Whole life insurance offers three nonforfeiture options that ensure policy owners receive value from their policies should they cancel them prior to death. The exact value of the nonforfeiture benefit depends on the length of time that the policy owner paid premiums–more premiums paid means more nonforfeiture benefit.
These benefits stem from laws originating in Massachusetts that set forth minimum benefits life insurers must share with policy owners who pay a certain level of premium. These laws evolved and eventually all states in the U.S. adopted some level of nonforfeiture requirement.
The Three Nonforfeiture Options
Today there are three nonforfeiture benefits traditionally found on all whole life policies; they are:
- Surrender for Cash Value
- Extended Term Insurance
- Reduce Paid-up
Surrender for Cash Value
All whole life policies accumulate cash value. This accumulation is guaranteed by the contract and some whole life policies can accumulate non-guaranteed cash value through the payment of dividends.
These nonforfeiture benefits work as the payment of the accumulated cash value to the policy owner should he/she decide to cancel the policy.
For example, assume George has a whole life policy with a $1 million death benefit and $50,000 in cash value. George decides that he no longer wants his death benefit and no longer wishes to pay the premium on his policy. He cancels his policy and by virtue of canceling it, he exercises his nonforfeiture benefit to surrender the policy for its cash value.
Upon cancelation, the insurance company sends George a check for the $50,000 accumulated in his whole life policy.
Extended Term Insurance
Extended-term insurance is a way whole life policyholders can turn their whole life policies into term life insurance without needing to pay premiums. This option takes the present death benefit of the whole life policy and turns it into a term policy that will last for a predetermined period of time. This period of time depends on the amount of cash value accumulated in the whole life policy.
For example, assume Beth has a whole life policy with a $500,000 death benefit and $100,000 of cash value. She would like to exercise the extended term insurance option on her whole life policy. The insurance company calculates the nonforfeiture benefit and determines that Beth will have her term life death benefit of $500,000 for the next 35 years.
Upon completing the paperwork for the extended term insurance option, Beth will have a $500,000 death benefit that will require no premiums paid by her. At the end of year 35, Beth's term life insurance will expire.
It's worth noting that most whole life policies default to this nonforfeiture benefit. So if the policyholder does not pay the premium when due and he/she has not elected the automatic premium loan feature, it's extremely likely that the policy will trigger the extended term insurance benefit. This is a way for insured's to keep their coverage should they fail to pay the premium when due.
The Reduce paid-up option allows the whole life policy owner to keep a portion of his/her death benefit in force and continue to benefit from other features of the whole life policy such as guaranteed accumulation of cash value and dividends (if applicable). Exercising this option makes the policy immediately a paid-up life insurance policy.
The death benefit created by the reduce paid-up option is dependent on the cash value in the whole life policy at the time the policy owner exercises the option.
For example, assume Vivian has a whole life policy with a $1 million death benefit and $250,000 in cash value. She wishes to exercise her reduce paid-up nonforfeiture benefit. Upon triggering this option, Vivian will still have $250,000 in cash value, but her death benefit will become $600,000. She will pay no future premiums to her policy, but she will continue to earn dividends on her policy and her cash value will continue to earn guaranteed interest. She'll also have the ability to withdraw money and take policy loans from the policy.
What do the Nonforfeiture Options Guarantee the Policy Owner?
All three nonforfeiture options guarantee different things to the policy owner. In the case of a cash surrender. The guarantee is the cash value currently in the whole life policy. The extended term insurance option guarantees the policy owner the current death benefit of the whole life policy for a guaranteed number of years with no premium payment required. The reduce 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.
Which Nonforfeiture Option Continues to Build up Cash Value?
The reduce paid-up option will continue to build up cash value. It will do this through the accumulation of guaranteed interest and (if applicable) the payment of dividends assuming the dividend option is set to paid-up additions.
The other two options, extended-term and cash surrender will not continue to build up cash value for the policy owner. Term insurance has no cash value. And the surrender for cash value completely ends any life insurance in force from the whole life policy. The policy owner is free to do whatever he/she wishes with the money released from the surrender for cash value option.
Which Nonforfeiture Feature Provides Coverage for the Longest Period of Time?
We need to break this question down into two targeted goals because the answer depends on the specific goal.
The option that will provide guaranteed coverage of the original death benefit for the longest period of time is the extended term insurance option. There is no change made to the death benefit when the policy owner triggers this benefit.
The option that will provide some level of death benefit for the longest period of time is the reduce paid-up option. The resulting death benefit after triggering this feature will be less than the current death benefit, but this amount is guaranteed to remain in force for the insured entire lifetime. There is a chance that the death benefit will grow to an amount greater than the amount of death benefit remaining after triggering this feature. This situation will only be true if the whole life policy earns dividends, if the dividend option is set to paid-up additions, and if the dividends paid are large enough to eventually create a greater death benefit. This means this result is not guaranteed.
Cash Value Required to Exercise one of the Options
The option to exercise a nonforfeiture benefit only exists if the whole life policy has cash value. Some whole life policies will have no cash value for the first few years. In this case, the policy owner does not have the option to use one of these benefits. If he/she wishes to cancel his/her whole life policy, he/she will receive no benefit at this point.
The amount of cash value in the whole life policy will dictate the amount of nonforfeiture benefit value the policy owner can get upon triggering the feature.
For example more cash value will generally produce a greater number of years of extended term insurance coverage. More cash value when using the reduce paid-up option will cause the reduction in death benefit to be less. And of course, the more cash value will mean the larger sum of money the policy owner gets if surrendering the policy for cash.
4 thoughts on “Nonforfeiture Options of Whole Life Insurance”
A Whole Life policy, issued in 1990 for $300,000 face value, has reached a cash value of $155,000 with a Guaranteed 5% Interest rate and a COI of $4,140 annually (Policy holder has paid in $3226 for 30 years – also poured in $18,000 the first year). This policy is now generating over $7,000 annually in guaranteed interest – more than enough to cover the growing COI. Additionally, this policy has a Maximum Premium cost of $6801.19. The company stands firm that the cash value is not ample enough to suspend premium payments, until year 34 of policy. Yes, the company has offered a reduced paid up amount of approx. $260,000 – BUT after 30 years the policy owner desires to retain the original $300,000 death benefit. This policy originated with Sovereign in 1990, then acquired by Jefferson Pilot, then acquired by Lincoln in 2006. The current company stands firm that this policy has not reached the point for the interest to cover the annual premium or COI due to non-guaranteed values. How can that be applied to this policy when the 5% annual interest rate is guaranteed and the cap on the premium costs, even growing annually has a cap (now, at current COI costs, completely covered with current annual interest amount paid). The continued response from the company states that the policy has not performed as projected due to fluctuation in interest rates and COI.
What? If this policy has always had the 5% GUARANTEED annual rate and there is a Maximum Premium cost stated as part of the Policy – why, after 30 years, doesn’t this policy qualify to suspend annual premium payments with retaining the $300,000 death benefit?
What is the insurance company’s response to what you laid out in this comment?
Their legal consultant has stood firm stating, “Because interest rates have not remained at the level they were (8.25%) when you purchased the policy, you do not yet have sufficient non-guaranteed cash value in your policy to use those values to pay future premiums.” “Our information indicates that based upon the continuation of our current non-guaranteed factors (cost of insurance and interest rates), you will need to pay premiums through policy year 34 (age 78) in order to utilize the automatic payment of premium provision to pay all future premiums.” Just wondering what “math” they are using? Another, earlier, reply projected that premium payments would need to continue to ensure that this policy would stay in force until age 99, point when the policy would reach the point of maturation! I certainly understand that interest rates dropped significantly since the policy was established in 1990 (projection for “vanishing” premium was year 8!) but, even when interest rates dropped below 5% (in the 2004 range?) this particular policy would not have been negatively affected, due to the GUARANTEE 5% factor. Why would Lincoln continue to state the terms “non-guarantee”, when, in my opinion, my agent ( who, sadly, passed away in 1992) put some definite protections, guarantees, in my policy. My wife and I certainly do not have the financial resources to move ahead, aggressively, with a law suit – just hate to keep paying annual premiums. We are both in our seventies and feel we have been patient, yet prudent, in our inquiries. We have, recently, asked for an in force illustration, again, that will show cash accumulation values and premium payments (used by the ample interest generated) going forward. The first time this particular illustration was requested, and the letter stated IF in bold face letters, we were to choose now to stop payments (of course, filling out required documents) the reply we received from the legal contact at Lincoln stated “the policy will lapse, without value” – good grief, do they think we are complete idiots? We are, currently, waiting for the same illustration, requested a week ago, clearly stating that we only want to see what the numbers look like – perhaps, we could view when the values would “zero out.” My wife is an excellent mathematician (retired elementary teacher) and she has constructed her own illustration. It shows there is plenty of cash value, continuing to grow, using the interest alone to pay the COI, even with exaggerated increases in this amount (remember, there is a CAP on the COI of $6801.19) that would take ample coverage of annual premium payments way beyond age 100. Can you give us any advise? Thank you!
I would certainly wait for the in-force illustration and see what the guaranteed ledger tells you. If you haven’t requested it, you might want to amend the in-force request to include a year-by-year policy expense breakdown, which is customary for current day universal life insurance policies, but I’m not sure what will be available for this policy.
Part of the problem for Lincoln may be the systems that Jefferson Pilot used to track policy values. When an insurer acquires another, it has to figure out how to track policies issued by that other insurer, this can lead to long term policy maintenance problems. By now, Lincoln should have figured it out, but unfortunately, a part of figuring that out may have been to simply limit what they were capable of reporting on for a specific policy.
The other thing that may become necessary if sorting out what state laws apply to this policy. If you submitted a premium payment with the application, then the laws of the state in which the insurance company was domiciled at the time of application govern. If you did not submit payment with the application, then the laws of the state in which you had legal residence govern. The tricky part will be unearthing what laws might compel Lincoln to provide you with more precise/timely information. These can vary quite substantially. It might be worth reaching out to the department of insurance for whichever state’s laws apply here to see if you can get any free advice.
But before you go there, see what the in-force guaranteed ledger says. If it shows the ability to pay no premiums and maintain the death benefit, then the rep at Lincoln was simply wrong. But you also need to ensure that you understand what the ledger is saying. It may be worthwhile to at least hire someone to interpret (from an inside the insurance industry point of view) the information coming from Lincoln.