Before you replace a permanent policy: a fifteen-point checklist

Use this checklist if someone has suggested replacing your cash value life insurance policy, or if you are thinking about it yourself. It has fifteen items in four groups. Each item gives the question, the reason it matters, and what to ask for. The goal is not to talk you out of a replacement. It is to make sure that if you do replace the policy, you do it knowing what you hold, what you would get, how the process works and who gains from it.

You can work through it in an evening with the policy file in front of you. Where an item asks for a document, ask for it in writing; a verbal answer from a salesperson is not a record. Keep everything together in one folder, because you may want a second opinion from a fee-only planner, and they will need it. The larger framework is in replacing a life insurance policy: when it makes sense; a companion post, replacing a permanent policy: mistakes that make the new one cost more, explains how the errors this list is designed to catch tend to happen.

How to use the list

Mark each item as answered, open or bad news. A single "bad news" is not necessarily a reason to stop, but you should be able to say in plain words why you are going ahead anyway. If three or more items are still "open" when you are asked to sign, wait. No legitimate replacement is hurt by a week's delay, and a rushed one often is.

Dates matter. Ask that every figure be dated, because cash value, loan balances and quotes change.

Group A: what you hold today

1. What does the in-force ledger say?

Request a full in-force ledger or how to request and read an in-force illustration from the current insurer, showing the policy's projected values at the current premium, to maturity or age 100. It is the baseline you must beat. Without it you are comparing the new policy to someone's memory of the old one.

Ask for: the ledger at the current non-guaranteed assumptions, and one at the guaranteed assumptions.

2. What guarantees would you give up?

Old policies often carry features that new ones do not: a guaranteed interest rate, a fixed low loan rate, guaranteed insurability, a favorable dividend history, a waiver of premium, or an option to convert. Find them in the contract.

A hypothetical shows the size of the issue. Say the old contract guarantees a 4 percent guaranteed interest rate on cash value, and the new one guarantees 1 percent. $85,000 growing at the guaranteed rate for ten years reaches about $125,800 at 4 percent ($85,000 × 1.4802) and about $93,900 at 1 percent ($85,000 × 1.1046), a difference of about $31,900. These are floors, not forecasts, and actual credits may be higher, but a floor is what you can rely on when everything else disappoints.

Ask for: a list of every guarantee in the new contract, compared item by item with the old.

3. What is your basis, and is there a loan?

Your cost basis determines how much of a surrender or exchange is taxable gain. A loan outstanding can be taxed if it disappears in the process. Both numbers should come from the insurer, dated.

Ask for: basis, loan balance with accrued interest, and the loan rate and type. A fixed 5 percent loan on $40,000 costs $2,000 a year; a 7 percent loan costs $2,800, which is $800 more a year, so the loan terms that follow you matter too.

4. Is the old policy a modified endowment contract?

A policy that failed the seven-pay test is a modified endowment contracts and the 7-pay test, with loans and withdrawals taxed gains first and a possible 10 percent additional tax before age 59½. The status carries to the new policy in an exchange, and a new policy funded too quickly can become one.

Ask for: written confirmation of MEC status for both policies, and the new policy's seven-pay limit if it is life insurance.

Group B: what you would be getting

5. What is the new surrender schedule?

A fresh surrender period means charges if you leave the new policy early. They can last ten years or more on some products. Ask for them year by year and for the cash value in each of the first several years.

Ask for: the surrender value table, for the amount you would put in.

6. When does the new contestability period end?

For two years in most states the insurer can investigate a claim and rescind the policy for material misrepresentation on the application. The old policy's period has probably ended. See the two-year contestability period. Any health history left off the new application is a risk.

Ask for: the date the contestability period ends, and a copy of the application as submitted.

7. How does the new policy do at lower assumed rates?

Request the illustration at a lower assumed rate and at the guaranteed column. The method for doing this on any illustration is in stress-testing an in-force illustration at lower crediting rates. Check whether the premium you are quoted holds, whether the policy lapses earlier, and whether the death benefit survives.

Ask for: three versions: as illustrated, at a lower rate, and guaranteed.

8. What are the charges?

For universal life products ask for the cost of insurance charges, administrative fees and any expense loads. For whole life, ask where the premium goes in year one. A policy whose cash value is far below the premiums paid in early years is more expensive to leave.

Ask for: the charge schedule, in writing.

9. How are age and health priced?

A new policy is priced at your current age and health. Ask for a firm underwriting offer before any decision, not an indicative quote. If your health has worsened, the offer may be rated or declined; if it has improved, the new rate class might be better than the old one.

Ask for: a written offer showing your risk class and the premium, valid for a stated period.

Group C: how the process works

10. Will the old policy stay in force until the new one is issued?

Never cancel first. The new policy must be issued, delivered, funded and in force before the old one ends. If underwriting fails, you still have the old coverage.

Ask for: confirmation that the old policy will remain in force until you tell the insurer to release it, and a written description of the sequence.

11. Is the move a direct 1035 exchange, and does the paperwork match?

If you want to defer tax, the money has to move from insurer to insurer. A check made to you is a surrender. Names, ownership and the insured must match on every form. The steps are laid out in 1035 exchanges: swapping policies without tax.

Ask for: both insurers' exchange forms, a written statement of what happens to any loan, and the expected 1099-R reporting.

12. Have you read the replacement notice and the comparison?

State rules generally require a notice that a replacement is involved, a list of the policies being replaced and, in many states, a side-by-side comparison. The insurer is told too. Read them for accuracy: the right policy numbers, the right values, the real charges. If a state rule gives you a longer free-look period on a replacement, note the date.

Ask for: copies of everything you signed, and the free-look deadline.

Group D: who gains, and what else is possible

13. Who is paid, and how much?

An agent who earns a commission on the new policy and nothing on the old has a reason to favor the swap. That is not a character flaw; it is a structure. Ask how the agent is paid on each option, including doing nothing. Be wary of anyone who cannot or will not say. The sales pattern to watch for is described in twisting and churning: replacement sales abuses.

Ask for: the commission or compensation disclosure, in writing.

14. What are the alternatives that do not involve a new policy?

Before replacing, consider whether the old policy can be changed in place:

• Reduce the face amount to lower the premium.
• Switch to reduced paid-up coverage, if the contract offers it.
• Change the death benefit option or premium pattern on a universal life policy.
• Use a rider or an internal conversion.
• Take a partial withdrawal or repay a loan.
• Keep the policy as it is.

Each may deliver most of the benefit without new underwriting or a new contestability clock. The keep, surrender or sell your policy? is a place to start.

Ask for: the old insurer's list of what can be changed on the current contract, and the effect of each.

15. Has someone with no stake in the sale reviewed it?

A fee-only financial planner, a tax professional or an attorney paid by you can review the comparison. Bring the ledger, the new illustrations, the forms, the surrender schedules and the tax numbers. If you cannot get anyone to look at it, treat that as information about the time pressure you are under. a worksheet on what you give up when you replace an old policy gives you a way to total what you would be giving up before you meet with them.

Ask for: a written second opinion, even a brief one.

The list applied to one hypothetical household

Say Gordon, 61, is told that a new universal life policy would "fix" his 25-year-old whole life policy, which has a $200,000 death benefit and a premium of $5,400 a year. Here is how a pass through the list might go. Every figure is invented.

• Items 1 and 2. The old policy's in-force ledger shows the policy is projected to stay in force to age 100 at the current premium even on the guaranteed column. It carries a fixed 5 percent loan rate and a guaranteed interest rate that the agent's new policy does not match. Result: answered, with bad news on guarantees.
• Items 3 and 4. Basis is $98,000, cash value is $140,000, no loan, not a MEC. A surrender would produce $42,000 of ordinary income ($140,000 minus $98,000); a direct exchange could defer it. Result: answered.
• Items 5 through 9. The new policy's surrender schedule runs ten years. The agent's illustration shows a premium of $4,200 a year. At a lower assumed rate the required premium is $6,300, which is $900 a year above his current $5,400 and $2,100 above the pitched figure. His offer is rated one class worse than the agent's quote assumed. Result: bad news on cost and on health pricing.
• Items 10 through 12. The agent said the old policy would be cancelled when the application was signed. Gordon asked for that in writing and was told it could be left in force until the new one was issued. The replacement notice listed the wrong cash value. Result: open, then corrected.
• Items 13 through 15. The agent is paid a first-year commission on the new policy and nothing for keeping the old one. Gordon asked the old insurer what could be changed in place and learned he could reduce the face amount to $150,000, which would cut the premium. A fee-only planner, paid a flat fee, reviewed the file in an hour.

The outcome in this example is not that replacement is always wrong. It is that Gordon went from a pitch that said "save $1,200 a year" ($5,400 minus $4,200) to a documented view in which the saving disappears at a lower rate and turns into a $900 annual cost, with a ten-year surrender schedule and a rating one class worse. He kept the old policy and reduced the face amount. Another person with a different ledger, a worse policy or a company concern might reach the opposite answer, using the same list.

Questions people ask while working through it

What if the old insurer will not give me an in-force illustration? Policy owners are generally entitled to request one, and most insurers provide it on request, sometimes through the agent of record or an online portal. If you are refused, ask in writing and contact your state insurance department.

What if the agent says the new policy is "better" but cannot explain how? Ask for the specific feature, number or guarantee that is better, and where it appears in the contract. If the answer is a projection, go back to item 7.

Is there a time limit? The pressure to act this month is usually the seller's. Underwriting offers have expiration dates, but you can request a new one. The free-look period after issue is the real safety net, and the old policy should still be in force during it if you sequence the process correctly.

A scoring sheet you can copy

What to do with the answers

If most items are answered and none is bad news, you have a documented decision, and the replacement may be a good one. If several are bad news, ask yourself what specific thing improves and whether it outweighs the list of things that get worse. If you cannot name it, the old policy deserves another look.

When a complaint seems warranted, because the notice was not given, the comparison was misleading or the old policy was cancelled before the new one was issued, your state insurance department takes complaints and enforces replacement rules, and the contact for your state is on its website. Keep your folder for that purpose too.

Key takeaways

• Start with the old policy's in-force ledger and its guarantees, because the old policy is the alternative the new one must beat.
• Ask for the new policy's surrender schedule, contestability end date and illustrations at lower assumed rates before you decide.
• Keep the old policy in force and use a direct insurer-to-insurer exchange if you want tax deferral.
• Find out how the person recommending the swap is paid, and explore changes to the existing policy before replacing it.
• Get a second opinion from someone who is not paid on the sale, and keep every document in one folder.