Replacement of Life Insurance and Annuity Contracts
Written by Bill Douglas, Individual Annuity Compliance Manager
State insurance departments want to make sure that a replacement of a life insurance policy or annuity contract is in the best interest of the consumer. With respect to annuities, a replacement may mean a new surrender period, new plan design features, and different guarantees from the current annuity. Therefore, most state insurance departments have adopted regulations to mandate certain rules to follow and forms to complete and retain for insurance companies and producers to ensure viable replacement activity. Additionally, new suitability rules have added a focus on replacements. It is in your best interest as a producer to compare the various features of the current policy and of the prospective policy to ensure that a replacement is a good decision on behalf of your customer.
- WHAT DO I NEED TO DO TO MEET THE STANDARD’S REPLACEMENT REQUIREMENTS?
First, make sure the replacement is in the best interest of your client. A comparison of the plan design and features of the current contract and the proposed replacement contract is the best place to start. Compare the following features:
- Current interest crediting rates.
- Interest rate guarantee period.
- Surrender charges.
- Length of time remaining in the current contract’s surrender period vs. length of time of the proposed contract’s surrender period.
- Cash surrender values.
- Death benefit values.
- Access to funds features, especially instances in which surrender charges are waived.
- Applicable bonus features.
- Renewal rate histories.
- Premium tax implications.
There are other issues you may want to consider for replacement transactions:
- What are the tax consequences of buying a new policy?
- Is this a tax free exchange?
- Is there a benefit from favorable “grandfathered” treatment of the current contract under the federal tax code?
- How do the quality and financial stability of the new carrier compare with those of the current carrier?
Make sure your client understands the comparative features of the current contract and the proposed replacement contract. Both you and your client must be convinced that the replacement is in the best interest of your client.
Secondly, read through, complete, and sign any state-required replacement form with your client. Submit the signed required replacement form together with the application. You and your client should retain copies of the signed and completed replacement form.
Thirdly, leave any marketing materials and illustrations you’ve used during the point of sale with your client.
- WHAT IS CONSIDERED A REPLACEMENT?
A replacement is any transaction in which a new life insurance policy or annuity contract is to be purchased by any means in which an existing life insurance policy or annuity contract has been or will be:
- surrendered, lapsed, forfeited or otherwise terminated.
- Converted to reduced paid-up insurance, continued as extended term insurance, or otherwise reduced in value by the use of nonforfeiture benefits or other policy values.
- Amended to result in a reduction of benefits or in the term for which coverage would otherwise remain in force or for which benefits would have been paid.
- Reissued with any reduction in cash value.
- Used in a financed purchase.
- A financed purchase is the purchase of a new policy involving the actual or intended use of funds obtained by the withdrawal or surrender of an existing policy, or by borrowing from values of an existing policy, to pay all or part of any premium due on the new policy.
- Note: A financed purchase also includes premiums paid for a new policy through withdrawal, surrender, or borrowing the policy values when the new policy is owned by the same owner and issued by the same carrier within 4 months before or 13 months after the existing policy’s effective date.
- WHAT IS NOT CONSIDERED A REPLACEMENT?
- Credit life insurance.
- Group life insurance and group annuities provided there is no direct solicitation of individuals by an agent. Note: Group life insurance and group annuities marketed through direct response solicitation are subject to the replacement rules.
- New policies of the same carrier when a contractual change or conversion privilege is being exercised.
- New policies of the same carrier when the existing policy is being replaced pursuant to a replacement program filed with and approved by the state insurance department.
- Life coverage that replaces existing life coverage under a binding or conditional receipt issued by the same carrier.
- Policies or contracts used to fund:
- Employee pension or welfare benefit plans subject to ERISA.
- 401(a), 401(k), and 403(b) plans established and maintained by an employer and subject to ERISA.
- Governmental or church plans under IRC 414.
- Governmental or church welfare benefit plans, or a state or local government or tax exempt organization deferred compensation plan under IRC 457.
- A non-qualified deferred compensation arrangement established and maintained by an employer or plan sponsor.
- Note: With respect to the above list, the replacement rules will apply to policies or contracts used to fund any plan or arrangement that is funded solely by employee contributions (whether pre- or post-tax), and when the carrier has been notified that participants may select from two or more carriers and there is a direct solicitation by a producer.
- New life insurance when the entire cost is borne by the employer or association.
- Existing life coverage that is non-convertible term coverage which will expire in five years or less and may not be renewed.
- Immediate annuities that are purchased with the proceeds of an existing annuity contract. Note: Immediate annuities that are purchased with the proceeds from an existing life insurance policy are subject to the replacement rules.
- Structured settlements.
- When a term conversion privilege is exercised among corporate affiliates.
- WHAT’S IN IT FOR ME?
Unsurpassed customer service should be a goal for all of us. It is always in our best interest to ensure that the best interests of our clients are met. An important element when there is a potential contract replacement is to follow the state rules as well as practical means to ensure that we always act in the best interest of our customers. It surely is advantageous from a customer retention standpoint, and can lead to new customers given our customer service focus.