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A
The policy is void and no benefit is paid
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B
The outstanding loan balance plus accrued interest is deducted from the death benefit; the net amount is paid to the beneficiary; the policy remains in force as long as cash value minus loan balance exceeds policy charges
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C
The beneficiary must repay the loan before receiving the death benefit
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D
The death benefit automatically doubles to compensate for the loan
Why this is the answer
POLICY LOANS against permanent life insurance cash value are a unique feature of these products. Understanding how they work is heavily tested on licensing exams. HOW POLICY LOANS WORK: The policyowner can borrow up to the cash surrender value (minus any surrender charges) at any time without a credit check; interest accrues on the loan (set by the policy, typically 5-8%); the loan is not 'due' — the policyowner can repay whenever they choose or never; there is no repayment schedule or credit bureau reporting; UPON DEATH WITH OUTSTANDING LOAN: The insurance company deducts the LOAN BALANCE plus any ACCRUED INTEREST from the death benefit; the remaining amount is paid to the beneficiary; the insurer does NOT pursue the estate for repayment — the deduction from the death benefit IS the repayment; WHILE ALIVE WITH OUTSTANDING LOAN: If the loan plus interest grows to equal the cash value, the policy lapses (termination of the policy with possible taxable income if the loan principal exceeded basis); annual statements will show loan balance and warn when this is approaching; INCOME TAX IMPLICATIONS: Policy loans are generally NOT income (they are debt, not received value) while the policy is in force; HOWEVER, if the policy lapses with an outstanding loan AND the loan exceeds the policy owner's basis (premiums paid minus dividends received), the excess IS taxable income; PARTIAL SURRENDERS: Similar to loans but reduce the face amount — different tax treatment.
Source: Life Insurance License Exam, Policy Loans