What is a Nonforfeiture Clause?
How does it work in insurance contracts?
What are the payout options under a nonforfeiture provision?
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Nonforfeiture Clause Overview
A nonforfeiture clause is an insurance contract provision allowing the insured to receive full or partial benefits or refund a portion of the premiums paid after a certain time due to non-payment of premiums.
The insurance policy’s nonforfeiture clause can also be triggered when a whole life insurance policyholder surrenders the policy.
Definition
According to The Free Dictionary by Farlex, a nonforfeiture clause is defined as:
A clause in some insurance policies entitling a policyholder to receive the benefit, or a portion of it, for a short period of time after allowing the policy to lapse.
How It Works
After the passing of a certain period of time, nonforfeiture clauses allow the policyholder to obtain a certain guaranteed cash value should the policy be surrendered.
Many policies indicate that a minimum cash value will be available to the insured after three years.
As such, if the policy has been in force for a sufficient amount of time, the nonforfeiture values will become available to the policyholder should the policy be surrendered or terminated due to failure to make premium payments.
Typically, life insurance, long-term disability, and long-term care insurance policies may include nonforfeiture provisions.
In a permanent life insurance policy, the policyholder can access the cash value in four different ways:
- By terminating the policy and getting the cash surrender value
- Choose a reduced coverage for the remaining term of the policy (paid-up policy)
- Use the accumulated cash value to cover future premium payment obligations (automatic premium loan)
- Acquire extended-term insurance policy with the accumulated cash surrender value without premium payment obligations
Nonforfeiture Provision Payout Options
Life insurance policies are taken to provide benefits to the surviving dependents of the insured or policyholder in the event of death.
However, if the policyholder terminates the policy before the event of death, the insurance provider will no longer have an obligation to cover the surviving dependents.
On the other hand, the policyholder may recover some of the past premium payments.
In essence, the policyholder did not “forfeit” some of the past premium payments and will be entitled to receive it as cash value.
There are three payout options:
- Cash surrender value
- Extended-term option
- Reduced paid-up insurance
Let’s look at each of these options.
Cash Surrender Value
With a cash surrender value payment option, the policyholder receives the “cash value” of the policy within a certain period of time (generally six months).
As premiums are paid and time goes by, the cash surrender value increases over time.
The accumulated cash is applied to the savings element of the whole life insurance policy.
Extended-Term Option
The nonforfeiture extended-term option enables the insured to use the policy cash value to purchase term insurance with death benefits equal to that of the original policy.
After a certain number of years, the term policy ends based on a nonforfeiture table outlined in the policy.
The validity period of the new policy will depend on the age of the insured and the amount of cash values available in the policy.
The extended-term option is typically a default nonforfeiture payment option allowing the policy owner to quit paying premiums but retain the accumulated equity.
Reduced Paid-Up Insurance
With a reduced paid-up insurance payment option, the policyholder will receive a lower amount of payments made for the life insurance but will retain the death benefits without having an obligation to pay further premiums.
On the other hand, the death benefits the surviving dependents receive may be lower than the cash value in the original policy.
The reduced life insurance coverage will be a function of the policy owner’s age, the accumulated cash value, and the premiums paid.
Takeaways
So what is a Nonforfeiture Clause?
How do nonforfeiture clauses work in insurance policies?
Let’s look at a summary of our findings.
Nonforfeiture Clause
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