Universal life insurance policies can lapse if they are not properly funded or monitored over time. A lapse terminates coverage and eliminates both the death benefit and remaining cash value. Understanding how and why lapses occur helps policyholders take steps to keep coverage in force.
What a Policy Lapse Means
A policy lapse occurs when the policy’s cash value and premium payments are insufficient to cover ongoing monthly charges. When this happens:
- Coverage ends
- The death benefit is lost
- Any remaining value may be forfeited
Once a policy lapses, reinstatement may be difficult or impossible.
Primary Causes of Policy Lapse
The most common causes include:
- Paying only the minimum premium for too long
- Declining interest or crediting rates
- Rising cost of insurance charges
- Failure to adjust premiums over time
These factors often compound gradually rather than occurring suddenly.
Role of Cash Value Depletion
Universal life insurance relies heavily on cash value to support policy costs. If cash value:
- Is drawn down to cover premiums
- Grows slower than expected
- Is reduced by loans or withdrawals
The policy becomes increasingly vulnerable to lapse.
Impact of Rising Insurance Costs
Cost of insurance charges increase with age. If premiums are not increased to offset rising costs:
- Monthly deductions accelerate
- Cash value erodes faster
- Lapse risk increases significantly in later years
Many lapses occur after decades of underfunding.
Effect of Lower-Than-Expected Interest Rates
Policy illustrations often assume higher interest rates than what actually materializes. When credited interest is lower:
- Cash value growth slows
- Premium assumptions become insufficient
- Additional funding is required to sustain coverage
Failure to respond to changing rates can lead to lapse.
Loans and Withdrawals as Contributing Factors
Loans and withdrawals reduce the effective cash value available to support policy charges. If unmanaged:
- Loan balances and interest grow
- Remaining cash value becomes insufficient
- Policy sustainability weakens
Loans must be monitored carefully.
Grace Period and Lapse Notices
Before lapsing, policies typically enter a grace period. During this time:
- The insurer notifies the policyholder
- Additional premiums may be required
- Action must be taken promptly
Ignoring lapse notices often results in permanent termination.
Preventing Policy Lapse
Lapse risk can be reduced by:
- Funding policies at or above target premiums
- Reviewing annual policy statements
- Ordering in-force illustrations regularly
- Adjusting premiums or death benefits proactively
Active management is essential.
Consequences of Policy Lapse
A lapse can result in:
- Loss of coverage when it is most needed
- Possible tax consequences if loans exist
- Difficulty obtaining new coverage due to age or health
The impact can be severe and irreversible.
Key Takeaways
Policy lapses in universal life insurance usually result from long-term underfunding and lack of monitoring. Understanding how lapses occur allows policyholders to take corrective action early and preserve permanent coverage.
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