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.
This 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 take 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 immediate 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 of 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.