How lapses in life insurance policies hurt you

Allen Wastler

By Allen Wastler
Allen Wastler is a former financial journalist with over 30-years of experience, including time at CNBC, CNN, and Knight-Ridder Newspapers.
Posted on Nov 12, 2019

Want to void the protection and security you gained when purchasing a life insurance policy? Let it lapse.

Simply put, a lapse occurs when premium payments on a life insurance policy are missed and, depending on the type of insurance, the cash value is exhausted. “Lapse” is shorthand for a “lapse in coverage,” which means the policy will no longer pay a death benefit for the insured person.

At the other end of the spectrum is a paid-up policy, where all the premium obligations have been met and the policy remains in force for the rest of the insured’s life. We have a 76-year-old example below.

Lapse procedures

A lapse doesn’t necessarily mean immediate termination of a policy. Life insurance policies often have a grace period after a missed payment where the policy is still in force or at least offers some limited benefit.

For whole life insurance policies , missed premium payments are sometimes automatically covered by loans from the cash value to keep the policy in force. These are called automatic premium loans and typically have to be elected when the policy is purchased. Other types of insurance, like universal life , will also tap into any account value to keep the policy in effect.

But once grace periods have passed and possible cash value is used up, a lapsed policy will terminate. Sometimes, depending on the type of life insurance and its terms, there are opportunities to reinstate the policy.

At a minimum, missed premiums have to be made up with interest. Also, depending upon when the policy is reinstated, new underwriting may be required, meaning that the insurance company will reassess the cost of your insurability. Given age and possible health changes, this process will likely result in your premiums increasing from when you originally purchased the policy. In fact, the situation might amount to simply buying a new policy with a higher premium.

So a lapse not only can result in a loss of protection, but it can also mean having to pay more to get that protection back.

Nevertheless, lapses do occur. By one estimate, the five-year average lapse ratio on the face value (the total amount of death benefit proceeds represented) of ordinary life insurance — which doesn’t include group, term, or business policies — was about 5.5 percent in 2018.By comparison, MassMutual’s lapse ratio for the same period was 4.39 percent. The lower a lapse ratio, the better, since it indicates, in part, that fewer people may have been dissatisfied with their policy or the carrier’s service.

Of course, sometimes there are justifiable reasons for letting a policy lapse. For instance, term policies, which offer coverage for a specific period of time, are sometimes used to protect against a specific risk, like a mortgage or business loan. Once that obligation is over — the mortgage paid off or the loan repaid — that insurance may no longer be necessary.

That’s why certain types of insurance have different lapse rates.

Life insurance policy longevity

A recent study of 2009–2013 data by LIMRA, a life insurance industry group, and the Society of Actuaries found that the lapse rate of whole life insurance was about half that of term policies.2

“Whole life insurance is a powerful tool for so many reasons,” said J. Todd Gentry , a financial professional with Synergy Wealth Solutions in Chesterfield, Missouri. “It is a guaranteed contract, and as long as premium commitments are met, it will not lapse. Of course, this necessitates that wise decisions at purchase be made, like staying within your budget and building a plan that can grow with you.”

Indeed, as of the end of 2018, more than 121,000 life insurance policies have been with MassMutual for 50 years or longer.

In fact, this past summer, MassMutual paid a death claim on a policy written back in World War II. It was bought in 1943 by a mother for her 17-year-old son, who soon joined the U.S. Army’s 42nd Infantry Division, commonly known as the “Rainbow Division.” That unit ended up being one of the primary units driving into Germany and Austria in 1944 and liberating the infamous Dachau concentration camp in April 1945.

“He was a 93-year-old guy and pretty cool,” said Brandon Jordan, a financial professional with the Arch Advisory Group in Atlanta, Georgia. “He was a veteran and served his country bravely, winning two Bronze Stars and a Purple Heart. And he was devoted to his family. He had over 70 years to surrender the policy and take cash, but he cared more about his family than doing so. And not too many insurance companies have policies that are more than 76 years old.”

The policy originally had a face value of $1,000. But, owing to dividends over time, ended up paying out about $15,000.

And all because the policy didn’t lapse.

Discover more from MassMutual …

Single? Reasons you might still need insurance

Understanding life insurance policy riders

Estate planning and keeping a farm in the family

_________________________________________

 

SNL Financial and internal calculations, December 31, 2018. “Ordinary life,” in statutory annual statement terminology, includes individual life insurance policies but excludes industrial, credit life, term, and group life policies. Ordinary life lapse ratio is the five-year average of lapses and surrenders as a percentage of average face value in force. Lapses and surrenders occur for a variety of reasons including failure to pay premiums, cancellation of a policy, etc. Ordinary life lapse ratio compares the amount of ordinary life insurance face value lapsed or surrendered during a time period to the average amount of face value in force during that time period. Source: SNL Financial and internal calculations; SNL data (as of 12/31/18) on group basis includes parent and life subsidiaries adjusted with eliminating entries by SNL where relevant.

LIMRA, “U.S. Individual Life Insurance Persistency,” April 2019.

The information provided is not written or intended as specific tax or legal advice. MassMutual and its subsidiaries, its employees, and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of MassMutual.