A Lapsed Policy, and How Reinstatement Works

The letter arrives and it is worded so mildly that people put it aside. The policy has lapsed. What that means, and whether anything can be done about it, depends on which kind of policy it was, how long ago it happened, and what has changed in the insured person’s health since the contract was first issued. None of that is in the letter. What most households do next is either nothing at all, on the assumption that the coverage is simply gone, or they buy a new policy without asking whether the old one could be brought back. Both are frequently the wrong move, and the second one can be expensive for the rest of a lifetime, because the lapsed contract was issued at a younger age than the new one will be. This article sets out what actually happens when a premium goes unpaid, what reinstatement requires, what it quietly restarts, and when starting over is genuinely the better answer.

What happens before a policy lapses

A missed payment does not end a policy on the due date. Life insurance contracts provide a grace period, a stated interval during which the coverage stays in force and the premium can still be paid. The length is in the contract. If the insured person dies during the grace period, the policy generally pays, with the unpaid premium deducted.

What happens at the end of the grace period depends on the kind of policy. A term policy with no accumulated value lapses, and the coverage ends. A permanent policy that has accumulated value may have provisions that keep it in force using that value, either by advancing the premium automatically or by converting the coverage to a reduced amount that requires no further premium.

Those provisions are a rescue and they are also a cost. A contract that is keeping itself alive out of its own value is depleting the thing the owner spent years building, and a contract that has been quietly converted to a reduced paid up amount is no longer the policy the family thinks it has. Either way, the moment to act is when the letter arrives.

What reinstatement actually is

Reinstatement is the restoration of the original contract, on its original terms, rather than the purchase of a new one. That is the whole reason it matters: the age at which the contract was issued, and the premium that follows from it, are preserved.

It is available for a period the contract states after the lapse, and it is not automatic. Three things are generally required. Evidence of insurability, meaning the insurer asks about health again and may require the same kind of evidence it asked for originally. Payment of the overdue premiums, commonly with interest. And a written application, because reinstatement is a request the insurer approves rather than a right the owner exercises.

Where a permanent policy has an outstanding policy loan, that balance is part of the picture too. A policy loan is an advance made by the insurer under the contract and the interest is owed to the insurer, so what has to be settled on reinstatement includes that balance on the terms the contract sets.

What reinstatement restarts, which nobody mentions

This is the section to read before signing anything. Reinstating a contract can restart periods that had already run their course on the original policy, and the important one is the contestable period, during which an insurer may review the statements made in the application if a claim occurs.

A policy that had been in force for many years may have been past that period entirely. A reinstated policy may not be, in relation to the statements made in the reinstatement application. Whether it restarts, and for how long, is governed by the contract and by the applicable provincial law, and it is a question with a written answer that the insurer will give when asked.

The same question applies to any suicide provision the contract contains, and to any exclusion that had a time limit. None of this is a reason not to reinstate. It is a reason to know what the reinstated contract is, so that a family is never told something at a claim that the owner could have learned in an afternoon.

Reinstating, or starting over

The comparison has four elements and it can be done properly in a single meeting. What premium does the reinstated contract require, and what would a new policy cost at today’s age and today’s health. What has to be paid to reinstate, including overdue amounts and interest. What restarts on reinstatement. And what is lost permanently if the old contract is abandoned, which for a permanent policy includes accumulated value and any rider the original contract carried.

In most cases the old contract wins, and it wins for a reason that has nothing to do with cleverness: it was issued at a younger age, and age is the one input nobody can improve. Where health has changed since the original application, the old contract wins by a wide margin, because a new application is underwritten on today’s health and the old one was not.

The old contract loses in a narrower set of cases. Where the coverage no longer matches the need, where the health picture has improved materially, for example a smoker who has stopped and can now qualify differently, or where the amount required to bring the policy back is out of proportion to the coverage restored, a new application may be the honest answer.

One rule governs both paths. Never cancel or allow existing coverage to end until the replacement policy has been issued, delivered and paid for. An application is not coverage, and the gap between them is where families get hurt.

If the reinstatement window has passed

Where the period stated in the contract has expired, reinstatement is no longer available and a new application is the only route. That is a worse position and it is not a hopeless one, and it is worth being specific about what is still possible rather than assuming the worst.

A fully underwritten application remains the first thing to try, because people routinely assume they are uninsurable when they are insurable with a rating. Where full underwriting is not available, simplified issue coverage asks fewer health questions and guaranteed issue coverage asks none, both at a higher cost for the coverage obtained, and guaranteed issue commonly limits what is payable in the first years for a death that is not accidental.

One more thing is worth doing in this situation, and almost nobody does it: find out why the payment was missed. A lapse caused by a changed payment account, an address the insurer never received, or a payment date that fell out of step with an income cycle is a solvable administrative problem, and solving it is what keeps the replacement coverage from lapsing the same way.

Preventing the next one

Most lapses are administrative rather than financial. The payment method changed, the notice went to an old address, an email filter caught the reminder, or the person who handled the household’s paperwork became ill. These are all fixable in advance and almost none of them get fixed, because nobody thinks about a policy that is working.

Four steps take one afternoon. Confirm with the insurer what address, email and payment method are on file, and correct them. Ask the insurer to add a secondary addressee, a person who receives a copy of a lapse notice, which many insurers offer and few clients use. Align the payment date with the household’s income cycle rather than the date the policy happened to be issued. And tell one other adult that the policy exists and where the documents are.

That last step is the one that matters most and costs nothing. A policy nobody else knows about is a policy that lapses quietly during the exact months a household is least able to notice.

The part of a lapse that arrives by mail in the spring

On a term policy with no accumulated value, a lapse is a coverage event and nothing else. On a permanent policy it can also be a tax event, which households do not see coming.

A permanent contract has an adjusted cost basis, a figure the insurer tracks. Where the contract ends and the value accumulated in it exceeds that basis, a policy gain can arise for that year and is reported. Where the insurer has advanced money under the contract and the advance is outstanding when the policy terminates, that amount is part of the same arithmetic rather than a debt that quietly disappears.

So a family who let a permanent policy go, assuming nothing further would come of it, can receive a slip months later for money they never held. Ask the insurer in writing what the adjusted cost basis is and what would be reported if the contract ended, and take the answer to a qualified tax professional.

The lapse nobody missed a payment on

One route into this problem involves no missed payment at all, and it belongs here because it produces the same letter.

A dividend on a participating policy is declared annually at the insurer’s discretion and is not guaranteed. Where one is credited, the owner has chosen what it does: taken in cash, left to buy paid up additions, or applied against the premium. Some contracts allow the values inside the policy to carry the premium, and an owner then hears that premiums have stopped.

They have not stopped. They are being paid from inside the contract, on assumptions current when the projection was run. If the dividend scale changes, or the values do not build as assumed, the contract can require money again, and an owner who is not watching learns that from a lapse notice. The remedy is the annual statement read rather than filed, and a written question to the insurer.

What else ends when the base contract does

A policy often carries more than one thing, and a lapse takes all of them at once. Riders attached to the base contract end with it: a term rider on the same life, coverage on a spouse or a child, a waiver of premium benefit.

Two deserve naming. A conversion privilege exists only while the term contract does, so a lapse can close a door that had years left on it. And coverage on a child or a spouse, cheap to add at issue, is not cheap to replace at today’s ages.

One more reaches beyond the family. Where a policy has been assigned as security for a loan, a lapse removes the lender’s security and may put the loan agreement in default. Speak to the lender before the policy ends.

Frequently Asked Questions

Continue Learning

Read What happens if you miss a premium for the step before this one, The contestability period for what reinstatement can restart, and Cash surrender value for what a permanent policy uses to keep itself in force. Renewing a term policy covers the other decision people face at the same moment.