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The effects of lapsing your life insurance policy

When you buy a life insurance policy, it's important to make sure the policy meets your needs today and in the future.

But what happens if you change your mind about your policy? If you decide after a few days that you don't want the policy, your state likely has a "free look" law that entitles you to a full premium refund. 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 and, when your insurer doesn't receive your money, it terminates the policy.

Why lapse your policy?

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, and your stocks aren't performing, you might be unsatisfied with the amount of cash value you are accumulating.

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.

But lapsing a policy could cause you problems in the future if you decide to go life insurance shopping again. Insurance companies might overlook one policy lapse, but multiple lapses could lead to higher rate or even an application denial.

Who cares?

Some insurance companies don't care and won't even ask about previous policy lapses on the application. Mark Supic, a spokesperson for Primerica, says his company doesn't ask about previous policy lapses and that they have no effect on Primerica's underwriting decisions.

Others will review your history and decide on a case-by-case basis. For example, The Hartford will look for reasons behind the lapses. If you failed to pay premiums on several policies, you would likely be denied a new life insurance policy.

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. An unethical agent might also try to persuade you to lapse your policy through practices called "churning" or "twisting." This is when an agent convinces you to lapse your current policy in order to replace it with a more costly policy, thus allowing him to make the commission.

If you want to reinstate a lapsed policy, it may be costly. According to the Texas Department of Insurance, to reinstate a lapsed policy, a policyholder may be required to pay the overdue premium plus interest. Also, if loans were taken out against cash value before the lapse, they would have be repaid in order to put the policy in force again. Some life insurance companies give policyholders at least a five-year grace period to reinstate a lapsed policy, according to Supic, but you may be required to take a new medical exam to prove your "insurability."

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. Insurers can't recoup their costs if you keep buying and lapsing policies, and that makes you an undesirable customer.

According to Patrick Leary, associate director of 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.

Do your homework and buy it once

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.

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