The last thing that any person wants is for their life insurance policy to lapse before they really need it, thus leaving both the insurance company and the surviving members of the person’s family distraught and helpless without any death benefit. This is definitely not something to be taken lightly: The potential consequences of a lapse in life insurance stretch far and wide, from your dependents to your heirs to your spouse to your estate and everyone and everything in between. Therefore, staying on top of life insurance premiums and making payments on time is of the utmost importance.
Still, what happens if your life insurance policy does happen to lapse? Is there a grace period, or will the policy simply be dropped? Can the policy be reinstated, or are the death benefits gone for good? If a reinstatement is possible, will your premiums go up after a lapse in life insurance? And what can you do to save yourself the trouble and avoid them altogether? To understand the answers to these pressing questions, we must first understand the basics of insurance policies and who benefits from them — These different components will all impact the answers to varying degrees.
First thing’s first: There are four different kinds of life insurance policies for a person to choose from. These include term life, whole (or permanent) life, universal life, and variable life. No one policy will be a one-size-fits-all for every person, and each policy comes with a unique set of terms and conditions to fit an individual’s unique needs. Not to mention, each policy comes with its own set of rules for handling a lapse.
The four different types of life insurance are broken down below, with each section highlighting the unique factors that distinguish one policy from another. To truly understand lapses, it’s essential to understand how these four policies differ.
As the simplest form of life insurance currently available, term life insurance only offers a death benefit if the death happens during the term of the policy (which can stretch anywhere from one to 30 years or more). Because it's so simple, there are usually not any benefits beyond the payment.
It's also worth noting that there are two different kinds of term life insurance: level and decreasing. Level means that the death benefit stays the same from the first day of the policy to the last. Decreasing means that the death benefit shrinks at a steady rate throughout the duration of the policy, typically dropping a bit each year from year one to year 30.
Whole (also known as permanent) life insurance doesn't limit the death benefit to the terms of the policy — the insurance company pays no matter when the holder of the policy happens to die. Whole life breaks down into three different types: traditional, universal, and variable universal. Additionally, each of these three types has variations within them.
To keep things simple, let's focus solely on traditional whole life. This form keeps the death benefit and the premium the exact same throughout the length of the policy. From there, the cost per thousand dollars of benefits will increase as the policyholder gets older. This means that, if the person happens to live for quite some time, their death benefit could get very high. Typically, whole life insurance charges higher premiums that exceed the minimum payment in the early years to help account for this.
Referred to as “overpayments,” the law states that, when the money reaches a designated value, it has to be made available to the policyholder in the form of a cash value. This way, if the policyholder decides to drop their policy, they'll still be able to have the money they invested. Of course, this overpayment cash value is considered an alternative, not an additional, benefit for whole life.
Then there's the aforementioned universal life insurance, also sometimes referred to as adjustable life insurance. This specific policy gives the holder a lot more wiggle room than other policies like traditional whole or term life. The cash value amount of the death benefit steadily increases in value because of its money market rate of interest. Once the money has accumulated a bit of value, the policyholder is presented with the option to alter their premium payment (as long as there's actually enough money to cover the premium costs, that is).
Lastly, there's variable life. Variable life policies are unique because they take death protection and combine it with a personal savings account with funds that can be used to invest in stocks, bonds or other money market mutual funds. This means that the monetary value of the policy can increase in value quite quickly, but it also means that it involves a lot more risk than any other policy. If a policyholder's investments aren't the best, their death benefit might end up being a lot lower than with any other policy. To account for this, some insurance companies will set a minimum level that the death benefits aren't allowed to fall below.
There's also universal variable life, which takes the best features of variable and universal life and combines them into one policy. This means that it carries the same investment risks and rewards of variable life insurance with the ability to tweak premiums and the death benefit of universal life insurance.
Now that there's a better understanding of the basics of life insurance policies and what each of the different policies has to offer, it's important to take a look at who exactly benefits from these insurance policies in the first place. If a life insurance policy lapses, these are the people who are going to be hurt the most from the loss of a life insurance benefit.
From the policyholder's children to their spouse to their potential heirs to the charities they wish to donate to, a lapse in life insurance has the potential to impact a wide-ranging web of people that stretches far beyond the policyholder themselves. Let's take the time now to break down each of these different potential benefactors and examine how the death benefit helps ease the stress and financial burdens that arise in the wake of the policyholder's eventual passing.
A policyholder's dependents can stretch far and wide: children, adopted children, foster children, brothers, sisters, nieces, nephews, grandchildren, or anyone else who depends on the income of the policyholder. Life insurance death benefits exist to help replace the missing income when the person passes away. While the list of potential dependents is endless, simply think of parents who have young children.
A replacement income is essential for the surviving spouse to survive — this is especially true if/when the government or employer benefits of the remaining spouse are reduced in the wake of the policyholder's death and the young children are not nearly old enough to enter the work force themselves.
Creating an inheritance for heirs is important to a lot of life insurance policy holders, especially when there aren't many other assets to pass on to future generations. By purchasing a policy and listing one's heirs as the benefactors, a policy holder has the potential to provide their heirs with a nice death benefit.
Policyholders also have the option to support their heirs with designated savings accounts funded by their policy proceeds. This is most often seen with policies that provide a cash value. If that cash value is not paid out to benefactors as a death benefit, it can be borrowed or withdrawn from freely based on the owner’s request. This means that a cash value policy has the ability to create a unique kind of savings plan. Plus, as an added bonus, the interest credited is always tax deferred (and tax exempt, too, as long as the money was paid in the form of a death claim).
When a spouse dies, the surviving spouse is left dealing with a whole slew of stressful expenses: the price of the funeral and burial, probate and other estate administration costs, medical or financial debts and expenses not covered by the deceased's health insurance, federal and state "death" taxes (depending on the state), and all sorts of other costs that can't possibly all be accounted for. This makes the death benefit an essential thing for the surviving spouse especially. Without it, they'd be left scrambling to come up with a way to cover these very expensive costs on their own. Nobody wants to deal with that sort of thing, especially during the early months of the grieving process.
Last (but definitely not least), charities can benefit immensely from a policyholder's life insurance death benefits. Many people take great pride in listing their preferred charity of choice as a benefactor to their life insurance policy, giving them the opportunity to do something good with the insurance money they've been adding to throughout the decades.
This is typically why we see university buildings, park benches, research centers, and even budding trees named after a deceased person: their life insurance policy allotted a designated amount of funds to be donated to the institution, and they repaid them by naming something after them. Not only is a charitable donation an incredibly noble thing to do, it's also a great way to establish a profound and lasting legacy for decades to come.
Now that we have a firm grasp on the basics of life insurance policies and understand who benefits the most from them, it's time to answer the important questions about lapsed insurance policies. From grace periods to refunds to premiums, these questions and their answers should resolve any lingering inquiries you may have about your life insurance policy.
If your life insurance policy does happen to lapse, you need to move very quickly. Get in touch with your agent as soon as you possibly can and ask them for a reinstatement. They should be able to take your payment and get it where it needs to go so that your lapsed policy can be reinstated.
Luckily, a life insurance policy will not simply lapse the day after you miss a payment. All 50 states require that an insurance policy goes through a grace period (typically 30 days). During this time, the insurance provider will still offer coverage and make a full payout of death benefits if the policyholder happens to pass. After those 30 days without a payment, the policy has effectively lapsed. At this time, the insurance company doesn't have to pay a dime if the policyholder passes away.
This question does not carry a simple yes or no answer — While some insurance policies include a nonforfeiture clause that guarantees you still receive some sort of significantly reduced benefit even if the policy lapses, others might not be so kind. However, with other policies, coverage doesn't lapse when payments stop. Instead, your death benefit will be significantly decreased according to the percentage you paid.
If your policy lapses, you can expect to make a much larger payment in order to reinstate the policy and make up for the payments you didn't make. This supersized payment is not considered a late fee, but rather an advance on the next few monthly payments: It's a way to prove to the company that you will not be lapsing any longer and that you are committed to your policy's terms.
Typically, if a premium payment is missed, whole, universal, and variable universal life insurance policies will subtract the payment from the cash value. While this can save your skin once or twice, this can't happen forever. Once the cash value hits or nears zero, the policy will totally lapse. (Not to mention, term life policies don't have a cash value — the policy will enter the grace period immediately after a missed payment and then lapse once the period is up.)
The very best thing a policyholder can do is not miss a premium payment. You can't always depend on the cash value or the potential nonforfeiture clause to have your back when there's a lapse in life insurance. To keep your life insurance policy from lapsing and to secure your death benefit for your dependents, heirs, spouse, and charities, just make your payments to the insurance company when they're due and you'll be in the clear. It's best to just not risk it at all in the first place.
Still have questions about the consequences of a lapse in life insurance? PolicyScout is here to help you understand. Learn more about life insurance policies in our learning section, or get a quick, easy (and free!) life insurance quote today.