How To Prevent and Solve A Life Insurance Policy Lapse

The image shows happy seniors playing guitar together after avoiding a life insurance policy lapse.

How much cash is your policy worth?

Find out in seconds

If you own a life insurance policy of any kind and you allow it to lapse, you can lose several key benefits that were provided by the policy. If you owned a term insurance policy and just quit making the premium payments because you either could no longer afford them, or decided that you didn’t need the death benefit protection anymore, then your policy will lapse after a grace period of 30 to 60 days. If you owned a cash value policy and allowed it to lapse, then you may also forfeit some or all of your cash value in some cases.

Life insurance policy lapse: A major event but not irreversible

Allowing a life insurance policy to lapse is a major event in your financial timeline. The insurer that provided you with the lapsed policy will notify you that your policy is in danger of lapsing and will try to get you to pay all of the premiums you owe so that you can stay current with your coverage.

However, reinstatement can be an expensive proposition in many cases. If you quit making payments eight months ago and want to renew your policy, you will most likely have to make those eight payments up before you can do so.

What happens when my life insurance lapses? 

Research suggests that as many as 8 out of every 10 life insurance policyholders eventually stop making life insurance premium payments either before the policy’s term has expired (in the case of term life insurance) or the policy pays out (as with whole life or universal life). When a life insurance policy lapses, the death benefit becomes inactive and will stay that way until you make up for all of those missed premium payments. The life insurance company will not reinstate your policy until you are current once again.

If you allow a cash value policy to lapse, then you may have to settle for taking the surrender value of the policy, which could be considerably less than you were counting on. This can also be a taxable event in some cases, so talk to your tax advisor before you do this.

How many payments do I have to miss before my policy lapses?

Any type of life insurance will lapse if you miss one or more premium payments, so there will always be consequences from this. If you own a term life insurance policy, then you’re most likely allowing a much larger amount of coverage to disappear if you quit making the premium payments.

Can I get my policy back, or should I get new coverage? 

It is usually cheaper to reinstate your old policy than to take out a new one, depending upon various factors such as your age and health. If insurability is an issue, then you should probably take all reasonable measures necessary in order to keep your current life insurance coverage in force. Non-payment of one or more policy premiums will always disrupt your coverage, so it may be a good idea to add on a waiver of premium rider so that you’re covered if you were to become incapacitated for a period of time in the future.

Reinstatement requirements

It is also not a given that you will be allowed to reinstate your policy if you let it lapse. Life insurance companies are not required by law to extend this courtesy, so you’ll have to check with your life insurance carrier to find out what their requirements are for reinstatement.

At the very least, you will probably have to fill out a few forms in addition to making up for your missed payments in order to get your policy going again. There may also be additional fees and penalties assessed by the carrier. But most life insurance carriers allow their policy owners to reinstate their policies for up to five years after they lapsed. It all depends on what is written into the insurance contract.

Automatic premium loans 

Those who own whole life policies or another type of permanent life insurance policy may be able to use the cash value that has built up inside the policy to cover their premium payments for at least a certain period of time. Most cash value policies have a rider built into them that allows the insurance company to use the cash value in the policy to cover the payments if the insured cannot make them.

For example, a whole life insurance policy that has accumulated $50,000 of cash value can allow the insurance company to make payments this way for a long period of time if necessary.

The grace period

Requirements for reinstatement may differ depending upon how long ago your policy lapsed. If you’re less than 30 days late with your premium, then you’ll probably be able to get by completing a single reinstatement form and sending them the payment you missed.

Happy senior couple celebrating by taking a selfie after preventing a life insurance policy lapse.

If your policy lapsed several months or even several years ago, however, then you may have to satisfy some additional underwriting requirements in order to make your policy effective again. The life insurance company will probably want to know whether you have developed any new major health conditions since your last medical exam.

The coronavirus effect

Of course, the coronavirus has substantially disrupted the cash flows of millions of Americans, and the life insurance industry has taken steps to help policy owners keep their coverage in force while they reorganize their finances. Some policy owners have been able to make their lost payments by the end of the grace period, while others have been forced to stop making their life insurance payments altogether. But many life insurance carriers have offered measures of relief in all of their insurance products as a way to keep these policies alive.

Some insurers have extended their grace periods to 60 or even 90 days in some cases. Higher premiums are sometimes necessary for those who discontinue their payments beyond the grace period, but the life insurance industry has on the whole been very understanding to its customers during this outbreak. Some insurers have even automatically extended their grace periods, while others require the policyholder to call the carrier or provide written proof of financial difficulty.

Consequences of reinstatement 

If you are able to reinstate your policy, then you’ll usually have to make a larger payment than your regular payment. This shows the insurance company that you are serious about keeping your policy in force. And, as mentioned previously, you may also have to pay late fees and other administrative costs on top of your missed premiums. Your incontestability period will also begin again, and you’ll need to disclose any changes in your health to your insurance company.

Always be honest

Regarding this last point, it is never a good idea to lie to the insurance company about any possible changes in your health. If you were in relatively good health when you signed up for the policy but have gone downhill in some respects since then, then you’ll probably have to pay a higher premium payment from now on in order to keep your policy in force. You may have to prove to the carrier that you’re still just as healthy now as you were then in order to keep your payment close to what it was before. If your carrier finds out that you lied about your health on your reinstatement paperwork, they will cancel your policy and keep all of your premiums.

How to prevent a life insurance lapse 

As is the case with most problems, prevention is the best solution. Here are some ways you can make sure your policy doesn’t lapse so you don’t find yourself without coverage.

Set up autopay

Since a single missed payment can cause your policy to lapse in many cases, so it’s a good idea to set up an automatic draft from your bank account by the policy due date so that you don’t accidentally neglect this obligation. A lapsed life insurance policy may also show up on your credit report, just like other types of late payments, so be cognizant of this consequence when you take out a new policy.

What's your life insurance policy worth?

Your loved ones are counting on the payout from this coverage to protect them, so don’t put them at risk by accidentally allowing your policy to lapse. Be sure to notify your life insurance carrier or your life insurance agent if you change your checking account or move to a new address so that your monthly premium payments continue as before.

Pay an annual premium 

Paying an annual premium is another strategy. You may get a slight discount if you can manage a single payment every year, and this way it is less likely that your payments will get disrupted for any reason going forward. Most life insurance carriers offer a discount of anywhere from 2% to 8% for an annual premium payment, so be sure to take advantage of these savings if you possibly can.

Stay in touch with your insurer 

Your life insurance company will always notify you through text, email or written notice if your policy is about to lapse. You should contact your carrier immediately if you receive this notice so that they know that you are on top of things. If you have to miss a payment or two for any reason, explain this to them so that they know what to expect going forward. This alone may prevent your policy from lapsing in some cases. If you incurred a large medical bill and didn’t have enough money to pay the hospital and your life insurance policy too, then your insurer may be willing to grant you a free extension. But it’s imperative that you get hold of them before the grace period ends.

I am the beneficiary of a policy that has lapsed. What can I do? 

If you are the beneficiary of a policy that has lapsed, you may be able to keep the policy in force by paying the premiums yourself. You may have to obtain a power of attorney from the policy owner in order to do this, so be prepared to enlist the help of an attorney if this is what you need to do. You can also keep in touch with the owner of the policy to make sure that the premium payments are made on time with regularity.

An example of a life insurance policy lapse 

Jim bought a policy on himself when he was 40 years old. He paid $200 per month for $200,000 of convertible term coverage. He made premium payments for five years before losing his job. He was unable to keep the policy in force before the grace period ended, so he had no choice but to let it lapse.

A year and a half later, Jim found another job and applied to get his policy reinstated. But by then his health had started to decline, as he was diagnosed with cirrhosis of the liver. He was required to make 18 back payments of $200 each for a total of $3,600 plus some late fees and other administrative costs. All told, he had to pay a total of $4,000 and had to restart his contestability period again. Jim’s new premium cost rises to $250 per month going forward.

If Jim had purchased an indexed universal life policy instead, he might have been able to use the cash value that built up during the first five years of the policy to pay his premiums while he was unemployed. Of course, term insurance has no cash value, so this was not possible for Jim.

The life settlement option

If you’re like Jim, and you have no choice but to let your policy lapse, there’s another option that’s quickly becoming the most popular among life insurance policyholders today: A life settlement. 

A ‘life settlement’ is when an individual sells their life insurance policy to a third-party buyer in exchange for a lump-sum cash payment. The policy can then be resold on the secondary market, oftentimes to institutional investors who hold them as part of diversified financial portfolios.

“Selling” a life insurance policy technically means that the policyholder agrees to transfer ownership of their policy —including the death benefit and monthly premiums — to the buyer. The buyer then assumes responsibility for paying these future premiums (in order to keep the policy active) and in exchange receives the cash payout when the policy matures.

The amount one receives for the sale of a life insurance policy differs based on a number of factors —primarily the size of the policy and the life expectancy of the insured individual. Policyholders will typically receive more cash from a life settlement than from the cash surrender value of the life insurance policy.

Life settlements go by a number of names, including “senior settlement”, and “reverse life insurance.” Occasionally they will also be referred to as “viatical settlements” but this more accurately a type of life settlement designed for terminally and chronically ill policyholders.

Get a free life insurance valuation   

It is seldom a good idea to let a life insurance policy lapse unless you are absolutely certain that you will not need the coverage anymore. Reinstating a lapsed insurance policy can also cost you a bundle, as all missed back payments plus interest and late fees must be paid up before the policy becomes active again.

If you own a life insurance policy and you are trying to decide whether to keep the coverage or not, think of all of the possible reasons why you might need the coverage (or at least the cash value) at some point in the future.

Consult your financial advisor for more information on life insurance and the benefits of keeping your policy in force. Or, if you think a life settlement might be the right option for you, find out what kind of payout you could get with our free life settlement calculator.

Author:
Chris Granwehr is the Founder of Dawn Life Settlements and a former senior manager with Mason Finance, an industry-leading life settlement provider in California. He's a member of the Life Insurance Settlement Association, and he has a passion for empowering customers financially through a faster, easier life settlement system.