The Board of Directors of the American Society of CLU & ChFC has just approved a new educational product, the Replacement Questionnaire (closely akin to the Life Insurance Illustration Questionnaire). In this second of a three-part series, Richard Weber reviews this educational concept and its timeliness in this market environment.
Policy replacement might account for as much as one-third of all individual insurance policies sold. Stephen Brobeck, President of Consumer Federation of America, suggested in a National Underwriter article that consumers lose $6 billion a year in surrender charges and costs — presumably associated with replacing existing coverage. Although it’s difficult to gather historical statistics, I suspect this level of replacement has been going on since the mid-1980s.
One of the most critical issues is that of replacement. Indiscriminate replacement hurts the policy owner, the ceding carrier, and even the accepting carrier — they’ll eventually become the ceding carrier on the next 'roll.' And it certainly has a negative effect on the industry. The 'hurt' can be economic. But if the policyowner develops a subsequent sense of having been 'taken,' this is a problem that we all share and is harder to measure.
Although we’re pretty sure what replacement is (you think you know it when you see it) the long list of technical definitions of replacement might surprise you. Not only does it cover the obvious replacement of a new policy for an old, it includes applying for Life insurance while exercising the right to borrow from an old policy. A Term conversion is technically a replacement, as is dropping a waiver of premium or ADB while applying for new coverage. Reducing the face amount of a policy or placing it on APL is also a replacement if it coincides with the purchase of a new policy.
Sometimes it boils down to the fact that it might seem easier to find a prospect with an existing policy to replace than to take the time to go through the entire Life insurance needs process. And policy illustrations and their unique tendency to give the impression of a predictable future have certainly aided the process of convincing the client and the agent that a replacement is to the client’s benefit.
Consider for a moment just this type of replacement: When an agent recommends that a prospective client terminate an old policy in favor of the 'new, improved' version, a whole range of questions arises. Has the old carrier encountered problems that suggest it can no longer be relied on to deliver the death benefit? Or does something suggest that they can’t deliver the death benefit as economically as broad economic conditions might allow over the long term? Is the recommendation based on exhaustive research, or a 'gut' feeling on the part of the agent? If the old policy is to be replaced, what are the replacement rules established by the state of domicile? In California, for example, not following the rules can cost the unwary agent a $25,000 fine! Are the reasons for replacement economic, subjective, or both? In the final analysis: Is this policy replacement being recommended because it’s in the best interest of the client or the best interest of the agent?
One of the reasons replacement is a problem is that there’s no standard approach to quantify the issues surrounding replacing one policy with another. There can be a mighty fine line between a justified replacement and a not-so-justified one. When I came into the business, the most I was ever told about dropping one policy in favor of another was that when it was done to you it was 'twisting' and illegal; but if you did it, it was just that kinder and gentler term, 'replacement.'
For this reason the Board of Directors of the American Society of CLU & ChFC has approved a new educational product, the Replacement Questionnaire. And, as an educational concept closely akin to the 'IQ,' the 'RQ' — as it has been dubbed — is a timely concept in this market environment. The Society wanted its members to be able to deal with the fact that there’s no single resource for Life insurance salespeople to address the many issues that they should review before talking to a client about a possible replacement of policies. Although addressed to members of the American Society of CLU & ChFC, the RQ is an educational tool that should be utilized by anyone who is reviewing a recommendation for replacement: agent, client, advisor, or carrier.
The introduction to the Replacement Questionnaire emphasizes that replacing an existing Life insurance policy with a newer one is generally not in the policyowner’s best interest. Changes in health and age are two obvious reasons. Less obvious is the fact that duplicate sales loads and other expenses would be incurred: once during the initial purchase, and then again when the replacement has been performed with a newer policy. There have also been a number of changes in the tax code over the years, many of which 'grandfather' policies purchased before a certain date.
Another aspect of replacing a policy is that the 'new' Life insurance company has substantial rights to challenge a death claim if death occurs within two years from the date of issue. Policyowners and insureds must clearly understand this point.
The 'RQ' form is similar to the flight list that pilots use before they take off. No matter how many thousands of hours they’ve flown, they must review the list to make sure that critical details affecting the safety of the pilot and passengers have been checked. So, too, does the professional Life underwriter wish to make certain that the client’s best interests are being served by reminding ourselves to address the major issues surrounding replacement.
The items listed in the Replacement Questionnaire are not intended to create an opportunity to replace one policy for another; the RQ emphasizes several different times that it’s generally not in the client’s best interest to pursue such a strategy. Rather, these items make sure that the agent can examine the important issues safely and economically.
Some Life insurance agents might use the RQ for their own process of deciding what’s right for the client. Others might share it with the client. In the latter case, the Replacement Questionnaire list of items for consideration are not a substitute for state law requirements and should only be used to supplement required forms and duties.
REVIEWING THE RQ
The first section of the RQ lists the issues that come up frequently when considering replacement. They include the possibility that a newer policy might have more favorable values in the future. The RQ reminds us to distinguish between guaranteed values and illustrated values. This section explores whether the reason for replacement might rest with the appearance of a shorter out-of-pocket payment period, better underwriting class, more favorable carrier ratings, or the desire to move to a variable form of insurance — or from a variable form of insurance. (Note, if you’re applying the RQ to a Variable Life insurance policy, and if you’re showing the RQ to the client, you must first obtain your Broker-Dealer’s approval).
It’s important to point out that while the issues of greater cash value, shorter payment periods, superior ratings, etc. might be valid considerations, there’s no intention to promote the idea that any issue or combination of issues is a reason to replace an in-force policy. These issues must be taken in context of the other items in the RQ. Again, replacement is generally not in the best interest of the policyholder and the professional Life insurance salesperson will want to underscore that statement to the client directly.
The next section of the RQ determines whether the agent has reviewed the sister IQ of each carrier for additional information to assist in understanding the assumptions that underlie the illustrations of both the in-force and the possible new policy. Confirming the review and allowing for the possibility of generally similar responses can be a key factor in recommending against replacement.
It’s especially important in looking at an IQ of two different products to understand if current illustrations are based on similar assumptions. Do both companies use the portfolio method for illustrating yield, or does one use the portfolio method where the other uses investment generation method? Does either company assume future mortality improvements or expense reductions? There can be many other substantial differences in illustration assumptions. A thoughtful review of the IQs should be considered, and to be perfectly objective in the process, it might be appropriate to invite each carrier to comment on your analysis. After all, if replacement is truly warranted, it’s in the best interest of the client as well as the agent to allow the carriers to comment on and confirm your recommendation.