Premium payment modes and grace period

How often the premium is paid: payment modes

A life insurance premium is quoted as an annual amount, but the policyowner chooses how often to pay it. This choice is the premium mode. The common modes are:

• Annual: one payment a year. This is the cheapest way to pay.
• Semiannual: two payments a year.
• Quarterly: four payments a year.
• Monthly: twelve payments a year, usually by automatic bank draft (a pre-authorized check or electronic funds transfer arrangement).

Two other arrangements describe how long premiums are paid rather than how often. A single-premium policy is fully paid with one lump sum at issue. A limited-pay policy, such as a 20-pay or paid-up-at-65 whole life policy, collects premiums for a set period and is then paid up for life.

Why paying more often costs more

The insurer converts the annual premium into a modal premium using modal factors. A typical company might charge about 52% of the annual premium twice a year, about 26% four times a year, or about 8.5% to 9% every month. Add those payments up and the yearly total is higher than the annual premium. The extra charge covers two things: the investment earnings the insurer loses by receiving the money later, and the added cost of billing and processing more payments.

For example, with an annual premium of $1,000 and a monthly factor of 0.09, the monthly premium is $90, or $1,080 a year. Paying annually saves $80.

The mode does not change the face amount or the coverage. The policyowner can usually change modes, often on a policy anniversary.

The grace period

The grace period gives the policyowner extra time to pay a premium after its due date without losing coverage. The standard rule for a scheduled-premium policy is a grace period of 31 days, or one month, following each premium due date. It applies only after the first premium has been paid. The first premium has to be paid for coverage to begin, so there is no grace period on it.

During the grace period the policy stays in full force. If the insured dies during the grace period, the insurer pays the death benefit minus the overdue premium. Standard provisions let the insurer deduct the unpaid premium only through the end of the policy month in which death occurred. They also work in the other direction: if premium was paid for a period beyond the policy month of death, the insurer refunds it with the death proceeds. The grace provision does not apply to single-premium or paid-up policies, because no further premium is owed.

Grace period = time to pay late while still covered. It is not free insurance: if death occurs, the unpaid premium is subtracted from the claim.

Flexible-premium policies

Universal life and other policies with flexible premiums have no fixed due date. Their grace period starts when the policy's cash value is no longer enough to cover the monthly charges that keep it in force. These policies usually allow a longer grace period, commonly 61 days, for the owner to pay enough premium to keep the coverage going.

What happens if the grace period ends unpaid

If the premium is still unpaid when the grace period expires, the policy lapses. The owner of a cash value policy does not lose everything:

• If the owner elected the automatic premium loan provision, the insurer borrows the premium from the cash value, and the policy stays in force.
• Otherwise, the nonforfeiture options apply: cash surrender, reduced paid-up insurance, or extended term insurance. Extended term is the usual automatic default.
• The owner can usually reinstate a lapsed policy within a set period, typically three years. Reinstatement requires evidence of insurability and payment of all back premiums with interest.

Insurers typically mail a premium notice before each due date. The notice states the amount, the due date, and the consequence of not paying within the grace period.