What Happens If a Life Insurance Policy Lapses?

Life insurance policies provide a death benefit to designated beneficiaries upon the insured’s passing. This financial protection can help cover various expenses, such as lost income, outstanding debts, or educational costs, offering a degree of security for families. Maintaining an active policy is therefore important to ensure these intended protections remain in place. An active policy means that premiums are paid regularly, keeping the coverage in force.

Understanding Policy Lapse

A life insurance policy lapses when premium payments are not made, leading to the termination of its coverage. This means the insurance company is no longer obligated to pay a death benefit. The process of a policy lapsing typically begins after a missed premium payment.

When a premium is not paid by its due date, the policy enters a grace period, usually 30 or 31 days. During this time, the policy remains active and the overdue premium can still be paid without penalty. If the insured individual passes away during this grace period, the death benefit is still paid, though the missed premium amount might be deducted from the payout.

If the premium is not paid by the end of the grace period, the policy lapses. The way a policy is affected by non-payment can differ based on its type. For instance, term life insurance policies, which do not accumulate cash value, lapse once the grace period expires.

Permanent life insurance policies, such as whole life or universal life, accumulate a cash value. If a premium is missed on these policies, the insurer might first use the existing cash value to cover the payment, preventing an immediate lapse. However, if the cash value is depleted or insufficient to cover the premiums, these policies also enter a grace period and lapse if payments are not resumed.

Maintaining Policy Coverage

Life insurance policies include provisions designed to help policyholders maintain coverage or retain some value, even when facing challenges with premium payments. One such feature found in cash-value policies is the Automatic Premium Loan (APL). This provision allows the insurer to automatically use the policy’s accumulated cash value to pay an overdue premium.

The APL acts as a loan against the policy, drawing from its cash value to ensure the policy remains in force. This automatic action helps prevent an unintended lapse, providing a temporary solution for missed payments. While beneficial for maintaining coverage, these loans accrue interest, which can impact the policy’s cash value and death benefit over time if not repaid.

Cash-value policies also offer non-forfeiture options, which allow policyholders to access accumulated value if they stop paying premiums, rather than letting the policy lapse. One option is Reduced Paid-Up Insurance, where the existing cash value is used to purchase a smaller, fully paid-up policy. This new policy requires no further premium payments and provides a reduced death benefit for the remainder of the insured’s life.

Another non-forfeiture option is Extended Term Insurance. Here, the policy’s cash value is used to purchase a term policy for the original face amount. This term coverage lasts for a limited period, determined by the amount of cash value available. These options offer alternatives to policy termination, allowing policyholders to retain some form of insurance protection or value from their premiums paid.

Reinstatement of a Lapsed Policy

If a life insurance policy lapses, it may be possible to reinstate it. Reinstatement is typically available within a timeframe after the policy lapses, often ranging from two to five years. This period offers a window of opportunity to restore the policy, but eligibility is not guaranteed and depends on the insurer’s specific terms.

The process requires several actions from the policyholder. First, all overdue premiums must be paid, often along with accrued interest. The interest rate on these overdue amounts can vary but might be around 6% annually.

Second, policyholders must provide evidence of insurability. This involves completing a health questionnaire and, depending on the time elapsed since the lapse, may require a medical examination. The insurer assesses any changes in the insured’s health since the policy was originally issued.

Third, any outstanding policy loans, along with their accumulated interest, must be repaid. Finally, an application for reinstatement must be submitted. The insurer reviews the application and health information to approve reinstatement.

Financial Considerations of a Lapsed Policy

A policy lapse carries financial implications, primarily the loss of the intended insurance coverage. The death benefit will not be paid to beneficiaries upon the insured’s passing, leaving them without the anticipated support.

For permanent life insurance policies that have accumulated cash value, a lapse can also result in the forfeiture of this built-up value if non-forfeiture options were not elected. While policyholders might have the option to surrender the policy for its cash value, this typically involves receiving the cash value less any applicable surrender charges or fees.

The decision to let a policy lapse can lead to a loss of the premiums paid, especially for term life insurance where no cash value accumulates. If new coverage is needed after a lapse, obtaining a new policy might come with higher premiums, particularly if the insured’s age or health has changed since the original policy was issued.