What is the Nonforfeiture value of a life insurance policy?

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The three nonforfeiture options can easily be remembered with the acronym C-E-R and they are as follows:

1 – Cash Surrender – If the owner of the policy selects this nonforfeiture option, the policy will be canceled and the insurer will mail a check to the policy owner.  If the policy owner elects cash surrender there will be no further life insurance coverage, and they may have to pay ordinary income tax if they receive more money than they paid into the policy in premiums.

2 – Extended Term – If this option is selected by the policy owner, the cash value from their original policy will be used to purchase a term policy that will have the same face amount (amount of insurance protection) as the original policy.  If this option is selected, there is no additional premium due from the owner of the policy and they will have the same amount of coverage as they had in the original policy, but only for a limited time.  Remember, term insurance is temporary.  Term life insurance is NOT permanent.

3 – Reduced Paid-up – If this nonforfeiture option is selected by the policy owner, the cash value from their original policy is used as a single premium to purchase them a paid-up whole life policy.  There are two things you need to know about this selection for your licensing exam.  First, the amount of coverage under this new policy is reduced.  Second, this new whole life policy will provide permanent coverage.

What is a nonforfeiture values policy?

Any policy which accumulates cash value is a nonforfeiture values policy.  In fact, the cash values in a policy are sometimes referred to as nonforfeiture values.  You need to know which policies will accumulate a cash value.  Term insurance has NO cash value.  In turn, term insurance has no nonforfeiture values.

However, policies such as whole life and endowments do accumulate cash value, which means they both have nonforfeiture values.  Usually, the cash value will begin to accumulate in a policy after the first three years, however, single premium policies will have an immediate cash value.

Which nonforfeiture options continue to build up cash value?

If a policy owner elects the reduced paid-up nonforfeiture option, the cash value from their original policy will be used to purchase a single premium whole life policy.  Whole life insurance is permanent and accumulates cash value.  Remember, term insurance has no cash value, so if the owner selects the extended term option, there will be no further cash value accumulation.  Of course, if they select cash surrender, there is no further life insurance coverage at all.

Which nonforfeiture option provides the highest amount of insurance protection?

Well, think of it this way.  Say you have $50,000 that you would like to use to buy a life insurance policy.  Between a whole life and a term policy, which policy would be able to provide you the biggest bang for your buck?  Or, in other words, which policy would provide the highest amount of life insurance protection?  Term!!  Term insurance has no cash value and is the cheapest form of life insurance.

Which nonforfeiture option provides the highest amount of protection?  Extended Term!  Why?  It’s the cheapest form of life insurance and accumulates no cash value!

Why is a nonforfeiture option used?

In most states, those life insurance policies that accumulate cash value are required to have nonforfeiture values.  What if the owner of the policy forgets to pay their premium and the policy lapses?  Can the insurance company just keep the cash value?  No!  They are generally required by law to provide the owner of the policy a choice of what they would like to do with their cash value.  This is where the nonforfeiture values come in!

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In permanent life insurance, a non-forfeiture clause stipulates that if the policy lapses due to non-payment or the policy owner decides to cancel coverage, they won’t forfeit the policy’s accumulated cash value.

When non-forfeiture applies

You might find a non-forfeiture clause in many types of permanent life insurance policies, but it’s most common in whole life insurance.

In most cases, the non-forfeiture clause only applies when the policy owner has consistently made on-time premium payments for a specified amount of time. Many non-forfeiture clauses go into effect once the policy has been in place for three years, for example.

At that point, two distinct situations can activate this clause. First, non-forfeiture can apply when the policy owner has missed a premium payment and the grace period has expired. The policy lapse means losing the death benefit, but the non-forfeiture clause protects the policy’s accumulated cash value for the policy owner.

Non-forfeiture clauses can also apply when a policy owner voluntarily cancels the policy. Again, they lose the death benefit but not the policy’s associated cash value. The non-forfeiture clause may stipulate how the policy’s cash value gets distributed to them.

Non-forfeiture options

Generally, policy owners have options about how they’ll receive the cash value this clause protects against forfeiture. Some of the most common options include:

Using the accumulated cash value to fund a term life insurance policy, with the term lasting as long as the cash value will sufficiently cover.
A lump-sum payment of the cash value to the policy owner, minus any outstanding loans against the cash value and applicable fees.
A refund of a portion or all of the paid premiums. Using the cash value to purchase a paid-up permanent life insurance policy with a death benefit reduced to the level proportional to what the cash value will cover. To clarify, the policy owner would owe no future premiums on this reduced policy. An automatic premium loan, which means the insurance company will use the cash value to pay the missed premium.

Generally, the non-forfeiture clause will lay out the policy owner’s specific options and a deadline by which they need to choose one. If they don’t, the insurance company selects the default option.