Lapse

What Is a Lapse?
A lapse is the expiration or loss of a right, privilege, or policy because required conditions were not met or time limits were missed. In insurance, a lapse most commonly occurs when a policyholder fails to pay premiums on time, causing coverage to end until the policy is reinstated. Lapses also occur in other contexts, such as stock options that expire if not exercised within a specified window.

Key Takeaways
* A lapse happens when a contract or policy becomes inactive due to unmet requirements (e.g., missed payments).
* Insurance lapses typically stop coverage; reinstatement may be possible but can require documentation and higher premiums.
* Many insurance policies include a grace period—usually about 30 days—before a lapse takes effect.
* Auto insurance lapses can raise premiums, trigger legal penalties, or require proof of financial responsibility (SR-22).
* Employee stock options can lapse and revert to the employer if not exercised within the deadline.

How Lapses Occur
Lapses take effect when contractual conditions are unmet by specified deadlines. Common triggers:
* Missed premium payments for insurance.
* Expiration of a contract period without renewal.
* Failure to exercise stock options within the allowed exercise window.

Insurance Policy Lapses: Mechanism
* Grace period: Insurers generally provide a grace period (commonly 30 days) after a missed payment. Coverage continues during this period in many policies.
* Cash-value policies: Whole life, universal life (UL), and variable universal life policies may use accumulated cash value to cover missed premiums. If cash value is exhausted and premiums remain unpaid after the grace period, the policy lapses.
* Term life policies: Term insurance does not build cash value, so a missed premium typically leads to lapse once the grace period expires.
* Reinstatement: Policies can often be reinstated, but requirements vary by how long the policy has lapsed:
* Within 30 days: many insurers allow reinstatement without health documentation.
* 30 days to 6 months: insurers may require proof of insurability and financial information.
* Over 6 months (up to several years): reinstatement is at the insurer’s discretion and can require full underwriting.

Consequences of an Insurance Lapse
* Loss of coverage: Benefits cease once a policy lapses.
* Higher premiums: A history of lapses signals increased risk to insurers and often leads to higher future premiums or placement with lower-rated insurers.
* Requalification hurdles: Reinstatement may require medical underwriting or higher rates.
* Credit impact: Lapses alone usually don’t affect credit, but unpaid premiums sent to collections can lower a credit score.
* Legal penalties (auto insurance): Many jurisdictions require continuous auto coverage. Penalties for driving uninsured can include fines, license suspension, and mandatory SR-22 filings. Example: some states impose a reinstatement fee and may suspend driving privileges until proof of insurance is provided.

Lapse Ratio (Insurance Metric)
Lapse ratio (or expiration ratio) measures the proportion of issued policies not renewed relative to policies active at the start of a period. It is used to gauge an insurer’s customer retention and revenue stability.

Stock Option Lapses
Employee stock options and restricted shares often have vesting schedules and exercise windows. If options are not exercised within the specified timeframe (for example, 90 days or 6 months after departure), they lapse and typically revert to the employer. This means the employee loses the right to buy those shares at the grant price.

Example: Life Insurance Lapse
Sam buys a term life policy with a $1 million death benefit and a $100 monthly premium. After two years he loses his job and stops paying. After the 30-day grace period ends with no payment, the policy lapses. If Sam were to die during the lapse, no death benefit would be paid. Later, after finding work, Sam successfully applies to reinstate the policy and resumes premium payments.

Frequently Asked Questions
What percentage of life insurance policies lapse?
As of 2021, the lapse rate for individual life insurance policies was about 5.2%.

How does a lapse affect car insurance rates?
A lapse typically increases auto insurance rates. Short gaps (up to 30 days) can raise rates modestly (around single-digit percentages), while longer lapses often produce larger increases—studies have reported significantly higher rates (e.g., ~35%) for lapses beyond 30 days. Exact impacts vary by state, insurer, and driving history.

Will an insurance lapse hurt my credit score?
Not directly. However, if unpaid premiums are referred to collections, that can be reported and lower your credit score.

How long do I have to reinstate a lapsed policy?
It depends on the insurer and the type of policy. Many allow reinstatement within 30 days without medical proof; beyond that, evidence of insurability or underwriting may be required. Some policies can be reinstated months or years later, but terms vary.

How to Prevent a Lapse
* Mark payment due dates and enroll in automatic payments where appropriate.
* Use available grace periods and communicate promptly with your insurer if you expect difficulty paying.
* For cash-value policies, monitor policy cash value reductions and plan for supplemental payments if needed.
* If you lose coverage (e.g., after leaving a job), understand exercise windows for stock options and act before deadlines.

Conclusion
A lapse—whether of an insurance policy, stock option, or other contractual right—occurs when required actions aren’t taken within specified deadlines. Lapses can stop coverage, increase costs, complicate reinstatement, and in some cases trigger legal consequences. Monitoring deadlines, maintaining communication with providers, and understanding policy terms are the best ways to avoid the risks associated with lapses.