Especially in this “new economy,” life insurance professionals need to be very familiar with nonforfeiture benefits and other policyholder-friendly features of life insurance products.
Clients in rough financial situations may need to use the features or at least know that they exist, “just in case” their money gets too tight.
So, here is a refresher.
Nonforfeiture benefits became a unique feature of United States life insurance products, as far back as the 1800s. They were the brainchild of a Massachusetts regulator named Elizur Wright.
They became embedded in The Standard Nonforfeiture Law, which was adopted (with minor variations) by every state in the nation.
That law has been repeatedly tweaked, but remains a proud feature of U.S. regulation, designed to protect the public from unwarranted forfeiture of accumulated funds in a life insurance policy.
This law effectively applies to all forms of traditional permanent insurance. (Most term plans are exempt because the required formulas generate no cash values for them.) It requires calculations to be made on specified mortality tables and interest rates.
(A changeover has just been made to the 2001 Commissioners Standard Ordinary mortality tables; but most of today’s in-force products are based on earlier tables–the 1980 CSO or the 1961 CSO tables. Over the years, maximum interest rates have been specified for use with the tables.)
What are nonforfeiture benefits? Generally, for traditional products, the law requires a cash value and one or both of the following: (1) a reduced paid-up life insurance benefit and (2) extended term life insurance. These are mathematically equivalent to the cash value.
Universal life policies may not contain the paid-up option, as such; but the face amount could be reduced to an amount which the cash value can support indefinitely with no further premium payments. Some UL policies allow the cash value to be placed on a single premium endowment option, which would be equivalent. An extended term option is never present in UL policies.
There is a third option, known as “automatic premium loan (APL),” which is often thought of as a nonforfeiture benefit. The traditional product requires that if a premium is not paid, and the policyholder has not applied for the cash value or one of the options, the policy will be automatically placed on a “specified” option. Historically (and especially in the home service market) extended term was the specified automatic option. These days, however, APL is usually the automatic option for traditional policies. But UL policies, because of their nature, do not usually have APL clauses.
The application of nonforfeiture provisions becomes quite complex for UL policies. That is another reason why professionals need to become familiar with the features in a UL product with which they are dealing.
The chart illustrates reserves and paid-up benefits for traditional life policies. But look at specific products, too. Policies differ a lot.
The essential discovery is that for traditional life products, cash values increase with age. Even if the policyowner takes reduced paid-up life, the cash values for that option keep increasing also. (UL is a different animal, however.)
Agents and other professionals also need to be familiar with other policy features. These can include features that enable the insured to buy additional paid-up life insurance by specific cash pour-ins. (In the present interest rate climate, this could be a very good deal, depending on the interest rate guaranteed in the contract.) And don’t forget, the interest is tax favored.
“Settlement options,” which are required by law, are another policy feature deserving attention. They typically provide (1) an interest payment option, (2) fixed period and fixed amount options, and (3) life income options. Although designed specifically for death benefits, they also can be used for cash value applications.
With so much financial uncertainty in the current marketplace, this is a good time for advisors and other insurance professionals to get to know the standard life policy features, such as nonforfeiture. Senior clients, who are hanging on to a rope of financial hope, need to know about them, too.
John M. Bragg, FSA, ACAS, MAAA, is actuarial consultant at Bragg Associates, Atlanta; past president of Society of Actuaries; and past CEO of Life Insurance Company of Georgia. His e-mail is [email protected]