Life Insurance: What to Consider Before Replacing a Policy

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You might consider replacing your life insurance policy if you think you can:

1. Get a better deal on a policy — that is, higher coverage for the same monthly premium or the same coverage at a lower price
    
2. Buy a policy that is better suited to your financial goals, which may have changed since you signed a life insurance contract

Life insurance policies and the regulations surrounding them, though, can be complicated. Replacing a policy with a seemingly better one is not like switching banks to get a higher rate on a savings account (a straightforward decision when you can earn better returns without adding risks).

When evaluating a policy replacement, investigate and consider these issues. (See also: Financial IQ Test: How Healthy Is Your Life Insurance Plan?)

The Incontestability Clause

If you’ve had a policy in place for more than a couple of years, then the incontestability period has likely expired. That’s good news for you and your family, because it eliminates the risk that the insurance company will dispute or deny a claim, except in the cases of fraud.

Signing a new life insurance policy typically restarts the incontestability period. So, whereas you may be covered under your old policy if you forgot to disclose certain information, you will have to wait two years to have the same peace of mind.

Financial Stability of the Insurance Companies

You may be able to find a slightly better deal on the list price of a new insurance policy compared to your current one. But you should also be concerned with the financial stability of the insurer and its ability to pay claims in the future.

To make comparisons, Life and Disability Insurance Analyst Tony Steuer recommends that you check out measures of financial strength by rating agencies, such as A.M. Best.

Your Health Status

You may want to buy a new policy because you are healthier now than when you purchased your current policy, even though you are older. For example, you may have lost a significant amount of weight or stopped smoking. As a result, you may be eligible for more favorable rates based on your current health status.

However, the health problems that you had as a younger person may not have impacted the price of your life insurance policy. There may not have been a penalty for being overweight or a significant rating difference between smokers and non-smokers, for example. So, even if your health has improved, a new policy may not automatically result in a better deal.

Alternatively, your financial goals may have changed dramatically and unexpectedly, prompting you to revisit life insurance choices. However, if your health has declined, then you may not be eligible for coverage or the cost may be prohibitive because the policy is rated (that is, the premium is higher than typical because of a health or lifestyle concern).

Outstanding Loans

Getting a new policy to replace the old may be complicated if you have an outstanding loan associated with the life insurance. Consider these issues if you have a life insurance loan:

• Surrendering a policy with an outstanding loan may trigger a taxable event
• Premiums may be higher than usual because of a loan
• Outstanding loan balances may reduce the cash value and/or death benefit

So, if you have borrowed against the policy's cash value, apples-to-apples comparisons between your current policy and a proposed one may be difficult to make. Plus, you'll need to make sure you understand the financial consequences of giving up an existing policy for a new one.

Costs Embedded in a New Policy

New insurance contracts may have origination or acquisition costs (such as underwriting fees and sales commissions) that must be covered. Such costs may not impact your premiums but still prevent the build up of policy value during its initial years.

In contrast, you may have accumulated value in your current policy, after paying such acquisition costs years ago.

Length of Coverage

Compare the length of coverage between the current and proposed policy. You may have locked in a guaranteed rate and renewal for a long time (say 30 or 40 years) with your original policy but not have the same provision in a new one.

Premiums and coverage amounts are major concerns, but they are not the only issues to consider when replacing an insurance policy. Read the fine print on current and proposed policies. Talk with your insurance agent to get a full picture of your options; you might request an in-force illustration of your current policy, ask for a waiver of the incontestability period for a replacement policy, or negotiate a policy redesign with your present insurance company. Finally, consult with your financial advisor to make sure that you and your family stay protected in the way you intend.

Have you considered these issues when buying or replacing a policy? Do you have an advisor who has helped you make a decision?

This post is part of the Life Insurance Movement.