Life insurance companies must give back the cash value of whole life policies when consumers decide to cancel. The cash value is given back in the form of payment or coverage. Insurance companies refer to this as nonforfeiture options. The three options are: cash surrender, reduced paid up, and extended term. Consumers don’t know about reduced paid up or extended term, and the insurance companies don’t mention these two options when people call in to cancel their policy. Cash surrender is usually not the best option, but people select it from a lack of knowing other options.
Cash surrender sends you a check for the cash value. Extended term provides the original amount of coverage in the form of term insurance. The duration of term coverage depends on the cash value. Reduced paid up, my favorite option, provides a reduced amount of coverage that is paid up forever. The amount of coverage depends on the cash value.
Here is the problem with cash surrenders: if you decide to buy life insurance again after doing a surrender, you are essentially starting over from scratch. However, if you buy life insurance again after doing a reduced paid up, you are starting with the coverage provided by the reduced paid up. This can be a significant cost savings. One note of caution: if you are only contemplating cancellation because of a temporary financial hardship, then you are better off taking a premium loan instead. For more life insurance topics visit our life insurance blog.
The above image is a sample of nonforfeiture values that you might see in a whole life policy. The column on the far left is the policy year. The next column to the right is the cash value, which also represents the maximum loan amount. The next column is the amount of reduced paid up insurance available. Reduced paid up values continually increase until the policy matures (usually age 121 in modern policies). The last column is extended term. You’ll notice that extended term values start to decrease after a certain policy age; the cost of term insurance starts to outpace the accumulation of cash value. You’ll also notice that no cash value accumulates during the first two years of a policy. Agent commissions are the main reason for no cash value in the first two years.