Premium loans are advances of policy cash values that the insurer makes to the policyowner for the purpose of paying the premium. Automatic premium loans are advances the insurer makes under a policy clause providing that, if the policyowner fails to pay a premium by the end of the grace period, the insurer will automatically advance the amount of the premium if the policy has a sufficient net cash value.
Usually, the insurer notifies the policyowner of this action. If the loan value of the policy is insufficient to pay an annual premium, the insurer will typically pay a semi-annual, quarterly, or monthly premium although it is not required to do so.
When the loan value is so small that it will not even cover a monthly premium, nonforfeiture benefit options will apply.
In most states, the payment of premiums by APL has the same result as paying premiums with cash, so the death benefit continues (decreased by the policy loan) and cash values continue to increase. Most states do not require an insurer to notify a policyowner that there is insufficient cash value to make a policy loan through APL or to tell a policyowner how long the loan will keep the policy in force. A device that pays premiums at the end of a grace period by automatic loan from policy values is an incredibly valuable safety device to keep insurance protection in full force.3 But the automatic premium loan is effective to prevent a policy lapse only if it is requested by the policy-applicant (or at some later date by the policyowner at a time when no premium is unpaid beyond the policy’s grace period). The authors suggest that this provision is extremely valuable and should be considered in every case—especially because the policyowner may cancel the applicability of the automatic premium loan provision at any time.
There are downsides to the automatic premium loan when abused. First, “the automatic premium loan provision makes it too easy for the insured to avoid the payment of premium in cash.” Second, to the extent interest is still deductible, it is not deductible in the case of an automatic premium loan because the policyowner borrows the interest from the insurer rather than paying it in cash. A third potential disadvantage is that the contract may last longer if placed on extended term rather than allowing the policy to exhaust itself through automatic premium payments. But planners should keep in mind what this provision is really intended to do: prevent an accidental lapse.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM