Key Differences Between Lapse and Surrender of an Insurance Policy

Insurance policies provide financial protection and security to policyholders in case of unforeseen events or losses. However, under certain circumstances, a policy may be terminated or discontinued before reaching maturity. The two main ways this can happen are through lapse or surrender. While related, these are distinct processes with different implications for the policyholder.

What is Lapse?

A lapse refers to the termination of an insurance policy due to non-payment of premiums by the policyholder. If the premium is not paid within the grace period after the due date, the policy will lapse.

Features of Lapse

  • Premium Non-Payment: The primary cause of a lapse is failure to pay the required premiums within the grace period. This leads to discontinuation of coverage.

  • Termination of Coverage: A lapse results in the policy being terminated, rendering it void. The insurance coverage is forfeited once the policy lapses.

  • Loss of Benefits: The policyholder loses the benefits and protections outlined in the lapsed policy. A lapse leaves them without the intended coverage.

  • Grace Period: Most policies have a grace period, allowing late premium payments to prevent lapse. If this expires without payment, the policy will lapse.

  • Reinstatement Options: Some policies can be reinstated by paying outstanding premiums and fulfilling other conditions set by the insurer. This may not always be available.

  • Financial Consequences: Lapses can lead to loss of premiums paid and may require buying new policies at higher costs. This can impact financial security.

  • Impact on Coverage: Lapsed policies can affect eligibility for future coverage. Having coverage gaps due to lapses may also increase premiums.

  • Notification Process: Insurers typically send notices about impending lapse, providing a chance to pay overdue premiums.

Types of Lapse

There are several specific types of lapses that can occur:

  • Premium Lapse: The most common, occurs when a policy lapses due to non-payment of premiums within the grace period.

  • Non-forfeiture Lapse: Involves termination of a policy without the policyholder receiving nonforfeiture options like reduced paid-up insurance.

  • Cash Value Lapse: Applies to policies like cash value life insurance and involves loss of accumulated cash value upon lapse.

  • Automatic Lapse: Some policies have built-in provisions that trigger automatic lapse if certain conditions are not met by the policyholder.

  • Regulatory Lapse: Can occur due to failure to comply with regulatory requirements or changes in insurance regulations.

  • Voluntary Lapse: Policyholder consciously allows policy to lapse, often due to changed priorities or decision to discontinue.

  • Involuntary Lapse: Results from circumstances like financial difficulties that prevent the policyholder from paying premiums.

  • Policy Expiration Lapse: Happens when a policy expires at the end of its term and coverage is not renewed.

  • Reinstatement Lapse: A reinstated policy can lapse again if subsequent premiums are missed or reinstatement conditions are not fulfilled.

What is Surrender?

Surrender refers to the voluntary termination of an insurance policy by the policyholder before its maturity date or before a claim is made.

Features of Surrender

  • Voluntary Termination: The policyholder chooses to terminate the policy before maturity for reasons like changing priorities.

  • Policy Forfeiture: Upon surrender, the protections and benefits of the policy are forfeited.

  • Cash Value Payment: For policies with cash accumulation, like whole life insurance, the cash value is paid to the policyholder.

  • Change in Priorities: Evolving financial needs and reassessment of insurance often drive voluntary surrender.

  • Policyholder’s Initiative: Surrender is initiated by the policyholder, unlike lapse which occurs due to non-payment.

  • Contacting Insurer: Policyholders must contact the insurer, often via customer service, to begin the surrender process.

  • Cancellation of Coverage: Surrender leads to immediate cancellation of policy coverage and benefits.

  • Surrender Charges: Some policies impose surrender fees, especially in early years, reducing the payout.

  • Paperwork: Surrender requires paperwork and documentation provided by the insurance company.

  • Financial Implications: Surrender may result in loss of cash value or tax implications. Gains are also possible.

Types of Surrender

There are a variety of surrender types, depending on the policy:

  • Full Surrender: Requires termination of the entire policy to receive full cash value payout, less applicable surrender charges.

  • Partial Surrender: Allows withdrawing a portion of the cash value while keeping the policy in force at reduced levels. Charges may apply.

  • Early Surrender: When a policy is surrendered before a specified period, typically resulting in higher surrender fees compared to later surrender.

  • Maturity Surrender: Involves surrendering a policy at maturity, usually at the end of term or when the insured reaches a certain age.

  • Automatic Surrender: Some policies have built-in automatic surrender provisions triggered by certain events like non-payment over an extended period.

  • Voluntary Surrender: Initiated by the policyholder’s voluntary choice to terminate the policy and get the surrender value.

  • Involuntary Surrender: Can occur due to circumstances beyond the policyholder’s control, like regulatory actions or insurance law changes.

  • Market Value Adjustment Surrender: The surrender value may be adjusted based on market conditions to provide fair value.

  • Non-Traditional Surrender: Unique insurance products may offer non-standard surrender options catering to specific policy features.

Pros of Surrendering an Insurance Policy

Surrendering a policy has certain potential benefits:

  • Access to Cash Value: Provides liquidity to policyholders by unlocking accumulated cash value to address financial needs.

  • Financial Flexibility: Cash obtained can be used for various purposes like debt repayment, education, or addressing urgent needs.

  • Freedom to Explore Alternatives: Allows policyholders the flexibility to invest funds elsewhere or buy better aligned insurance.

  • Eliminates Premium Payments: Surrender relieves policyholders of future premium payment obligations related to the policy.

  • Reduces Financial Commitment: Removes the ongoing financial commitment associated with paying policy premiums.

  • No Further Obligations: Policyholders are released from any further contractual obligations or commitments.

Cons of Surrendering an Insurance Policy

Surrender also carries some potential downsides:

  • Loss of Coverage: Surrender results in loss of policy’s insurance coverage and benefits.

  • Surrender Charges: Fees imposed, especially in early policy years, reduce the payout amount.

  • Tax Implications: Surrendering certain policies may create tax consequences that reduce net gains.

  • Lost Future Benefits: Any future benefits or coverage provided by the policy are forfeited upon surrender.

  • Impact on Goals: May adversely affect long-term financial goals if the surrendered policy was meant to support specific objectives.

  • Alternatives Overlooked: Surrendering without adequately exploring options like nonforfeiture benefits can result in lost opportunities.

  • Market Value Adjustments: The surrender value may be lower than expected due to downward market value adjustments.

  • Consider Alternatives: Surrender without carefully weighing alternatives could lead to choices ill-suited to needs and objectives.

Key Differences Between Policy Lapse and Surrender

Though related processes, lapse and surrender have some important differences:

Basis of Comparison Lapse Surrender
Definition Non-payment leads to policy termination. Voluntary termination of policy by policyholder.
Initiation Unintentional, often due to non-payment. Voluntary decision made by the policyholder.
Policyholder’s Intent Unintentional or involuntary termination. Voluntary and deliberate termination.
Coverage Forfeiture Coverage is forfeited without any return. Coverage forfeited, but cash value may be returned.
Financial Impact May result in loss of premiums paid. May result in loss or gain, depending on cash value.
Payment to Policyholder Typically, no payment to the policyholder. Cash value may be paid to the policyholder.
Timing of Termination Can occur at any point in the policy term. Typically before maturity, but can occur anytime.
Reasons for Occurrence Often due to financial difficulties or oversight. Voluntary decision based on changing priorities.
Process Involvement May involve notification and reinstatement process. Requires contacting insurer and paperwork.
Notification Process Insurer may notify impending lapse. Policyholder initiates surrender without notifications.
Availability of Reinstatement May be possible with payment of overdue premiums. Not applicable as surrender is permanent.

What happens if I lapse, surrender or cancel my policy?


What does lapse mean in life insurance?

A life insurance lapse occurs when you stop paying your policy’s premium and the contractual grace period has expired. If you let your life insurance lapse, coverage will end. Depending on your policy, you might be able to reinstate a lapsed policy by meeting certain requirements.

What does it mean when a policy is surrendered?

Surrendering a policy means you’re dropping coverage. By doing that, you may face tax liabilities. The other ramification of surrendering your policy is that your beneficiaries no longer will receive a death benefit if you pass away with the policy in force.

What happens if life insurance lapses?

What Happens When Life Insurance Lapses. Once a policy has lapsed, you no longer have coverage. That means the insurer does not have to pay a death benefit to your beneficiaries if you die. But you may be able to reinstate a lapsed policy, depending on how long ago it lapsed.

Can I surrender a lapsed policy?

If the policy has a surrender value, the policyholder may be able to receive some money back by surrendering the policy to the insurance company. The surrender value may be paid out to the policyholder after deducting any outstanding premiums, penalties, or charges.

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