Last week we looked at when you should perform a life insurance review. One of the suggestions that was brought up during a review was to replace your current policy if a new one would better serve your needs. How do you determine if a new policy is more suitable for you? In which way is it better? Worse? Is there a cash surrender value in the old policy that would trigger tax if you cancelled it? Would you qualify for a new policy for the same or better rate? These are all questions that you need to ask before replacing a life insurance policy.
Some background on the need for a regulated replacement form
Before we get into when and why you should replace your current policy, we should discuss the implementation of a unified replacement form in Canada. Officially called the ‘Life Insurance Replacement Declaration’, it replaces the old ‘Basic Disclosure Statement’ with a one page form outlining the benefits of the replacement policy. The BDS was a rigid form that often included irrelevant information and was not helpful in determining if the replacement policy was suitable. The LIRD addresses this problem by presenting eleven questions that helps the life insurance agent or broker assess the pros and cons of the new policy. On the form, agents and brokers are required to explain how the new policy is appropriate for the client.
All provinces in Canada now require the completion of the LIRD when replacing a life insurance policy. Although not mandatory, it is recommended that agents and brokers in the three territories also have the completed form on file for future reference.
Perhaps the move to standardize life insurance replacement was brought about by unscrupulous agents and brokers who replace old policies without regards to their clients’ situations or needs. By requesting more disclosure, the LIRD should make it more difficult for them to continue their malpractice. If you feel you’ve been manipulated into replacing a life insurance policy, please report it to the OmbusdService for Life & Health Insurance (OLHI).
Why you should replace your life insurance policy
The three main reasons that you would replace your life insurance policy are: premium, coverage and features.
Premium: Pricing between similar products among the life insurance companies in Canada typically don’t vary widely. After all, it’s a competitive market and they are all fighting for your premium dollars. But pricing depends on interest rates, and as rates fall, premiums rise. The opposite is also true, so ideally it is to the consumer’s benefit to replace life insurance policies during periods of rising interest rates.
Besides comparing the premiums for the initial terms, you should also check the price when the policy renews. For example, two of the most competitively priced term 10s for 40 year olds are from Foresters Life and Empire Life, with annual premiums of $360 and $370 respectively for $500,000 of coverage (1). You may be more inclined to choose Foresters based on the initial premium alone. But when the policy renews in 10 years at age 50, Foresters’ policy will cost $2,675/year while Empire’s will cost $2,015/year, for a difference of $660 annually!
Of course, premiums also depend on your health. If you are less healthy and would not be able to qualify at the same or better rate than your first policy, then you probably won’t be able to save any money replacing your policy.
Coverage: As mentioned in last week’s post, there are many instances where you may not feel like you have enough life insurance coverage. If this is the case and you don’t have a guaranteed insurability option as a rider for your existing policy, then your only means to more coverage is through a new policy.
Insurance premium is also dependent on something called rate bands. For example, a common banding for insurance companies is $100,000-$249,999 and $250,000-$499,999. What this means is that it is actually more expensive to purchase coverage for $249,999 than it is for $250,000, even though the latter provides a greater death benefit. If you can calculate that your total insurance needs would bump you into a higher rate band and thus save you money, you should consider cancelling your old policy and applying for a new one.
Features: The final reason that you may consider replacing your policy is for the features. In this case, a simple comparison between premiums or coverage is not possible. For instance, you may be drawn by the fact that a term 20 policy offers a longer guarantee of premium compared to your term 10 policy. Or maybe you’re attracted by the high dividends of participating whole life policies that are used to increase your coverage and can also be withdrawn as cash. Whatever the case, your agent or broker will go through the LIRD with you to make sure you understand the pros and cons of your choice. For example, everyone will appreciate the dividends from a participating whole life policy, but there are downsides to it. The most apparent is the increased cost. Together you can decide if the dividends outweigh the increased cost, and which is most suitable for you moving forward.
These types of analysis should be done for any type of policy replacement, whether you’re exchanging term for permanent, or vice versa, and even term for term and permanent for permanent.
Other things to consider
If your existing policy has been in existence for more than two years, then the suicide clause and contestability period have already expired. This means a death benefit will be paid out even if you commit suicide, and that material misrepresentation on the application cannot be used against you in a claim. Once your new policy is in force, you’ll have to wait another two years for the suicide clause and contestability period to pass again.
Furthermore, you’ll likely have to endure the underwriting process again. It can involve blood work, medical reports from your physician and other tests. Although it’s a minor hurdle to a new policy, most people would prefer to avoid it if possible.
If your existing policy has cash value in it, will cancelling (surrendering) it result in a taxable event? For life insurance, any gain is calculated as the cash surrender value minus the adjusted cost base and treated as income, not capital gain. You may want to consult with your carrier to determine your cash values and speak with a tax professional.
Last but not least, do not cancel your existing policy until the new one is in force and you accept it! This is the most important thing to remember when replacing your policy. You don’t want to leave a gap in coverage for even a single day. If you should be so unfortunate and pass away while there is a gap between your existing and new policy, your beneficiaries will receive nothing!
1. Rates current as of June, 2014.
Image courtesy of Stuart Miles / FreeDigitalPhotos.net
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