The Real Value Of Nonforfeiture Benefits

Nonforfeiture regulations must change with the times to protect consumer

By Andy Ware

In todays regulatory environment, owners of universal life insurance are not getting the same level of protection against forfeiture as those who own whole life insurance with similar guarantees. The current nonforfeiture law with its origins in the late 1930s is designed to protect a policy owners equity in a permanent life insurance contract. Yet, consumers who own UL policies with secondary guarantees receive less protection under the current interpretations of this law as these policies are held to a lower standard.

Nonforfeiture benefits safeguard policyholders by providing a fair value in the event a premium does not get paid. Cash surrender value, reduced to paid-up and extended term are all examples of nonforfeiture benefits.

It is not uncommon to hear actuaries state that if nonforfeiture benefits were not required, life insurance would cost less. While this may be true, it should not be the overriding reason to negate nonforfeiture laws. Consumer protection does not necessarily mean providing products at the lowest possible price.

A Financial Safety Belt

Think about it this way. Early model cars didnt have safety belts, air bags or crash absorbing bumpersall of which add to the cost of the vehicle and are totally unnecessary for a car to function. If they were optional, theres no doubt many buyers would choose to save money by not purchasing these features. However, safety has been deemed more important than cheaper cars and the government requires all new cars to be equipped with minimum safety features to protect the driver and passengers.

Nonforfeiture benefits act as a seat belt on a life insurance policy, as they safeguard the policy owners financial interest in the policy.

Impact on the Industry

Because current nonforfeiture law does not apply to the no-lapse guarantee features of universal life insurance, many insurers are offering these guarantees without significant nonforfeiture benefits. Heres the catch: without material nonforfeiture requirements, companies rely heavily on lapse-supported pricing. Pricing based on an inflated lapse assumption can unravel insurers financial strength if people do not surrender their policies as anticipated.

There are a number of reasons lapses may not occur at the rate companies had assumed in pricing. First, without nonforfeiture requirements, companies are free to assume a higher level of lapses simply to drive down premiums. Secondly, if people receive nothing for surrendering their policy, they may prefer to keep it. Rather than surrendering their policy and getting nothing in return, policy owners who feel they no longer need the coverage may prefer to sell their contracts in the secondary market. A policy owner can estimate a fair market value by using a combination of life insurance and annuity quote services (see sidebar).