Rhode Island Life Insurance Practice Exam

What happens to the death benefit if a policyholder borrows against their whole life policy?

1. The death benefit is increased

2. The death benefit remains unchanged

3. The death benefit is reduced by the loan amount

4. The loan cannot be taken against the death benefit

The correct answer is: The death benefit is reduced by the loan amount

When a policyholder borrows against their whole life insurance policy, the death benefit is reduced by the amount of the outstanding loan. This is because the loan represents a claim against the policy's cash value, which effectively decreases the total benefit that will be paid out to beneficiaries upon the policyholder’s death. For instance, if a policyholder has a death benefit of $100,000 and borrows $20,000 against it, the net death benefit available to beneficiaries would be $80,000 (the original death benefit minus the loan amount). This adjustment ensures that the insurance company is not paying out more than the originally stated death benefit minus any amounts that have already been claimed through loans. In contrast, the other options do not reflect the mechanics of how borrowing works with whole life policies, leading to a misunderstanding about the impact of loans on death benefits.