What Is an Automatic Premium Loan?
An automatic premium loan is an insurance policy provision that allows the insurer to deduct the amount of an outstanding premium from the value of the policy when the premium is due. Automatic premium loan provisions are most commonly associated with cash value life insurance policies and allow a policy to continue to be in force rather than lapsing due to nonpayment of the premium.
Understanding an Automatic Premium Loan Works
In order to take an automatic premium loan, you have to have a cash-value life insurance policy, in which every premium you pay adds to the cash value of the policy. Depending on the policy language, life insurance policyholders may be able to take out a loan against the cash value of their policy. This accrued cash value is a value over and above the face value of the policy and can be borrowed against by the policyholder at their discretion. Note that the policy contract’s language may indicate that no loans may be taken out unless the premium has been paid in full.
Since the accrued value is technically the property of the policyholder, borrowing against the cash value does not require a credit application, loan collateral or other good faith requirements typically found in loans. The loan is taken out against the cash value of the policy, and the loan balance is deducted from the policy’s cash value if not repaid. The policyholder will owe interest on the loan, just as with a standard loan.
An automatic premium loan taken out against an insurance policy is still a loan and, as such, does carry an interest rate.
Automatic premium loan provisions help both the insurer and the policyholder: The insurer can continue to automatically collect periodic premiums rather than sending reminders to the policyholder, and the policyholder is able to maintain coverage even when they forget or are unable to send in a check to cover the policy premium.
The policyholder may still choose to pay the premium by the regularly scheduled due date, but if the premium is not paid within a certain number of days after the grace period, such as 60 days, the outstanding premium amount is deducted from the policy's cash value. This prevents the policy from lapsing. If the automatic premium loan provision is used, the insurer will inform the policyholder of the transaction.
An automatic premium loan is a loan taken out against the policy and does carry an interest rate. If the policyholder continues to use this method of paying the premium, it is possible that the cash value of the insurance policy will reach zero. At this point, the policy will lapse because there is nothing left against which to take out a loan. If the policy is canceled with an outstanding loan, the amount of the loan plus any interest is deducted from the cash value of the policy before it is closed.