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 the 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 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 Society of Financial Services Professionals, may involve an action which eliminates the original policy or diminishes its benefits or values. Examples of this are policy loans, taking reduced paid-up insurance or 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 just as much as the producer who encourages a client to drop one policy and replace it with another.
Traditionally, improper replacement is divided into two categories: twisting and churning.
- Twisting also is referred to as external replacement. It involves illegally inducing a person to drop existing insurance to buy similar coverage with another producer or company. This often is associated with making false statements about another insurer or producer, an illegal act that also runs contrary to ethical market conduct.
- Churning also is known as internal replacement. It involves replacing policies within the same company, often by the same producer who sold the original policies.
