Replacing an existing life policy

Replacement means terminating or reducing an existing policy in connection with buying a new one.

It is regulated specifically because it has been a persistent source of unsuitable sales, and because the costs of replacing are frequently invisible to the buyer.

What replacement costs

New acquisition costs. A new policy incurs commission and expense loads again, front-loaded as before.

On a permanent policy, this can reset years of accumulation.

A new surrender charge period. The old policy may be past its surrender charges; the new one starts a fresh schedule.

A new contestability period. The insurer can contest the new policy for material misrepresentation, generally for two years.

An existing policy past its contestability period cannot generally be contested. Replacing it restarts that exposure, which is a real loss of certainty.

A new suicide exclusion period, generally two years on the new policy.

Higher cost of insurance, because you are older. The mortality charge in the new policy reflects your current age.

New underwriting, which may result in a worse classification than the original if your health has changed.

This last point is critical. Never terminate existing coverage until the new policy is issued, delivered and in force at the expected rating.

When replacement is genuinely appropriate

The original policy is performing badly and an in-force illustration shows it may lapse or requires substantially higher premiums to sustain.

This is common with universal life policies sold during periods of high interest rates, where credited rates subsequently fell.

Your health has improved substantially — smoking cessation, weight loss, resolution of a condition — such that new underwriting produces a materially better rate.

The coverage no longer matches the need, in amount or duration.

The insurer's financial strength has deteriorated significantly.

The product type is genuinely wrong — permanent coverage sold to someone who needed term, where the ongoing cost is unsustainable.

Rates have improved generally. Term rates have declined over long periods as mortality has improved, and a policy purchased many years ago may cost more than an equivalent new one even at an older age.

This is worth checking rather than assuming, and it does sometimes favor replacement.

The alternatives to replacement

Frequently better and rarely presented.

Keep the existing policy and add a new one for the additional coverage needed. This preserves the old policy's advantages entirely.

Reduce the death benefit on a permanent policy to lower ongoing charges.

Use dividends to reduce or pay premiums on a participating policy.

Convert to a reduced paid-up policy, ending premiums with a smaller guaranteed death benefit.

Use the existing policy's conversion option if it is term with convertibility, which requires no new underwriting.

A section 1035 exchange, which transfers cash value to a new policy without triggering tax and preserves basis.

Note that an exchange still incurs the new acquisition costs, new surrender charges and new contestability period. It solves the tax problem, not the cost problem.

The regulatory requirements

Most states require specific disclosure when a replacement is involved.

Typically: a notice explaining the consequences of replacement; a comparison of the existing and proposed policies; notification to the existing insurer, which gives them an opportunity to respond; and signatures acknowledging the disclosures.

If a producer is recommending replacement and these forms have not appeared, that is a significant warning sign.

The existing insurer's response frequently contains useful information, including options you were not told about.

The comparison to demand

Ask for a written side-by-side comparison containing, for both policies:

Death benefit, premium, and guaranteed premium.

Current cash value and surrender value.

Projected values at ten, twenty and thirty years, on both guaranteed and current bases.

Surrender charge schedule.

Remaining contestability status.

Insurer financial strength ratings.

Total cost over the expected holding period.

If a producer cannot or will not produce this, do not proceed.

The independent opinion

For any significant replacement, particularly involving permanent policies, obtain an opinion from someone who is not paid by commission on the transaction.

A fee-only advisor's cost is small relative to the amounts involved, and their assessment is not influenced by the sale.

Also request an in-force illustration on the existing policy directly from that insurer, rather than relying on figures supplied by the person recommending replacement.

The general position

Existing coverage has value that is easy to underestimate: it is past its contestability period, past its surrender charges in many cases, and was underwritten when you were younger and possibly healthier.

Replacing it should require a clear, quantified reason.

Where that reason exists, replacement is a legitimate and sometimes substantially beneficial decision. Where it does not, the transaction generally benefits the person recommending it more than the person doing it.

General information about insurance products, not insurance, financial or tax advice. Replacement regulations and policy provisions vary by state and insurer. Consult an independent advisor and review all disclosure documents.