K has a $10,000 traditional Whole Life policy with an outstanding loan of $1,000 and a 5% interest charge. If the loan interest is not paid at year end, what is the result?

• A. K's new loan balance is $1100.00
• B. The policy will lapse
• C. K's new loan balance is $1050.00
• D. The death benefit is reduced by $1000

Answer: (C)

Unpaid loan interest on a policy loan is capitalized, meaning it’s added to the outstanding loan and interest then accrues on the new, larger balance. Here, the policy has a $1,000 loan at 5% interest. If you don’t pay that year’s interest, $50 is added to the loan, making the new balance $1,050. The death benefit would only be affected by the loan amount at death, not immediately at year-end, and wouldn’t cause a lapse simply from not paying the interest in one year. The other options imply a larger one-year change or a lapse, which aren’t applicable in this scenario.