When a harsh spotlight fell on AIG last fall, many policyholders in AIG's life insurance subsidiaries became concerned about their policies. I was struck by the confusion and misinformation about a seemingly simple question: When you receive a premium notice from the insurance company, do you have to pay the premium?
AIG's answer is crystal clear:
http://www.aig.com/Home-Page_20_17084.html --> Customers
Should I pay the insurance premium bill I just received?
Yes, in order for your coverage with us to continue, you will need to pay the insurance premium.
And the New York State Insurance Department agreed:
Question: Should I pay the insurance premium bill that I just received from AIG?
Answer: Yes, in order for your coverage with AIG to continue, you will need to pay the insurance premiums. Failure to pay your premiums can result in the termination of your insurance policies by the insurance company.
However, the correct answer depends on the type of life insurance policy that you own.
If you own term insurance, you almost certainly have to pay the premium to keep the policy in force, although you may be able to change the premium mode from annual to monthly if you want to reduce the immediate outlay.
If you own a traditional whole life policy, you have more flexibility. You can take out a policy loan to pay the premium, although it will reduce the death benefit. If you have been using dividends to buy paid-up additions, you can surrender them to pay the premium, although you will probably be giving up an attractive investment opportunity.
You have the most flexibility if you own a flexible-premium policy, such as universal life or variable universal life. These policies stay in force as long as the cash surrender value (or sometimes the account value, before deducting the surrender charge) is sufficient to cover the monthly deduction for the cost of insurance and expenses. There is no required premium; the premium notice that you receive is for the "planned premium," which is just an arbitrary amount that was based on some set of assumptions in the past.
The picture is more complicated if your policy has a no-lapse guarantee, because you may have to pay a premium to keep the no-lapse guarantee in force. That depends on the terms of the policy.
In some cases, it makes good sense NOT to pay a premium. Suppose the insured has suffered a serious health problem, affecting life expectancy. You're just making a gift to the insurance company if you put more money into the policy than is needed to cover the monthly deductions for the insured's plausible lifespan.
Some policies have a load structure that creates an opportunity to save money by shifting premiums from one year to another. For example, New York Life has a universal life policy that has a 40% premium load up to a specified threshold and 20% above that, so you can save money by paying premiums in clumps, such as every other year. Similarly, if your policy's premium load declines from one year to the next, postponing a premium payment may be smart.
Many people do not really understand how their policies work, so they fail to take advantage of opportunities to save money. The recent wave of unsettling news about insurance companies has gotten the attention of policyholders. It would be good news if they used this moment to ask more questions about what they own.