It is common to see policy holders not able to pay for their insurance premiums a few years after buying the policy for a few years for various reasons. This can be avoid if proper cashflow analysis was conducted at the point of purchase to ensure there are sufficient funds to pay the premiums. But the truth is despite these prudent measures, there are situations where the policy holders not able to pay the premium remains especially in this period of uncertainty. Is termination of policy the best way for the policy holders or are there better ways? Read on before you terminate your policy.
Under the Insurance Act, the policy shall not lapse or be forfeited by reason of the non-payment of premiums if it the life policy has been in force for 3 years or more. An insurance company will need to provide the policy holder the Non-forfeiture Options to the policy holders if there are cash values (usually after the third policy year). Do note these option do not apply to Investment-linked policy.
The three non-forfeiture options are as below.
We shall look at the various options in detail.
Cash Surrender
Cash values are accumulated in an insurance policy usually from the third year onwards.
There are two ways to get the cash value. The first is to terminate(surrender) the policy and get the cash surrender values. The second way to to take a policy loan on your policy. To put it simply, you can withdraw up to 90% of your cash value and keep the policy in force. You can also use part of the cash surrender value to pay your premiums called Automatic Premium Loan(APL).
In the event of death or a claim, the insurer will pay the balance of benefit after taking away your loan and interest incurred. Typically, insurance companies will charge about 8% p.a. on the premium loan.
Extended-Term Option
For those who are not able to pay for the premium but you still need the insurance coverage can consider the extended-term option. It is more commonly known as the extended-term insurance. You can think this option work as though you are using your cash value to purchase a term insurance equivalent to the benefit of the original plan.
When the policy holder utilised this option, the insurance company will look at the accumulated cash value and base on your current sum assured to calculate the number of years for the extended term. The exact calculation used by life insurers may be slightly different across insurance companies but it should not differ much. Let’s assume a policy holder owns a whole life policy with a $500,000 death benefit and $25,000 of cash value. Due to a job loss, he is unable to pay the premium but you still need the $500,000 death benefit provided by the policy so he utilised the extended-term option.
The insurance company will calculate the number of years that the cash value of $25,000 can buy based on a $500,000 term insurance. You can think of it as buying a Term insurance of $500,000 with a single sum of premium. The number of years is dependent on:
- The death benefit of your policy.
- Your age when you exercise the extended term option.
- The amount of cash value in your policy at the time when you exercise the extended term option.
Let’s assume that in this example that the $25,000 will buy the policy holder a 20 years of $500,000 death benefit. During this 20 years, he will have the $500,000 death benefit if death occur. The $500,000 term life insurance policy will expire and there will not be any cash value should he be still surviving at the end of the 20 years.
One of the disadvantage of extended term option is any riders attached to the whole life policy will be forfeited.
Reduced paid-up option
Another non-forfeiture option is the Reduce paid-up option which is similar to the extended term option. The difference is the primary consideration for extended term option is keeping the death benefit unchanged and for the reduced paid-up option, the consideration is the period of coverage. The reduced paid-up option to allows the policy owner to keep a reduced death benefit in force for the remaining policy term.
The reduced death benefit is dependent on the cash value in the insurance policy at the time the policy owner exercises the option. For example, a policy holder has a whole life policy with a $500,000 death benefit and cash value of $50,000. Upon triggering the reduce paid-up option, the policy holder will still have $50,000 in cash value, but his death benefit was reduced to $200,000 for the remaining policy term. The computation process is similar to extended-term option except the basis of calculation will be based how much the cash value can cover the policy holder for the remaining years. Although the policy holder no longer pays any future premiums to the policy, he will continue to earn dividends or interest on the policy. He also have the ability to withdraw the dividends or take policy loans from the policy.
Any riders attached to your whole life policy will be forfeited as well.
How to apply for the non-forfeiture options?
Good news is you do not need to crack your brains over the calculations for any of the non-forfeiture options. All you need is to call up the customer service department of your insurance company and they will usually have the ready figures.
You are strongly encourage to discuss with your financial adviser representative on the options available and decide which is the most appropriate solution for you. You can drop me a message via whatsapp or by scanning the QR Code if you need any assistance.
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