Should I Replace My Life Insurance Policy If I Find A Better One?

This post discusses the good and bad reasons for replacing a life insurance policy.

I read life insurance articles all the time. One article that I read said replacements are typically a bad idea. As an agent, I know there are legitimate and illegitimate reasons for replacing a life insurance policy, but I would never make a blanket statement that replacements are generally good or bad. That would be irresponsible. Let’s start off discussing legitimate reasons for replacing a policy.

When it comes to simplified issue whole life, underwriters don’t care about certain medical events such as heart attacks if the event occurred long enough in the past. In fact, someone can have a dozen heart attacks and it wouldn’t matter as long as he or she passes the time threshold (agents call this the lookback period). I’ll explain why the lookback period matters when considering a replacement. Let’s assume someone was scared into buying a life insurance policy because he or she had a heart attack less than a year ago. That person would be limited to modified whole life. Modified whole life (sometimes referred to as graded whole life) has a two or three year waiting period for full coverage. During this waiting period, the full death benefit is only paid out for an accidental death. Let’s assume a year passes and the same person can now qualify for ordinary whole life (no waiting period). Replacing a modified whole life policy with ordinary whole life is appropriate in this situation.

That last example was an obvious one. A less obvious choice occurs when the same type of policy with the same amount of coverage is considered for replacement because of price. Many agents will point out that a replacement starts a new contestability period. A contestability period is a two year period from the start of a policy in which the insurance company can investigate a death claim. The consumer risk associated with a contestability period is sometimes overstated. As long as the insured was honest on the application, there is nothing to worry about except for a slight delay in benefit payments as the insurance company investigates the claim.

If there is only a slight price difference between the old policy and new policy, a replacement might not be worth it. The small price difference won’t justify losing the time spent satisfying the contestability period. Also, a replacement means you’ll be cancelling the old policy, and there is a time investment with that process (granted its not a huge investment of time). Be wary of agents pushing for a replacement when both policies are of the same type and similar price. Agents typically receive more commission by doing replacements instead of extra policies.

Are you protected from bad replacements? Yes, the insurance industry has put some safeguards in place. One safeguard is a free-look period in which a replacement can be rescinded and a full refund issued on the new policy that was purchased. The agent is also required to give you literature that helps you be more informed about replacements. Below is a sample replacement form that is used for all replacements in the state of Texas.

First page of standardized replacement form used in Texas
standardized replacement form used in Texas – page 1
Second page of standardized replacement form used in Texas
standardized replacement form used in Texas – page 2

Graded Whole Life and Fiduciary Responsibility

I remember a debate a while back about insurance agents and fiduciary responsibility. Fiduciary responsibility means that someone can be held liable for enrolling a client in a product, knowing that a better product is available. To my knowledge, insurance agents don’t have a fiduciary responsibility to the policy owner unless they are selling products that require a securities license (variable products).

In my opinion, insurance agents need fiduciary responsibility with graded whole life. Currently, insurance agents are required to disclose the limitations of graded whole life, but they do not have fiduciary responsibility per se. I can understand certain underwriting situations where an agent doesn’t know of a better offer because very few insurance companies would make a better offer. I am talking about the obvious situations where nearly all companies would offer something better. I think insurance agents should be held responsible in those situations.

When high risk clients come to the realization that graded whole life is the only option, I often hear them say, “Well, I wasn’t planning to die in two years anyway.” I think they say that to make themselves feel better, but the reality is that many people do pass away in the first two years of a policy.

Insurance agents are the last line of defense against inferior products. Even in a situation where you think graded whole life is the only option, an agent might be able to surprise you with something better. You should never buy graded whole life without consulting an agent. When your goal is to fund a cremation or burial, simplified issue whole life should be the product to reach for.

Graded Whole Life Versus Modified Whole Life

For all of you insurance nerds out there, there is a difference between graded whole life and modified whole life. Modified whole life is the more general term – it is any whole life plan where the benefits change over time. Ordinary whole life never has a change in benefits. Graded whole life is a subset of modified plans. Graded plans have a percentage of the death benefit that will only pay for accidental death during the first two or three years. There are two types of graded policies.

One type is often found on TV commercials and junk mail, talking about guaranteed acceptance and no medical questions. In exchange for no medical questions, the policy doesn’t pay any death benefit for the first two years unless its an accidental death (accidental death triggers all of the death benefit to be paid). In the case where its not accidental, all premiums are refunded along with interest. I’ll have a future blog post that discusses why people shouldn’t automatically jump to these plans without talking to an agent about qualifying for something better. Long story short, you should aim to get a simplified issue whole life policy to cover your burial or cremation needs.

Another type of graded whole life is less extreme and offers a gradual increase in the percentage of death benefit paid for non accidents. This type has a very small amount of underwriting. All graded plans behave the same as an ordinary whole life policy once the limited coverage period ends.