Cash Value of a Life Insurance Policy: What and Why?

A life settlement is a process of selling an existing life insurance policy to third-party institutions for an amount which is much more than the cash surrender value of the policy. This amount is known as the cash value of a life insurance policy.

This amount is usually less than the death benefit of the policy. Usually, the people who choose life settlements are 65 years or older and own insurance policy with a face value of a minimum of $100,000.

It all began in 1911 when the United States Supreme Court gave a revolutionary decision in the case of Grigsby vs. Russell. The court recognized the right of the policy owner to assign his/her life insurance policy to someone else. The Justice working on this case- Justice Oliver Wendell Holmes, announced that a life insurance policy is similar to any other property. Therefore, it can be transferred without any limitation by its owner.

Life settlements became common in the 1980s as the AIDS and Cancer epidemics drove many young, terminally ill policyholders to sell their insurance policies prior to their death. Hence, life settlements started gaining popularity among consumers.

Prior to the existence of this decision, a policy owner who wished to give up his/her life insurance policy had only two options:

  • He/she had to surrender the policy and receive the cash value. Surrendering the policy terminates the policy and all the benefits associated with it.
  • He/she had to allow the insurance policy to lapse. This would forfeit the policy and make it worthless.

There are basically two types of life insurance: Term life and Permanent life.

Term insurance provides coverage for a specific period of time such as 10, 15, or 20 years and can be renewed after the terms lapse. Permanent life insurance provides lifelong financial protection. Usually, term insurance premiums increase with every renewal whereas permanent life premiums remain the same.

The cash surrender value is the amount of money an insurance company pays to a policyholder or an annuity contract owner in the event that his or her policy is voluntarily terminated prior to its maturity or an insured event occurs.

Only permanent life insurance– such as whole life, universal life, and variable life- has a cash value account that grows over time called tax-deferred growth. A term insurance policy can be converted to a permanent policy, but permanent policies cannot be converted. Term life insurance is simple to understand and is less expensive when compared to a permanent life insurance policy. Hence, it’s widely popular among consumers.

The cash value of a life insurance policy is the cash amount offered to the policy owner by the policy provider upon the cancellation of the contract. This cash value can be borrowed as a loan by the policy owner. Universal life insurance, whole life insurance, and variable universal life insurance policies have a cash value, unlike term life insurance. The cash value is what makes an insurance policy a valuable investment. One can save money, receive quality returns and also protect our loved ones.

A policy owner needs to understand the cash value of a policy in order to make an effective decision.

This cash value of a policy can be used in the following ways-

  • Borrowing against cash value: In an emergency, a policyholder may wish to borrow a portion of the policy’s cash value. This loan, taken out of the cash value of the policy, has consequences; interest on the loan and repayment without a stipulated amount of time.
  • Surrendering the policy: The policy owner may choose to surrender his/her policy at will, and he/she has a less expensive alternative or may no longer need the policy. Surrendering the policy removes the death benefit; hence, this step must be chosen with caution.
  • Withdrawing from the policy’s cash value: This is an alternative option for borrowing money from the cash value of the insurance policy. Depending on the policy and its terms and conditions, policy withdrawals may have several effects on it.
  • A life settlement is one of the most widely popular options which involves a third party institution buying the policy for a one-time cash settlement.

Each of these options has its own pros and cons, and a policyholder may choose any one out of these depending on his/her own requirements. I hope that this article gave a better insight into understanding the meaning of the term “cash value of a life insurance policy.” Thank you for reading!