Non-forfeiture laws are standard in every state and thus are standard in every whole life insurance policy. A non-forfeiture provision is one that guarantees that a policy owner will receive, upon the lapse or cancellation of the whole life policy, a return equal to the cash value in the policy. There are three standard options:
Extended Term
If the insurer does not receive instruction to the contrary within 60 days after a policy lapses, the insurer will use the available cash value to purchase term insurance in the same face amount as the original whole life policy, for as long a term as the cash value will allow.
Reduced Paid-Up
This option will use the cash value to purchase a paid up policy of the same type as the lapsed policy, but for a lesser face amount. No further premiums will be due and the policy owner still owns a whole life policy.
Cash Surrender
Insurers are required to make cash surrender values available after the third year for an ordinary policy, although most insurers make the cash values available sooner. Insurers put a table of minimum cash surrender values in their policies.
Dividend Options
As discussed earlier, mutual life insurance companies issue participating policies that may pay policy dividends. Dividends are surplus that is distributed to participating policy owners in proportion to the face value of their contract.
In computing premium rates, mutual companies intentionally overestimate their future needs for funds. These overcharges provide additional protection to the insurer in the event that operating costs are higher than anticipated, and assure policy owners that a dividend will be forthcoming.
Policy dividends, unlike stock dividends, are not subject to personal income taxation because they are considered a return of premium. Dividends cannot be guaranteed by an insurer.
A participating policy owner has several options of what to do with a dividend. Common dividend options include:
Cash
The policy owner may elect to receive the dividend as a cash payment.
Reduce Premium Payments
The dividend may be used to offset future premiums.
Accumulate at Interest
The dividend may be left with the insurer to accumulate interest. While the dividend is paid tax free, any interest received is taxable to the recipient as ordinary income.
Paid-Up Additions
The policy owner may use the dividends to purchase a single premium policy of the same type with no evidence of insurability.
One-Year Term
This option allows the insured to use the dividend to purchase a one-year term policy for whatever face amount can be obtained using the available dividend.
Settlement Options
At some point, if not lapsed or surrendered for its cash value, a life insurance policy is going to pay its benefit. That’s the unique thing about life insurance–it is the only type of insurance with an inevitable covered peril. In most states, life insurance companies are required to pay death claims within 60 days after proper notification of claim is received. The beneficiary has several settlement options to choose from.
Cash
Most beneficiaries select this option and receive a tax-free lump-sum payment from the insurance company.
Fixed Period
A specified amount is paid out regularly for a specified period of time. If the beneficiary dies during this payout period, the company would continue payments to that person’s beneficiary for the remainder of the period. The amount of payment depends on the face amount, the rate of interest, and the length of the payout period. Any portion of the payment attributable to interest on the death benefit will be taxable.
Fixed Amount
This is similar to the fixed period option, except that a predetermined benefit payment amount is selected and payments will be paid for whatever length of time is possible, given the face amount and rate of interest.
Interest Only
With this option, the proceeds are held by the insurance company, which pays a guaranteed rate of interest at specified intervals.
Life Income
The life income option will, in lieu of a lump sum distribution, provide the beneficiary with a guaranteed monthly payment for life.
Lesson Summary
Additionally, aspects of whole life insurance policies include non-forfeiture options, where policy owners receive a return upon policy lapse or cancellation:
Extended Term: Cash value is used to purchase term insurance after lapsing, for as long as the cash value allows.
Reduced Paid-Up: Cash value is used to purchase a paid-up policy of lesser face amount, with no further premiums due.
Cash Surrender: Insurers provide cash surrender values after a specified period, allowing withdrawal of a portion of the policy’s value.
For participating policies that pay dividends, various dividend options are available to policy owners:
Cash: Receive the dividend as a cash payment.
Reduce Premium Payments: Offset future premiums with the dividend.
Accumulate at Interest: Leave the dividend to accumulate interest with the insurer.
Paid-Up Additions: Use dividends to purchase a single premium policy.
One-Year Term: Use the dividend to purchase a one-year term policy.
When a life insurance policy pays its benefit, beneficiaries have settlement options to choose from:
Cash: Receive a tax-free lump-sum payment.
Fixed Period: Get regular payments for a set period, with benefits passed to the beneficiary if the recipient dies.
Fixed Amount: Receive predetermined payments for a specific period based on face amount and rate of interest.
Interest Only: Insurance company holds the proceeds and pays guaranteed interest at intervals.
Life Income: Receive guaranteed monthly payments for life instead of a lump sum.
Chapter Vocabulary
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