4.3 Provisions Specific to Cash Value Policies
Policy Loans Provision
A policy loan may be taken against a life insurance policy that accumulates cash value once sufficient cash value has developed. In most policies, loans become available after the policy has been in force for approximately three years.
When a policy loan is taken, the cash value itself is not immediately reduced. Instead, the cash value serves as collateral for the loan. Interest is charged on the loan annually and, if unpaid, will be added to the outstanding loan balance. The interest rate may be either fixed or variable, depending on the policy terms.
The insurer may delay granting a loan for up to six months unless the loan is intended to pay a premium, such as through an Automatic Premium Loan provision. Failure to repay the loan or accrued interest will not cancel the policy unless the total loan balance and accumulated interest equal or exceed the policy's cash surrender value.
If the insured dies or the policy is surrendered while a loan is outstanding, the insurer will deduct the unpaid loan balance and any accrued interest from the death benefit or the policy's cash value.
Policy Loan Rate Provisions
For policy loans with a fixed interest rate, the maximum rate that may be charged is typically 8% or less, as specified in the policy.
For loans with an adjustable (variable) interest rate, the maximum rate is determined according to a benchmark such as Moody's Corporate Bond Yield Average, and the applicable limits are outlined in the policy.
In all cases, the loan amount cannot exceed the policy's available cash surrender value.
Partial Withdrawals or Partial Surrenders
A partial withdrawal of cash value is permitted in Universal Life and Variable Universal Life policies. This type of transaction is considered a partial surrender of the policy.
Unlike a policy loan, a partial withdrawal permanently removes funds from the policy's value. The amount withdrawn will reduce either the policy's death benefit, the cash value, or both, depending on the policy structure. Because the withdrawal is not a loan, no interest is charged on the amount taken.
However, tax consequences may apply. Any amount withdrawn that exceeds the total premiums paid into the policy (the policyowner's cost basis) may be subject to taxation.
When a partial withdrawal occurs, the policy's cash or account value is reduced by the amount withdrawn. The insurer may also impose a withdrawal or surrender charge, particularly during the early years of the policy. In addition, insurers often place limits on the number of withdrawals allowed each year and may establish minimum and maximum withdrawal amounts.
Surrenders
The policyowner of a cash value life insurance policy has the option to surrender the policy in full. When a policy is surrendered, the insurance coverage is terminated and the policyowner receives the policy's cash surrender value.
Certain policies, particularly Universal Life and Variable Universal Life, may include a surrender charge schedule that can extend for 10 to 20 years. This schedule outlines the percentage of the policy's cash value that will be deducted as a surrender charge if the policy is terminated during that period. Typically, the surrender charge decreases each year according to the schedule until it eventually expires.
Example:
| End of Policy Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
| Surrender Charge % | 10 | 9 | 8 | 7 | 6 | 5 | 4 | 3 | 2 | 1 |
The difference between the cash value and the cash surrender value represents the surrender charge. This charge allows the insurer to recover a portion of the initial costs associated with issuing and administering the policy.
Quiz
1. When may a policyowner typically begin taking policy loans from a cash value life insurance policy?
A. Immediately after the policy is issued
B. After the policy has accumulated sufficient cash value, typically around three years
C. Only after the insured reaches age 65
D. Only after the policy matures
Correct Answer: B
Rationale: Policy loans become available once sufficient cash value has accumulated. In most policies, this occurs after approximately three years, when the policy has built enough value to serve as collateral for the loan.
2. What happens to the cash value when a policy loan is taken?
A. The cash value is permanently withdrawn from the policy
B. The cash value is reduced immediately by the loan amount
C. The cash value serves as collateral for the loan
D. The cash value is transferred to the beneficiary
Correct Answer: C
Rationale: When a policy loan is taken, the cash value is not immediately removed from the policy. Instead, it serves as collateral for the loan, and interest accrues on the borrowed amount.
3. Which statement best describes a partial withdrawal from a Universal Life or Variable Universal Life policy?
A. It is treated as a loan with interest charged
B. It permanently removes funds from the policy value
C. It increases the policy's death benefit
D. It has no effect on the policy's cash value
Correct Answer: B
Rationale: A partial withdrawal permanently removes funds from the policy's cash value and may reduce the death benefit or cash value. Unlike a policy loan, the withdrawn amount does not need to be repaid, and no loan interest is charged.
4. What is the maximum fixed interest rate typically allowed for policy loans?
A. 5%
B. 6%
C. 8%
D. 10%
Correct Answer: C
Rationale: For policy loans with a fixed interest rate, the maximum rate is typically 8%, as stated in the policy. Variable rates may also be used, often tied to benchmarks such as Moody's Corporate Bond Yield Average.
5. What does the surrender charge represent in a cash value life insurance policy?
A. The difference between the face amount and the death benefit
B. The difference between the cash value and the cash surrender value
C. The amount of interest earned on the policy
D. The amount of dividends paid to the policyowner
Correct Answer: B
Rationale: The surrender charge is the difference between the cash value and the cash surrender value. It allows the insurer to recover some of the initial administrative and underwriting costs associated with issuing the policy.