Life Insurance Replacement: What You Need to Know
by Ray Sagner on Aug 23, 2017
The purchase of life insurance is typically triggered by a life event, such as marriage, the birth of a child, a home purchase or a job promotion. So, it is not uncommon for many people to change their life insurance coverage three or four or even eight times throughout their lifetime. In some cases it will require simply adding coverage, but, depending on the situation, it could require replacing one policy with another for purposes of efficiency. However, sometimes people are convinced to replace their life insurance policy for reasons more in the interests of the life insurance agent than your own. If you are ever advised to replace a life insurance policy with another, you should know that there are very strict rules and regulations in place to protect you against such replacements.
The Problem with Replacements
You have probably replaced or exchanged your auto or home insurance a few times, especially when you found you could lower your premium or obtain better coverage. Replacing a life insurance policy is a little more involved and, if you are not careful, it could end up negatively affecting your coverage and future costs. Granted, there are instances, when replacing a life insurance policy can improve coverage and lower premium costs. However, there are certain provisions in all life insurance contracts that can increase your risks when you change policies.
All life insurance policies include a contestability period provision which gives the insurer two years to contest a death benefit claim based on any misrepresentations made by the insured on the application. In many cases, a misrepresentation is made in error, with no mal intent on the part of the insured. But, an error is enough for an insurer to deny a claim. Whenever a policy is replaced with a new one, the contestability period starts anew. The same goes for the suicide exclusion, which is included in every contract, giving the insurer the right to deny a claim if death is caused by suicide within the first two years.
Replacements Can be Costly
For cash value life insurance policies, a replacement often hurts the policyholder. If a policy includes surrender fees, which are fees charged when cash value is surrendered before a certain period of time, the policyholder will lose a chunk of his cash value when it is transferred to a new policy. It rarely makes sense, if ever, to replace a cash value policy with another if there are surrender fees.
In addition, a sizable portion of life insurance costs are paid in the early years of the contract; so, when you start a new policy, you are paying for costs that were already covered in your existing policy. It takes several years for a policy’s cash value to grow with greater efficiency, which is lost when you start a new policy.
It has to be in Your Best Interest
The state insurance departments are most concerned with the small percentage of life insurance agents who engage in the illegal practice of “churning,” which is when a policyholder is persuaded to replace a policy for no other reason than to generate another commission for the agent. There has to be a valid reason, supported by analysis, that demonstrates how the insured’s financial position will be improved. All replacements must go through a mandatory review process and meet specific criteria before they are approved.
If you are ever advised to replace a life insurance policy, the agent is required to provide you with a document explaining the rules and requirements for policy replacements as well as the risks. Study it and ask a lot of questions before agreeing to a replacement. You need clear evidence that the replacement will substantially improve your financial position. If you have any doubts, get a second opinion from an independent life insurance professional.
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