South Carolina Life Insurance Practice Exam

What happens to the balance of the loan if the insured dies before it is paid back?

1. The balance is deducted from the death benefit

2. The loan is forgiven

3. The loan amount is paid out from the estate

4. The beneficiary receives the full death benefit

The correct answer is: The balance is deducted from the death benefit

When the insured passes away before repaying a loan taken against their life insurance policy, the outstanding balance of the loan is deducted from the death benefit. This means that the insurance company will pay the designated beneficiary the face amount of the policy minus the amount of the loan that remains unpaid. For instance, if the policy has a death benefit of $100,000 and there is a $20,000 loan balance at the time of the insured's death, the beneficiary will receive $80,000. This practice aligns with the terms of most permanent life insurance policies, which allow policyholders to borrow against the cash value they have accrued. Loans are secured by the cash value, and if not repaid during the insured's lifetime, the outstanding amount simply reduces the amount available to beneficiaries at the time of the insured's death. This process ensures that the insurer is compensated for the loan while still providing a death benefit to the insured's beneficiaries, albeit at a reduced amount based on any debt owed.