When a whole life policy is surrendered for its nonforfeiture value what is the automatic option

When a permanent life insurance policy lapses due to non-payment, or when the policyholder chooses to surrender the coverage, the nonforfeiture clause helps protect the accumulated cash value. Nonforfeiture clauses stipulate how a policyholder can receive their policy’s cash value, allowing them to receive a lump-sum payment or apply the funds to continuing coverage.

• A nonforfeiture clause helps protect a life insurance policyholder’s accumulated cash value.
• A nonforfeiture clause is triggered when a policyholder stops paying premiums or surrenders their permanent life insurance policy.
• A nonforfeiture clause may offer several payout options.
• Some payout options allow the policyholder to continue life insurance coverage.

A nonforfeiture clause determines how an insurance policyholder can receive their policy’s accumulated cash value in the event of a lapse due to non-payment, or when the policyholder chooses to surrender the coverage. The terms and conditions of a life insurance policy require you to make premium payments.

In addition to a death benefit, permanent life insurance policies also build a cash value over time. A nonforfeiture clause, which stipulates that a policyholder will not forfeit their accumulated cash value if they stop paying premiums, is part of many permanent life insurance policies.

Let’s say you have a $120,000 whole life policy that has accumulated a cash value of $30,000. Six months ago, you lost your job and now can’t afford the premium payments. If your policy lapses due to non-payment, you are still entitled to the accumulated cash value if your policy contains a nonforfeiture clause.

After a policyholder has paid premium payments for a sufficient period, the policy’s nonforfeiture clause may apply if the policy lapses due to non-payment. The nonforfeiture clause may also kick in if the policyholder surrenders the policy. The amount of money an insurer will return to the policyholder depends on the policy’s surrender value. This is the amount the policyholder can borrow or withdraw from the accumulated cash value.

Surrender value and cash value are two different things. The cash value is the amount a policy is worth as it grows over time. If you take an early withdrawal from the policy, you will most likely have to pay a steep fee, which will affect the remaining value—the surrender value. 

When a policyholder chooses to surrender their life insurance policy or if it lapses due to non-payment, they may have several payout options.

Automatic premium loan: When a policy lapses due to non-payment, some insurance companies allow the policyholder to borrow the amount of lapsed payments from their policy’s accumulated cash value. This option is only available when the lapsed premiums amount is less than or equal to a policy’s cash value.

Cash surrender value: With this option, the insurance company cancels the policy and pays its cash surrender value in one lump-sum payment. Most state insurance codes enable insurers to take up to six months to make the payment. And once the carrier cancels the policy, it cannot reinstate the coverage.

Extended term: The extended-term option enables the policyholder to use the cash value from the original policy to purchase term life insurance coverage. The length of the term will depend on the amount of cash value accumulated in the original permanent life policy. Nonforfeiture clauses stipulate a default payout, which is often the extended term option. 

Reduced paid-up: This option allows the policyholder to use the cash surrender value to purchase another permanent life policy of the same type with a single lump-sum payment. The new policy will have a reduced face value but will accumulate a cash value without paying further premiums.

Single-premium annuity: Some carriers enable a policyholder to use the cash surrender value to purchase an annuity. The amount of the lump sum payment will depend on the amount of the original policy’s accumulated cash value and will pay the policyholder for the remainder of their life.

Pros

• Retains accumulated cash value

• Option to continue life insurance coverage

Cons

• Reduced death benefit

• Loss of coverage

Retains accumulated cash value: A nonforfeiture clause safeguards a policy’s investment by allowing the policyholder to cash out the accumulated cash value.

Option to continue life insurance coverage: The cash value of a policy protected by a nonforfeiture clause may also be used to purchase another policy or annuity.

Reduced death benefit: When the policyholder chooses the extended term or reduced paid-up options, they can retain life insurance coverage, but with a reduced death benefit.

Loss of coverage: Choosing the cash surrender value option enables the policyholder to keep their accumulated cash value, but it also cancels the life insurance coverage. 

A nonforfeiture clause ensures that a permanent life insurance policy owner will not lose their accumulated cash value. While it’s an important financial safeguard, it requires the policyholder to make wise choices when selecting a payout option.

Sometimes, a policyholder may no longer need the life insurance coverage. In such cases, receiving a lump-sum payout can prove beneficial. But when a policy lapses due to non-payment and the policyholder still needs life insurance coverage, nonforfeiture options, which often reduce coverage, can leave them with insufficient protection.

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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

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