If a policy loan is outstanding and not repaid, how is the death benefit affected?

• A. The death benefit is reduced by the outstanding loan balance and interest.
• B. The death benefit remains the full face amount.
• C. The death benefit increases by the loan amount.
• D. The death benefit is payable only if the loan is repaid.

Answer: (A)

When a life insurance policy has an outstanding loan against its cash value, that loan is treated as a debt owed to the insurer. At death, the insurer pays the death benefit but first subtracts the outstanding loan balance and any accrued interest from the face amount. So the beneficiary receives the face amount minus the loan and interest. For example, if the policy’s face amount is 100,000 and there is a 15,000 loan with 2,000 in interest, the payout would be 83,000. If the loan plus interest equals or exceeds the death benefit, the payout can be reduced to zero. The loan doesn’t have to be repaid before death; it simply reduces the amount payable to beneficiaries.