There are many reasons you may want to replace your current life insurance policy with a new one. A new policy may offer better coverage at a lower cost, you may feel more confident in the agent or insurance company, or your needs may have changed, prompting you to think about a different policy -- whole life instead of term life, for instance.
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However, when you apply to replace your current life insurance policy with a new one, you'll likely encounter a peculiar little mambo that doesn't exist around the replacement of auto or homeowners insurance.
Prior to underwriting, you'll be asked about any existing policies. Be prepared to answer questions such as these on your application:
- Do you currently have a life insurance policy?
- If so, what is the policy number, insurance carrier and policy expiration?
- Do you plan to replace your current policy with your new one?
This section of the life insurance application can puzzle cautious consumers. Why does a new insurer need to know these details? Will your answers affect the terms offered? Could a wrong answer give your insurer "contestability" -- a reason to void the policy and deny benefits to your survivors?
The good news is these questions are aimed at protecting you and letting both insurers know you're busting a policy move.
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Method to the Mambo
"The main, if not the only purpose of those questions is to protect the consumer and in some small way, the insurance company against agents who would persuade the customer to buy a new policy for no other reason than to reap a new commission," says Steven Weisbart, senior vice president and chief economist with the Insurance Information Institute. Regulators call that "churning."
Unlike property and casualty insurance, life insurance can involve cash values, waiting periods, surrender fees and other complexities that can cost unwary consumers if they rush or are rushed into a new policy solely based on a more attractive premium or death benefit.
To that end, the insurance industry tries to police over-aggressive salespersons, "churning" agents, ill-informed financial advisers, con artists and consumers who try to deceive or over-purchase life coverage, by ringing a bell whenever a replacement is imminent.
"The companies are required by the state insurance departments to send out replacement forms to the ceding insurer, the one being replaced," says Tony Steuer, author of "Questions and Answers on Life Insurance." "In some states, including California, once you reach age 65, they're required to give more lengthy information to the consumer because people can be talked into doing anything."
Ron Herrmann, senior vice president for distribution and sales at The Hartford, says the paperwork required of both the new and ceding insurance company varies from company to company and state to state.
- Be sure to have a new policy in effect before you cancel your old policy. That will give you time to review it and make sure it meets your needs.
- You pay most of the fees and costs of a new life insurance policy upfront. Be sure the money you save on a new policy will be worth paying these upfront costs once again.
- Consider the tax consequences of dropping your old policy before committing to a new one.
- Premiums on your new policy may be higher, or you may not be insurable under the same conditions, based on your age or changes to your health.
- Be sure to compare your rights and benefits under your new policy against the old one; they may not be the same.
- You can save time and money by amending or adding to your current policy instead of replacing it.
- Most new policies have a waiting period before certain kinds of death benefits become effective. Consider this before replacing your old policy.
- If you're on the fence about replacing your old policy, ask your insurance agent or company for an illustration of how it has performed for you and its projected benefits moving forward.
How the Insurer's Concerns Affect You
Term life replacement tends to be straightforward. Since there are no cash values involved, the main hurdles involve insurability (think medical exam), ability to pay the premiums and a reset on the waiting period, which is usually a two-year stretch when your policy won't pay for death by suicide. You may also be setting the clock back to zero on your contestability period -- the time during which the insurer can cancel your policy for false statements on your application -- and your conversion period, during which you can convert your term policy into a cash-value one.
Annuities and cash-value policies, such as whole, universal and variable life products, can be more complex and costlier to replace because they often involve surrender charges, 1035 exchanges and the use of policy loans to fund a new life insurance policy.
However, the replacement mambo involves more than mere consumer protection. Your new insurance company has a stake in your answers as well. Their first concern: Can you afford the new policy if you don't cancel the old?
"There are upfront costs to issuing a policy, and it will take a while before the total revenues exceed their initial costs," says Weisbart. "If you buy a new policy, they want to be somewhat confident that you will pay premiums long enough to make this a profitable transaction for them."
The second concern: Is this an appropriate amount of insurance based on your financial information? "The insurance company doesn't want to give me $30 million in insurance when I'm only worth $1 million," Herrmann says.
Weisbart says such a move to overbuy coverage sets off other alarms as well. "If a person has more than reasonable coverage on his or her life, that may present an incentive to someone to turn this life insurance policy into a claim," he says. "While life insurers are happy to sell coverage, they are not in the business of creating financial incentives for people to die."
If you don't know whether you will cancel your old policy once the new one is issued (never do so beforehand), should you say you are replacing the policy on your application?
"Yes, you're supposed to," says Steuer. "The reason they do that is, you're not required to actually replace the policy. The new insurance company can't force you to actually replace the policy that you promised to replace nor can they use that for contestability. They can't contest because they can't force you to give up the policy."
Weisbart says to be safe, make sure the life insurance policy you seek is a reasonable one.
"If you have a schoolteacher who is applying for $10 million in insurance and there's no apparent reason for that amount of money, I could see a rejection," he says.