premium policies will have an immediate cash value.

Which nonforfeiture options continue to build up cash value?

If a policy owner elects the reduced paid-up nonforfeiture option, the cash value from their original policy will be used to purchase a single premium whole life policy.  Whole life insurance is permanent and accumulates cash value.  Remember, term insurance has no cash value, so if the owner selects the extended term option, there will be no further cash value accumulation.  Of course, if they select cash surrender, there is no further life insurance coverage at all.

Which nonforfeiture option provides the highest amount of insurance protection?

Well, think of it this way.  Say you have $50,000 that you would like to use to buy a life insurance policy.  Between a whole life and a term policy, which policy would be able to provide you the biggest bang for your buck?  Or, in other words, which policy would provide the highest amount of life insurance protection?  Term!!  Term insurance has no cash value and is the cheapest form of life insurance.

Which nonforfeiture option provides the highest amount of protection?  Extended Term!  Why?  It’s the cheapest form of life insurance and accumulates no cash value!

Why is a nonforfeiture option used?

In most states, those life insurance policies that accumulate cash value are required to have nonforfeiture values.  What if the owner of the policy forgets to pay their premium and the policy lapses?  Can the insurance company just keep the cash value?  No!  They are generally required by law to provide the owner of the policy a choice of what they would like to do with their cash value.  This is where the nonforfeiture values come in!

What else can help me prepare to pass my insurance licensing exam on my first attempt?

If you need any help preparing to pass an insurance licensing exam, we have some excellent courses which are primarily video-based.  Check out our available courses now:

Insurance Licensing Exam Prep Video Training Courses

Other tips to help you pass your insurance licensing exam on your first attempt:

Insurance Exam Test Taking Tips

Also, check out our definition and question of the day videos on our YouTube channel:

PassMasters Insurance Exam Prep YouTube Channel