Whole life policies have level premiums for the duration of the policy. This is achieved by charging a premium that is greater than the cost of coverage in the early years and less than the cost of coverage during later years. That’s fine for the individual who keeps his/her policy, but the person who surrenders the policy in the early years would have paid more than the cost of insurance. It is in response to this situation that the nonforfeiture provisions were established.
Although there are three nonforfeiture provisions, the cash surrender value option accounts for the overwhelming majority of surrenders. In this scenario, the owner of the policy receives the cash surrender value of the policy in exchange for relinquishing the death benefit. However, two additional nonforfeiture provisions are also available to owners of a whole life policy.
A second option is to take a reduced paid up policy. That option entails using the cash surrender value to purchase a single premium paid up policy. It is called a reduced paid up policy because the size of the policy the cash value will purchase will be less (reduced) than the current policy. That policy will require no premiums (in fact, no premiums are allowed) and will stay in force until death (or until surrendered). That policy’s cash value will continue to increase annually, and if it is with a mutual company, it will be eligible to receive dividends.
The last option is to use the cash value to buy term insurance. This option is called extended term. The face value of the term insurance will be the same as the face of the whole life policy at the time of surrender. The duration will depend on the amount of the cash value.
The numeric value of these nonforfeiture options are delineated in the policy. While it is the policy owner’s right to choose the option upon surrender, insurance law requires that the insurance company provide a default option. That default option is spelled out in the policy.
Whole life policies are surrendered for a variety of reasons, and some of those reasons would suggest that a nonforfeiture option other than cash surrender value would be more appropriate. Premium relief can usually be obtained without surrendering the policy, but if the policy must be surrendered, it is wise to look at all three options to determine which option is best for you.