Frayed RopeThere are many reasons that life insurance policies are allowed to lapse. You may have lost your job and have to decide between a premium payment and the mortgage or rent. You may no longer need the insurance. Whatever the reason for the lapse, there are options depending on the type of life insurance you have.

A life insurance policy must be "in force" for the death benefit to pay out if the insured dies. This means that the policy premiums must be paid on time at monthly, semiannually or annual intervals, whatever the policy requires. If the premiums are not paid, the policy lapses and the coverage and benefit will be lost. The type of policy you have will determine how it lapses.

What is term life insurance?

The Insurance Information Institute (III) defines term life as a form of life insurance that covers the policyholder for certain period of time. The death benefit pays out if the insured dies during the specified term. Term life is usually sold in one-, five-, 10- and 20-year terms. It does not have a savings feature.

The majority of term life sold is level term. In fact, the III estimates that 97 percent of term life is level term. This means that the death benefit and premiums remain level, or the same over the term of the policy.

How term life insurance lapses

If you fail to make a premium payment on a term life insurance policy, it will lapse. According to the American Council of Life Insurers, you normally have a 30- or 31-day grace period to bring the policy current. If the policyholder dies during this grace period, the death benefit is paid out, minus the overdue payment. If the policyholder dies after the grace period, the death benefit is forfeited. Once a term policy lapses, you will need to re-apply for a new policy. It can be difficult to find life insurance coverage if your health has deteriorated.

Permanent life insurance defined

Permanent life insurance is a bit more involved than term life and there are often options available if you are unable to make premium payment because of the cash value component. A permanent life insurance policy will enter a grace period if a payment is missed. The grace period is usually 30-31 days but it can be longer depending on the policy.

If the policy has cash value available, the insurance company will use money in the cash account to cover the premiums until the cash value has been depleted. At this point, the policy will lapse. This allows the policy to stay in force without a premium payment for an extended period of time.

Permanent life insurance policies, such as whole life, generally offer these additional options, according to The Insurance Information Institute:

  • Surrender value: You can stop paying the premium and collect the available cash surrender value. Your life insurance will be gone but you will have some of the policy proceeds. In some instances there may be tax consequences.
  • Non-forfeiture: Depending on your policy you may be able to settle on a reduced paid up level. What this means is that you stop paying premiums in return for a reduced death benefit. The cash value is surrendered.
  • Reinstatement: It is sometimes possible to re-instate some life insurance policies but it can be expensive. In most cases you will have to re-qualify, which can be difficult if your health has deteriorated. In addition, you will have to pay all of the missed payments and interest. The majority of policies can be re-instated up to 5 years after the first missed payment.

Understanding your options if you can no longer afford your policy premiums is important. If your policy is about to lapse, contact your agent or insurance company to discuss the options available to you.