Wednesday, August 25, 2010

Have You Unwittingly Fallen Prey To APL?

Premium holiday is a phrase that gives a happy connotation to something you might not be so hot about if you knew its workings. I was having a discussion lately with a friend of mine and he told me that his insurance policy is still inforce despite him not paying for a few months.  How was this possible? In insurance language, he has gone on a "Premium Holiday".

However, be clear that this post only applies to traditional life insurance policies and not investment-linked policies. You can take premium holidays on an investment-linked policy but its workings are different and hence are not applicable to what we're talking about here.

Premium holiday is available to any policy that has enough cash value accumulated to pay the next premium. You then get to skip paying your insurance premium while still enjoying the coverage. You can be on this holiday until your policy runs out of cash value. If it runs out and you still cannot pay your premiums, the policy will lapse and you will not be covered anymore.

While you might think that having your premium paid through the accumulated cash value in your  policy is a good option, this may not always be the case. How detrimental or beneficial a premium holiday is depends highly on the method used to go on a premium holiday. You can think of it as taking different modes of transportation to your holiday destination. This might get a tad technical but could save you thousands in the long run so bear with me.

What method should you use?

DON'T: Take an Automatic Premium Loan (APL) as a means to go on a premium holiday. This is essentially a loan that is automatically taken against the cash value of the policy to pay your premium in the event the policy was about to lapse due to no payment. The interest you pay on this can be as high as 7%! This will undoubtedly deplete your cash value rapidly. I only suggest using this clause if all other methods of payment are exhausted.

DO: If you find yourself in a situation where you cannot pay for your insurance premium you should first ask your insurance consultant about your options. Insurance companies usually pay out cash bonuses every year. This cash bonus is reinvested into you policy (unless stated otherwise) and forms part of your Cash Value. Cash Value is the amount of money you get if you choose to surrender the policy. The great thing about this is that after a few years you could have accumulated a substantial amount which can be used to offset future premium payments. This is NOT categorized as a loan and so its almost like using money from your own savings to pay for the premium.

I hope this has given you some clarity regarding APL and prevented you from falling into its trap.

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