What is the benefit of choosing extended term as a nonforfeiture option

How a Nonforfeiture Clause Works

If a policy owner has continually made premium payments for a sufficient amount of time, a forfeiture clause might become active in one of two ways. The insured party’s coverage can be terminated automatically when the policyholder fails to make premium payments or when he/she surrenders the policy.

In permanent life insurance, the policyholder will not lose the life insurance policy entirely. Instead, there are four options that the owner can choose from in order to access the accumulated cash value. These options include:

• The owner gets the cash surrender value in cash, either partially or in full.
• Opt for reduced coverage with a reduced death benefit for the remaining term of the insurance.
• Use the accumulated cash value to pay the remaining future premiums.
• Buy extended insurance with accumulated cash value with no additional premiums required.

If the policyholder does not choose any of the above options after the policy is terminated or surrendered, the insurance company will go for the payout option stipulated in the life insurance policy of the owner.

Payout Options Under Nonforfeiture Clause

The goal of a life insurance policy is to protect the surviving dependents of the policyholder such that, after the death of the insured person, the insurance company pays a specific sum to the named beneficiaries.

However, when the policy is terminated or the owner surrenders the policy, the death benefit ceases to exist. The policy owner does not forfeit the previous payments and is entitled to receive the policy’s cash value.

The insurance company charges a surrender fee to the policy owner to cover expenses incurred in recording the policy in the company’s books and any administrative expenses incurred. Also, any outstanding amounts on the insured party’s coverage are deducted from the cash value.

The following are the payout options outlined in the nonforfeiture clause of a whole life insurance policy:

1. Cash Surrender Value

If a policy owner chooses the cash surrender value option, the insurer will pay the remaining cash value within six months. Such an option considers the saving component of the policy. Usually, permanent life insurance generates low returns in the early years of the policy due to administrative and acquisition expenses.

The policy starts generating returns by the third year, and part of the revenue goes to policy reserve, while the remaining revenue goes to cover administrative costs, agent commissions, and acquisition costs.

When a policy is in force for a longer duration, the better the cash values and the nonforfeiture values. In most cases, the surrender cash value may be different from the cash value due to the policy owner. The cash surrender value will also be reduced by any outstanding loan amount.

2. Extended-Term Option

The extended-term payout option allows the policy owner to buy an extended-term policy using the cash values from the original policy. The length of time when the new policy will be in force will depend on the cash values available from the original policy and the age of the insured party at the time the person chooses the extended-term option.

In some instances, insurers provide an extended-term option as an automatic option in the event that the original coverage lapses due to missed premium payments. The extended-term insurance also helps the policy owner to quit paying premiums for the original policy, but retain the equity accumulated in the policy.

3. Reduced Paid-up Insurance

In a reduced paid-up insurance option, the policy owner receives a lower amount of payments made as premiums for the original whole life insurance. The option allows the policyholder to retain the death benefit without being required to make additional future premium payments.

However, the death benefit that surviving dependents of the policy owner would receive is lower than the amount of cash value in the original life insurance policy. The reduced life insurance coverage is calculated based on the insured’s attained age, cash surrender value, and the number of premiums paid by the policy owner. Insurers require policyholders to have paid at least three years of premiums before they can be eligible for paid-up insurance.

Related Readings

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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

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

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.

• 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.6
• 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.4
• 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.

• 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.4
• 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.

Categories: insurance, life insurance

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