A lapse is the removal or expiration of a privilege, right, or policy due to the passage of time or some sort of inaction. When a party doesn’t fulfill the conditions or requirements set forth by a contract or agreement, a lapse occurs.
When an insurance policy lapses, it usually happens because one party fails to act on its obligations, such as not paying the premiums. Similarly, in derivatives trading, the right given by an options contract will lapse when the option reaches maturity, making it void.
Key Takeaways
- A lapse occurs when the benefits and rights stated in a contract no longer remain active due to the contract holder failing to honor requirements.
- A lapse can occur due to inaction, passage of time, or failure to pay what is due.
- A stock option lapses when not executed according to the terms of the option contract.
- Insurance rates are generally higher for policyholders with lapsed coverage.
- Most policies can be reinstated within the policy’s grace period.
Understanding Lapses
When something has lapsed, the benefits and conditions stated in the lapsed contract or agreement no longer remain active.
A lapse is most often used in the context of insurance, where the term implies a “lapse in coverage,” meaning a lapsed policy no longer provides benefits or coverage. Lapsing can also occur in other contexts.
Lapsed Insurance Policies
When policyholders stop paying premiums and when the account value of the insurance policy has been exhausted, the policy lapses. A policy doesn’t lapse each time a premium payment is missed, thanks to a legally required grace period, usually 30 days, that insurers give policyholders to pay the missed premium.
Certain policies, such as whole life, variable universal life, and universal life (UL) insurance, use existing cash values to cover missed payments. If the account value isn’t sufficient to cover the premiums, the policy will lapse. A lapsed policy means the insurer is no longer under obligation to provide the stated benefits.
Term life insurance doesn’t have this benefit since it doesn’t build cash value. In this case, when premium payments are missed, the policy immediately lapses after the grace period expires.
Most insurers allow for policy reinstatement during the grace period. The requirements for reinstatement depend on how long the policy has lapsed. Documentation regarding health and finances may be required for lapses of up to six months, with more stringent requirements for longer lapses.
Consequences of Lapsed Car Insurance
Many states require drivers to have auto insurance. Driving without insurance can put personal finances and assets at great risk, and in some cases, may lead to penalties and higher insurance rates while seeking new coverage.
Auto policies can lapse for reasons like missed premium payments or excessive driving infractions. Lapsed coverage categorizes policyholders as high-risk, leading to steeper premium rates. Some individuals may even need to obtain coverage from lower-rated insurers.
Some states impose penalties for lapsed coverage. For instance, Alabama might suspend a driver’s license and impose reinstatement fees. Furthermore, this may necessitate filing an SR-22 certificate, increasing the cost of insurance due to the indication of poor driving history.
Lapses in Shares of Stocks
Sometimes stock shares or stock options are granted to employees as an incentive, often with restrictions preventing the sale or trading of shares over a particular period, dependent on the vesting period and duration of employment.
If the employee doesn’t exercise the stock option within the specified time, the options lapse, meaning the employee forfeits the shares, which return to the employer.
For example, if an employer grants employees with 10 years of service the option to buy 100 shares of stock at $20 per share to be executed within 6 months, but some employees fail to act within this time, their option lapses.
Example of a Lapse
Consider Sam who holds a term life insurance policy with a $1 million death benefit, requiring a $100 monthly premium. For the first two years, Sam pays as required, but then loses his job and can’t afford the payments. After the 30-day grace period ends and Sam still can’t pay, the policy lapses, leaving Sam without coverage if something were to happen.
Later, Sam finds another job and requests the insurer to reinstate the policy. The insurer agrees and coverage is restored when Sam resumes premium payments.
A lapse ratio, or expiration ratio, measures the number of policies not renewed compared to those active at the period’s start, acting as a key retention efficiency indicator in the insurance sector.
Lapse FAQs
What Percentage of Life Insurance Policies Lapse?
As of 2018, individual life insurance policies had a lapse rate of 4.7%, while group policies had a 5% lapse rate.
How Does a Lapse in Coverage Affect My Car Insurance Rates?
A lapse in auto coverage typically results in higher rates. A 30-day lapse might see an 8% rate increase, while lapses over 30 days can see a 35% increase.
Does an Insurance Lapse Affect Your Credit Score?
Generally, policy lapses don’t affect credit scores, but if debts to the insurer go unpaid and are reported to collection agencies, it can decrease the policyholder’s credit score.
The Bottom Line
A lapse in coverage can occur for multiple reasons with missed premium payments being the most common. Such lapses translate to higher risks for insurers and higher rates for policyholders. Facing a possible lapse? Contact your insurer to explore options and prevent a lapse.
Related Terms: insurance, premiums, options contract, underlying asset, grace period, cash values, reinstatement.
References
- Pocket Sense. “Lapsed & Restricted Stock Options”.
- ACLI. “Life Insurance”, Page 7.
- Value Penguin. “How Does a Lapse in Car Insurance Coverage Affect Rates?”
- Value Penguin. “What Happens if Your Car Insurance is Canceled for Nonpayment?”
