Financial Planning for Businesses

Life Insurance: What’s Wrong With Non-Forfeiture Laws?

Non-forfeiture Law refers to the laws created in the 19th century that required life insurance companies to provide an equity value to life insurance policies.

Before Non-forfeiture laws, life insurance companies were not obligated to provide policyholders with a cash value when they purchased life insurance. Life insurance prior to these laws was primarily term life insurance.

This means that, as a policyholder, you would buy a life insurance policy for a set period of time-say 10 years-and when the term was up, your life insurance would expire and your insurance ended. If you didn’t die, the life insurance company kept all of the premiums that you had paid.

Of course, both the life insurance company and the policyholder agreed to the terms of the contract that was signed when the policy was issued. There were simply no other options. Still, policyholders became disenfranchised with the idea of paying premiums for the term of the policy and receiving nothing in return if they lived.

Actuary, and insurance commissioner, Elizur Wright changed all of that by pushing for Non-forfeiture laws first in Massachusetts, and then for the whole country. Non-forfeiture laws would force life insurance companies to offer policies that provided cash values to their policyholders. This, combined with legal reserve requirements (more laws imposed by the states), would substantially raise the cost of insurance, but provide policyholders with an equity value, called a non-forfeiture value, cash surrender value, or “cash value”.

These laws essentially created the market for whole life insurance. These laws were supposed to “protect” policyholders from greedy insurance companies who took in premiums but never gave any money back to policyholders if they lived out the term of their insurance…so what’s wrong with non-forfeiture laws? 

First, the laws violate the right of the insurance company to create private contracts and conduct business as they please. These laws also dictated, as a practical matter, how all permanent life insurance policies had to be designed. Combined with capital reserve requirements, it also raised the cost of doing business for the life insurance company. These costs, of course, had to be passed onto the policyholder.

Secondly, the argument for non-forfeiture laws was erroneous. Since Canada did not have non-forfeiture laws and their insurance market still developed both cash value and non-cash value whole life insurance, it is reasonable to believe that the free market would have created these policies anyway-when the market was ready for it.

Policyholders could then have had a choice as to whether they wanted cash value policies or permanent policies without cash values. By forcing life insurance companies to offer cash values on all permanent policies, it violates the rights of individuals to make choices. In a profound way, it violates their right to life.

Non-forfeiture laws need to be repealed so that individuals and life insurance companies can do business with each other in an unrestricted manner.

July 10th, 2012 | by David | No Comments

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