What is Replacement?
In life insurance, replacement is the act of swapping out existing life insurance coverage with a new policy. There are some situations in which replacement makes sense, but replacement often comes with drawbacks about which consumers should be wary.
The spotty history of life insurance replacements
Life insurance has transformed through the decades to become the trustworthy, transparent product that it is today.
Not so long ago, life insurance agents were motivated to push policy replacements. They didn’t suggest these replacements because they would actually benefit the policyholder, but because selling the new policy would generate a new commission for the agent. This practice was called churning.
Oftentimes, that left the policyholder with more expensive coverage, reduced policy benefits, or both. The churning issue became so widespread that states and the National Association of Insurance Commissioners (NAIC) have since put a review process in place for replacement life insurance. Essentially, these checks ensure that the policy owner is fully apprised of what the replacement will mean for them before the swap can move forward.
Potential drawbacks with replacement
What’s the big deal with replacement, any? It can be detrimental to the policy owner in a few ways.
First, one of the biggest factors in determining the price of life insurance is the insured’s age. As you get older, life insurance gets more expensive. So replacing a policy with premiums based on the insured’s age when it was purchased with one you buy now will almost always be more expensive.
Additionally, new life insurance policies come with new timelines for specific clauses, like a suicide clause or a contestability period. These clauses usually last about two years. That means that if, within the clause timeframe, the insured dies by suicide or passes away and the insurer finds they were untruthful on their application, the policy’s beneficiaries could be denied the death benefit. Most likely, the timeline for those clauses has already expired on the policy the individual is considering replacing, significantly increasing the likelihood that their beneficiaries will receive the policy benefit.
Finally, some life insurance policies come with surrender fees that could come into play when giving up existing coverage in favor of a new policy.
When life insurance replacement makes sense
All this said, there are some instances in which replacing one life insurance policy with another is in the policy owner’s best interest.
This can be particularly true if you’re looking to change the type of life insurance you carry. If you have a term policy that’s nearing the end of the term date, replacing it with a permanent policy can help you avoid the jump in premiums that will come at the end of the term. Although permanent life insurance costs more than term insurance, it comes with benefits beyond its longevity, like a cash value component.
It might also make sense to replace permanent life insurance with a term policy as your needs change. If your mortgage is paid off, for example, you might be less concerned about the financial burden you’ll leave behind. Replacing your permanent policy with a term one can bring your premiums down significantly.
Ultimately, replacing life insurance can be a complex process with multiple factors at play. It can be helpful to consult with a trusted life insurance professional about when the choice could be right for you.