Policy Replacement

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Policy Replacement

Perhaps one of the biggest challenges a producer faces is deciding when it is appropriate to replace an existing policy with another.

On one hand, due to the rapid evolution of new (and, in many cases, improved) products in recent years, a replacement may be in the client’s best interests. On the other hand, a replacement often exposes the client to undue financial loss and risk.


Generally, replacement results from one of two possible motives:

First, the producer genuinely may believe canceling one policy (or reducing its values) to replace it with another benefits the client. This can occur when an existing policy appears to be completely inappropriate or no longer meets client needs, such as in a divorce or the death of beneficiaries.

 

The second motive, the one that has resulted in investigations into the abuse of replacements, is the result of a producer’s desire to generate new first-year commissions without regard to the client’s needs. Producers are paid high first-year commissions, followed by lower subsequent renewal commissions. It is not unusual for a producer to receive up to 80% of the first year's premiums as commission on life insurance policies.


Definition of Replacement

The legal definition of replacement varies from state to state, so it is important that each producer knows the law in the state in which he or she does business. Producers should be aware that replacement, by its broadest definition, under the American Society of Financial Services Professionals, may involve an action which eliminates the original policy or diminishes its benefits or values.

Examples of such reductions may be:

  1. Policy loans

  2. Taking reduced paid-up insurance

  3. Withdrawing dividends

Therefore, the producer who recommends that a client borrow cash value from an existing policy to pay premiums on a new policy may be engaging in replacement (25% of the cash value under FL law) just as much as the producer who encourages a client to drop one policy and replace it with another.

2 Categories of Improper Replacement
1. Twisting
2. Churning