When you buy a life insurance policy, it’s important to make sure the policy meets your needs today and in the future.
What happens if you change your mind about your policy? If you decide after a few days you don’t want the policy, you might have the option of canceling it.
If a few weeks, months, or years go by and you find you don't want the policy anymore, you have the option of lapsing it, meaning you stop paying premiums.
Insurance companies might overlook one policy lapse, should you decide to buy a new policy. If you lapse policies enough times, it could cause problems down the road.
A life insurance policy lapses — or cancels itself — when you stop paying premiums. If you have a permanent life insurance policy that has accumulated cash value, the insurance company drains your cash value to pay your premiums until it runs out, and then the policy lapses.
There are many reasons why someone might lapse a policy. You might feel you are paying too much for insurance, so you'll buy one at a better rate and lapse the old one. If you have variable life insurance, for example, you might be unsatisfied with the amount of cash value you are accumulating.
Some insurance companies don't care and won't even ask about previous policy lapses on the application.
| A high number of lapses may indicate financial instability, and the insurer wants to know that a full year's premium will be paid. |
Others will review your history and decide on a case-by-case basis.
For example, Hartford Life Insurance Co. will look for the reasons behind the lapses. If you failed to pay premiums on several policies, you would likely be denied a new life insurance policy. But if you were a past victim of churning — where an agent used the cash value in an old policy to replace it with a new one — the lapses may not weigh heavily on Hartford Life's decision and your application would likely be accepted because the lapses were prompted by illegally mishandled policies, not through any fault of your own.
Other insurance companies might reject your application if you have a high number of policy lapses. Some insurers might think you'll leave them for a better deal at the drop of a hat. They might think you are financially strapped and have a hard time paying your bills. In the worst case, some might even think you're involved in a scam with your agent in which you're getting a kickback on the agent's commission.
Multiple lapses cost insurers money because agents' commissions are paid as a percentage of the first year’s premium. Approving a new policy means paying another commission to an agent.
According to Tom Spinelli, a research manager for LIMRA International — a financial services marketing and research organization — typical commissions for the sale of life insurance policies can be more than 50 percent of the first year's premium for term life insurance. Commissions can rise above 60 percent for whole life insurance. Agents can also receive production bonuses, promotional trips and other incentives, depending on how many new policies they sell.
| Watch out for agents who encourage you to lapse policies. |
If an agent approaches you about giving you a chunk of his commission if you agree to lapse your policy and apply for a new one, watch out. That's a practice called "rebating" and it's illegal in most states, according to the American Council of Life Insurers. Rebating applies to any sales practice in which an agent entices a customer to buy an insurance product by giving him part of the commission.
Most life insurance experts will tell you to buy life insurance when you're young since it's more expensive as you grow older. The potential hazards you face in the future for lapsing policies make a strong argument to buy the right policy once and review your coverage needs as your life changes. Otherwise, you and your beneficiaries could suffer in the future.