Why would I consider a life insurance replacement?

A life insurance policy is a financial asset. It is a good idea to review it on a regular basis to make sure you are getting the value you expected, in exchange for the premium dollars you pay the life insurance company. Things change in the real world, and your life insurance policy can be affected by such things as changes in the issuing company’s financial condition and by competition.

Life insurance is also a financial tool, a complex tool that provides you with financial leverage. There is no substitute for life insurance, for it is unique in its ability to provide a self-completing financial plan, should the insured person die unexpectedly. Life insurance can be used to replace lost income, pay the federal estate tax, and provide money for many other worthwhile purposes.

Replacing an in-force life insurance policy can be a very good idea or a very bad one. It depends on many factors. Traditionally, the viewpoint within the life insurance industry is that replacing an existing life insurance policy with a new one is generally not in the policy owner’s best interest. This statement is ambiguous in the sense that it can be both true and false at the same time. Dealing with the complexities of the life insurance replacement issue is like peeling away the layers of an onion. Remove several layers and there are still many layers remaining.

This report is intended to aid you in the replacement decision-making process. It is not an exhaustive treatment of the subject, because your individual situation is unique and there is no one-size-fits-all solution. Our purpose here is to help you evaluate the pertinent facts and circumstances when considering whether or not to replace an existing life insurance policy. A replacement may be internal (i.e., replacing it with a new policy from the same company) or external (i.e., replacing it with a policy from a different company).

Consider these questions if you are thinking about replacing your policy:

  • What do you wish a new policy to achieve that your existing policy does not?
  • Have you contacted the current company to see if the policy can be modified to meet the desired objectives? Policy performance may actually be quite competitive if the factors adversely affecting this performance have been experienced by all insurers. In particular, the dramatic fall in interest rates over the last 20 years has lowered the returns of all traditional whole life and universal life policies to one degree or another. Rather than replace the competitive policy of a well-rated insurer, whose returns have only gone down to some extent with the broad decline in interest rates, it may be more appropriate to make any necessary adjustments to ensure the continuation of the policy by raising the premium, paying it for a longer time, reducing the policy’s death benefit, or seeking an adjustment with an updated policy from the same insurer.
  • Compare the benefits of each policy. Differences in the underlying investments of the old and new policies may make rate-of-return comparisons difficult or misleading, especially if the proposed new policy is variable and equity investments are contemplated in place of the old insurer’s fixed-income-oriented investment portfolio. Investment returns obviously need to be adjusted for risk for comparisons to be meaningful, and the other factors affecting product performance— mortality, expenses, and lapse rates—need to be considered as well.
  • Be aware that a new policy will have new suicide and incontestable provisions unless the company is willing to waive them.
  • Will the replacement (if it is a permanent life insurance policy with a cash value) qualify as a tax-free exchange under Internal Revenue Code Section 1035? (See Question 101 in the book.)
  • Will you be able to qualify both financially and health-wise for the new coverage?
  • Have you been urged to borrow from a current policy or policies to finance the new coverage? This is not a good idea.
  • Is this a replacement proposal that attempts to increase the death benefit for an existing premium or to lower the premium for an existing death benefit, by guaranteeing a death benefit—but only to a certain advanced age, such as age 95 or 100. Purchasers of “permanent” insurance want their policies to be “permanent” and not to expire before they do if they happen to live an especially long time.