Let Life Insurance Lapse at Your Own Risk

Multi-colored ceramic piggy banks
Multi-colored ceramic piggy banks

Nothing spells financial disaster like letting your life insurance lapse. OK, perhaps that's an exaggeration, but allowing a life insurance policy to lapse is one of the worst financial decisions possible for a senior or boomer. Individuals pay hundreds of millions of dollars into life insurance every year, yet four out of 10 seniors lapse or surrender their policies before they receive any payout. Of course, life insurance has a tremendous value if it is never cashed in, providing peace of mind for the insured and their families, but a financial opportunity is lost when a policy lapses.

Why Does it Happen and Why is it a Bad Idea?
Insurance lapses for a number of reasons: Typically, the coverage becomes unaffordable or the policyholder's life situation changes and the insured believe he or she no longer needs the coverage.

Life insurance is frequently purchased to protect the financial future of the policyholder's family. Parents purchase life insurance so that if one parent dies, then lost income is replaced by the insurance company and the surviving spouse and children will have money to pay bills, fund college tuition and have a financial cushion. Changes in life situations often alter the equation too. If parents divorce or one spouse dies after children are grown and out of the house, then life insurance may appear to no longer be needed and the policyholder may decide to let the policy lapse.

In some cases, particularly with whole life or other types of permanent insurance, the cost of life insurance rises as the policyholder ages, adding unforeseen financial strain. Escalating premiums make it appear that life insurance is no longer a good investment for the insured, and this regularly leads to policy lapses. In some instances, the insured may decide to surrender the policy back to the insurance company for a nominal payout. Compared to letting a policy lapse, surrendering looks like a pretty good deal, but it usually isn't.

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Individuals should do everything in their power to keep their policies in force. Insurance companies make a tremendous amount of money from lapsed policies, after individuals pay premiums for years and then never collect a death benefit. Even though they make money from your renewals, agents (and I'm not blaming them) are incentivized to write new policies. For such policies, they essentially get paid in advance, typically earning commissions equal to the first year's premium for signing a new policy. The renewal fees are peanuts in comparison.

Keep Policies in Force
Policyholders have a number of options if faced with the question of whether or not to let a policy lapse. For term policies that are nearing the end of the term, policyholders often have the option to convert the policy to a whole life policy. Particularly if you want to remain insured, then a conversion is an excellent option because the policy will be underwritten based on your health status when you purchased the original policy. In many instances, it will be more cost effective to convert a policy than purchase a new one based on your current health evaluation.

For whole life policies, premium amounts can rise quickly and become burdensome to the policyholder. Before letting the policy lapse or surrendering it, consult with your agent to ensure that you are paying the least amount of premium possible with your policy. Using some of the cash value to pay premiums may be an option. Keeping the policy in force long enough so that it pays -out for your beneficiaries should be a major goal.

Consider All Options
If the premiums are untenable and the insured is very late in life, another option is to have the beneficiaries assist in paying all or some of the premiums. For example, if the insured is in failing health, paying the premium for a few years may be an excellent investment. If the policy pays out two million dollars when you pass, but the premiums are a few thousand dollars per year, it makes financial sense for beneficiaries to help front the cost.

Look at Life Settlements
Life settlements offer yet another option to allowing a policy to lapse. Policyholders can sell their life insurance policy for cash, and a life settlement provider continues to pay the purchased policy premiums, collecting the full amount when the policy seller passes away. The value of a life settlement varies depending on the life expectancy of the policyholder at the time of sale, and the ongoing premiums necessary to keep the policy in force. A life settlement will always be less than the full value of the policy, but much more than the amount a policyholder would receive if he or she let the policy lapse or surrendered it to the insurance company.

For years, consumers have viewed life insurance as a mere financial backstop, but by exploring options to keep policies in force, additional value can be attained for policyholders and their beneficiaries.