What is a Nonforfeiture Clause?
A nonforfeiture clause is an element included in standard life insurance and long-term care insurance. It stipulates that the policyholder will receive a partial or full refund of premiums paid if the policy lapses after a defined period due to missed premium payments. The nonforfeiture clause may also become available when the holder of a whole life insurance policy surrenders the policy.
- A nonforfeiture clause is an insurance policy clause that is included in standard life insurance and long-term care insurance.
- It stipulates that a policy owner will receive partial or full benefits or a refund of premium paid towards a whole life insurance policy if the policy lapses due to non-payment.
- A nonforfeiture clause may also become available when the policy owner surrenders the policy.
How a Nonforfeiture Clause Works
If a policy owner has continually made premium payments for a sufficient amount of time, a forfeiture clause might become active in one of two ways. The insured party’s coverage can be terminated automatically when the policyholder fails to make premium payments or when he/she surrenders the policy.
In permanent life insurance, the policyholder will not lose the life insurance policy entirely. Instead, there are four options that the owner can choose from in order to access the accumulated cash value. These options include:
- The owner gets the cash surrender value in cash, either partially or in full.
- Opt for reduced coverage with a reduced death benefit for the remaining term of the insurance.
- Use the accumulated cash value to pay the remaining future premiums.
- Buy extended insurance with accumulated cash value with no additional premiums required.
If the policyholder does not choose any of the above options after the policy is terminated or surrendered, the insurance company will go for the payout option stipulated in the life insurance policy of the owner.
Payout Options Under Nonforfeiture Clause
The goal of a life insurance policy is to protect the surviving dependents of the policyholder such that, after the death of the insured person, the insurance company pays a specific sum to the named beneficiaries.
However, when the policy is terminated or the owner surrenders the policy, the death benefit ceases to exist. The policy owner does not forfeit the previous payments and is entitled to receive the policy’s cash value.
The insurance company charges a surrender fee to the policy owner to cover expenses incurred in recording the policy in the company’s books and any administrative expenses incurred. Also, any outstanding amounts on the insured party’s coverage are deducted from the cash value.
The following are the payout options outlined in the nonforfeiture clause of a whole life insurance policy:
1. Cash Surrender Value
If a policy owner chooses the cash surrender value option, the insurer will pay the remaining cash value within six months. Such an option considers the saving component of the policy. Usually, permanent life insurance generates low returns in the early years of the policy due to administrative and acquisition expenses.
The policy starts generating returns by the third year, and part of the revenue goes to policy reserve, while the remaining revenue goes to cover administrative costs, agent commissions, and acquisition costs.
When a policy is in force for a longer duration, the better the cash values and the nonforfeiture values. In most cases, the surrender cash value may be different from the cash value due to the policy owner. The cash surrender value will also be reduced by any outstanding loan amount.
2. Extended-Term Option
The extended-term payout option allows the policy owner to buy an extended-term policy using the cash values from the original policy. The length of time when the new policy will be in force will depend on the cash values available from the original policy and the age of the insured party at the time the person chooses the extended-term option.
In some instances, insurers provide an extended-term option as an automatic option in the event that the original coverage lapses due to missed premium payments. The extended-term insurance also helps the policy owner to quit paying premiums for the original policy, but retain the equity accumulated in the policy.
3. Reduced Paid-up Insurance
In a reduced paid-up insurance option, the policy owner receives a lower amount of payments made as premiums for the original whole life insurance. The option allows the policyholder to retain the death benefit without being required to make additional future premium payments.
However, the death benefit that surviving dependents of the policy owner would receive is lower than the amount of cash value in the original life insurance policy. The reduced life insurance coverage is calculated based on the insured’s attained age, cash surrender value, and the number of premiums paid by the policy owner. Insurers require policyholders to have paid at least three years of premiums before they can be eligible for paid-up insurance.
CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: