What does "policy loan" mean in life insurance?

A policy loan refers to a loan that a policyholder takes against the cash value accumulated within their life insurance policy. Many permanent life insurance policies, such as whole life or universal life, build cash value over time, which the policyholder can borrow against. This type of loan is beneficial because it allows the policyholder to obtain funds without the need for a credit check or the formalities associated with traditional loans.

When a policyholder takes a loan against their policy, the borrowed amount reduces the death benefit and cash value until it is paid back. If the loan is not repaid, the outstanding balance, including any interest accrued, will be deducted from the death benefit that the beneficiary receives upon the policyholder's passing. This option is particularly appealing to policyholders who may need quick access to cash without surrendering their policy or losing its protective benefits.

In contrast, the other options describe arrangements or processes that do not accurately reflect the nature of a policy loan. For instance, a loan granted to a beneficiary from the insurance company is not related to the borrowing provisions available to the policyholder. Similarly, there is no mandatory requirement for policyholders to repay the loan annually nor any provision allowing them to reduce premiums through loans, which differentiates policy loans