How does an outstanding policy loan affect the death benefit?

• A. The death benefit remains unchanged
• B. The death benefit is increased by the loan amount
• C. The death benefit is reduced by the outstanding loan balance plus accrued interest
• D. The policy terminates immediately

Answer: (C)

Taking a loan against a policy with cash value creates a owed debt to the insurer. The debt isn’t separate from the benefit; it sits against the policy’s value. Interest on that loan continues to accrue, so the amount owed grows over time. When the insured dies, the insurer deducts the current loan balance plus any accrued interest from the death benefit before paying the remaining amount to beneficiaries. In other words, the death benefit is reduced by what’s owed on the loan (principal plus interest). If the loan balance and interest wipe out the policy’s value, the payout can be zero or the policy could lapse. If the loan is repaid, the death benefit sits closer to the full face amount.