The surrender values provided under the Standard Nonforfeiture Law can be taken by the policyowner in one of three forms:

These forms are properly referred to as surrender benefits, but since the policyowner has the option or privilege of choosing the form under which the surrender value is to be paid, the benefits are usually referred to as surrender options.

The Standard Nonforfeiture Law requires that a surrender benefit be granted whenever a value appears under the formula. This may be as early as the end of the first year under some policies and later than 3 years under other policies. Under most plans and at most ages of issue, a surrender value will appear in the second policy year. Formerly no cash or other surrender benefits were required in the case of term insurance policies of 20 years or less. Under the current law a level-premium term policy for more than 15 years�or one that expires after age 65, regardless of its duration�must provide surrender benefits if the mandated formula indicates that one exists.

The nature and significance of the various standard forms of surrender benefits will be discussed in the following sections.

The simplest form in which the surrender value may be taken is cash. After the policy has been in force long enough to have no surrender charges, there is an exact equivalence between the surrender value of a policy and the cash that can be obtained upon its surrender, leading many persons to refer to the surrender value generically as the cash surrender value. The new law requires that the surrender value of a policy be made available in the form of cash, but it does not compel a company to grant cash values until the end of 3 years in the case of ordinary insurance. This limitation on cash values was provided in order to relieve the companies of the expense of drawing checks for the relatively small values that might have developed during the first and second policy years. It does not, however, relieve the company of the obligation to make available in some noncash form of benefit any surrender value that might accumulate during the first 2 years. Most companies waive this statutory provision and provide a cash value as soon as any value develops under the policy.

The law permits a company to postpone payment of the cash surrender value for a period of 6 months after demand thereof and surrender of the policy. This delay clause was given statutory sanction in order to protect companies against any losses that might otherwise arise from excessive demands for cash during an extreme financial emergency. The law has made the inclusion of a delay clause mandatory and has made the delay period of 6 months uniform. It is contem-plated that the clause would be invoked only under the most unusual circum-stances. Mutual Benefit Life Insurance Company was already experiencing a run on its assets from demand for policy surrenders and maximum policy loans before it sought both the protection of the delay clause and intervention by the state insurance commissioner. Even though the company was in poor financial shape, it was reluctant to impose the delay clause until loss of confidence was so widespread that it had no other choice.

As might be expected, provision is made for deduction of any policy indebtedness (policy loans plus accrued interest) from the cash value that would otherwise be available.

The impact of the election of each surrender benefit on the structure of the underlying insurance contract is illustrated in figures 10�1 through 10�4. In each case the underlying contract will be assumed to be a whole life policy, but the principle involved is applicable to any type of contract with some modification.

Figure 10�1 shows the change produced in cash value life insurance contracts by the exercise of the cash surrender option. The figure indicates that up to the point of surrender, the contract is a combination of protection and cash value. By surrendering the policy for cash, however, the policyowner takes the cash value element of the contract and, in so doing, terminates the protection element as well. Subject only to any reinstatement privilege, if any, that might exist, the company has no further obligations under the contract. Generally the reinstatement rights are available only to policies that have terminated for reasons other than a cash surrender.

This form of surrender benefit is referred to as reduced paid-up insurance, in recognition of the fact that under this option, the withdrawing policyowner receives a reduced amount of paid-up cash value insurance, payable upon the same conditions as the original policy. If the original policy was either an ordinary life or a limited-payment life policy, the insurance under this option will be paid-up whole life insurance. If the original policy was an endowment contract, this option will provide an endowment with the same maturity date but in a reduced amount. Some companies make this option available under a term policy, in which case an appropriately reduced amount of term insurance is paid up to the expiry date of the original term policy.

The amount of paid-up insurance provided under this option is the sum that can be purchased at the insured�s attained age by the net surrender value (cash value, less any policy indebtedness, plus the cash value of any dividend additions or deposits) applied as a net single premium computed on the mortality and interest bases specified in the policy for the calculation of the surrender value. The amount of paid-up insurance available at various durations under an ordinary life and under a 20-payment life policy, issued at age 35, is shown in table 10�1.

Paid-up insurance is provided under this option at net premium rates, despite the fact that maintenance and surrender or settlement expenses will be incurred on the policies. The law made no specific allowance for expenses on the theory that the margins in the mortality and interest assumptions underlying the net rates are sufficient to absorb any expenses that will be involved. In the case of participating insurance, however, any margins available for this purpose are reduced by the payment of dividends on the paid-up insurance.

It is interesting to note that there is a surrender privilege under reduced paid-up whole life and endowment policies. The law states that such policies can be surrendered for cash within 30 days after any policy anniversary, provided the original policy was in force long enough to grant a cash value. In other words, the cash surrender privilege of the paid-up policy cannot be used to subvert the provision in the law that cash values need not be granted until the end of 3 years.

The effect of the reduced paid-up insurance option on the structure of the whole life policy is illustrated in figure 10�2. It is readily apparent that the most important impact is on the protection element of the contract. In the example, the cash value before surrender had accumulated to a sum half the face of the policy, which at age 60, for instance, would purchase a paid-up whole life policy in an amount approximately 75 percent of the original face. The entire shrinkage comes out of the protection element, however, since the investment element continues to increase until it equals the reduced face at the end of the mortality table. The same phenomenon occurs with a surrender at any duration. As was pointed out, this cash value element of a reduced paid-up policy can be converted into cash by surrendering the policy pursuant to its terms.

Universal life insurance and variable universal life policies provide a nonguaranteed form of reduced paid-up option. The policyowner can reduce the death benefit so that the existing cash value is sufficient to cover all future charges, helped by the future earnings credited to the cash value. The nonguaranteed element is the fact that the policyowner bears the investment risk, and if the earnings on the cash value drop below the level anticipated when the policy benefit was reduced, further adjustment(s) may be needed.

The policyowner has to explicitly request a death benefit reduction to create the equivalent of a reduced paid-up surrender option for a universal or variable universal life policy.

The extended term insurance option provides paid-up term insurance in an amount equal to the original face of the policy, increased by any dividend additions or deposits and decreased by any policy indebtedness. The length of the term is such that it can be purchased at the insured�s attained age by the application of the net surrender value as a net single premium. This gives effect to the statutory requirement that the present value at the time of surrender of any paid-up surrender benefit must be at least the equivalent of the surrender value. The period for which term insurance is provided for various durations under an ordinary life policy, and under a 20-payment life policy, issued at age 35, is shown in table 10�1.

Universal and variable universal life insurance policies do not have a guaranteed extended term surrender option. However, they are automatically configured to work similarly to extended term insurance. These policies have no fixed or required premiums, and the viability of the contract depends on the account balance of the policy�s cash value. The policy will remain in force as long as the cash value is sufficient to cover the next 60 days of charges for mortality (term charges) and administration and until these charges consume the cash value.