What makes people lapse on life insurance payments?

Economic downturns can be tough to navigate for policyholders who are young and have higher health risks.

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Myles Ma, CPFCMyles Ma, CPFCSenior ReporterMyles Ma, CPFC, is a senior reporter and certified personal finance counselor at Policygenius, where he covers insurance and personal finance. His expertise has been featured in The Washington Post, PBS, CNBC, CBS News, USA Today, HuffPost, Salon, Inc. Magazine, MarketWatch, and elsewhere.

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A life insurance policy lapse happens when you stop paying your premiums. A policy lapse means you lose your life insurance coverage, so when you die, the policy won’t pay out to your beneficiaries. But who is most likely to lapse on their insurance policy? A working paper published by the National Bureau of Economic Research in 2022 used regulatory filings from the 30 largest life insurance companies from 1996 to 2020 to find out.

The researchers learned that lapsation rates declined from a little over 7% at the beginning of their sample to about 5% by 2020. Using this data, they found that during the financial crisis of  2007 and 2008, people living in areas with low home prices or income growth experienced more lapsation risk than others. 

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While previous studies showed that more people lapse during economic downturns, the researchers used proprietary data from a single large U.S. life insurance company to see how the economy impacts people based on the type of policy they have — term or whole, the length of the term, and the size of the policy — and their characteristics, including age, health status, and ZIP code. They found that overall, households with higher health risks had a higher chance of lapsing during downturns. Among whole life policyholders, younger households and those with larger death benefits were more sensitive to economic downturns. And for term life, households in lower-income neighborhoods not only lapsed more overall, but were more sensitive to economic downturns. 

The implication is that young, higher health-risk policyholders living in lower-income areas may be overpaying for insurance, given their greater risk of lapsing. 

“People with high health risks should not avoid life insurance,” says Ralph Koijen, a professor of finance at the University of Chicago’s Booth School of Business and a co-author of the paper. “They should be mindful, however, to purchase a policy that they can still afford during economic downturns.”

The paper didn’t explore how to design life insurance policies to better protect consumers from lapsing. But Koijen suggested that companies could introduce premium holidays during periods of economic stress to reduce the risk of households losing coverage. 

How to avoid a life insurance policy lapse

The first step is to select a policy you can actually afford. While having enough coverage to pay for your family’s expenses is important, it won’t help if you can’t keep paying premiums when times get tough. When shopping for life insurance, you can lower your premium by reducing your coverage amount or term length, or by choosing a term policy instead of a permanent policy, or by comparing rates with different insurance companies

Regulators require life insurance companies to provide a grace period for late payments, usually lasting 30 or 31 days starting from the payment due date. You’re still covered during the grace period, but your policy will lapse if you don’t pay by the end of the period, and you may owe a late fee. Read your policy carefully to understand how to get your back in good standing if you miss a payment.

Here are a few other ways to avoid a lapse:

  • Enroll in automated payments: This way you won’t have to track payments every month. Just be sure the account you use always has enough to cover the payments.

  • Switch to an annual payment schedule: Not only does this often come with a discount, but you only have to worry about one payment a year, as long as your budget allows.

  • Add a waiver of premium rider: This exempts you from paying premiums if you become disabled. (This can only be added when you first buy the policy, and may come with an additional premium.)

  • Lower your coverage amount: Even after buying your policy, you can do this to lower your premium.

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