Replacement Regulations
Policy replacement occurs when a new insurance policy is purchased and an existing policy is surrendered, lapsed, or otherwise terminated. Replacement transactions are heavily regulated to protect consumers from inappropriate replacements.
Definition of Replacement
Under the NAIC Life Insurance and Annuities Replacement Model Regulation, a replacement occurs when a new policy is purchased and, in connection with the sale:
| Action on Existing Policy | Description |
|---|---|
| Lapsed | Premium payments discontinued |
| Forfeited | Policy terminated for non-payment |
| Surrendered | Policy voluntarily terminated |
| Reduced | Benefits or values reduced |
| Converted | Changed to reduced paid-up or extended term |
| Amended | Materially changed |
| Reissued | Issued with reduced benefits |
| Used to Finance | Values used to pay new policy premiums |
Financed Purchase
A financed purchase is a specific type of replacement where:
- Funds are obtained from an existing policy (withdrawal, surrender, or loan)
- Those funds are used to pay premiums on the new policy
- The transaction effectively replaces old coverage with new
Exam Tip: Replacement includes not just direct surrenders, but also using policy loans or withdrawals to fund new policies. This is called a financed purchase.
Why Replacement Is Regulated
Consumer Protection Concerns
| Risk | Description |
|---|---|
| Loss of Benefits | May lose valuable policy provisions |
| New Contestability | Starts new 2-year contestability period |
| New Suicide Exclusion | Restarts suicide exclusion period |
| Higher Premiums | Older age means higher costs |
| Surrender Charges | May incur fees on surrendered policy |
| Tax Consequences | May trigger taxable gains |
| Misrepresentation | May be based on false information |
Historical Context
Replacement regulations were developed in response to market conduct examinations that found insurers using misleading tactics to encourage policyholders to replace existing coverage without proper disclosure of potential disadvantages.
Duties of the Replacing Producer
When a replacement is involved, the replacing producer (selling the new policy) has specific duties:
Before the Application
| Duty | Requirement |
|---|---|
| Determine if Replacement | Ask about existing coverage |
| Replacement Question | Include question on application |
| Signed Statement | Obtain signed statement about existing policies |
Disclosure Requirements
| Document | Purpose |
|---|---|
| Notice to Applicant | Explains replacement and its implications |
| Policy Comparison | Shows differences between old and new |
| Important Notice | Warns about potential disadvantages |
The Notice to Applicant Must Include
- Advising consumer to contact existing insurer
- Statement about potential disadvantages of replacement
- Recommendation to compare policies carefully
- Information about free-look period
Documentation Duties
- Submit signed replacement forms to insurer
- Provide copies to applicant
- Maintain records of all replacement disclosures
- Leave all materials with applicant
Duties of the Replacing Insurer
The replacing insurer (the new policy's company) also has obligations:
| Duty | Requirement |
|---|---|
| Verify Replacement | Determine if replacement is involved |
| Notify Existing Insurer | Send notice within 5 business days |
| Provide Comparison | Ensure policy summary or illustration provided |
| Monitor Agent Compliance | Verify agent fulfilled duties |
| Maintain Records | Keep replacement documentation 5+ years |
Notification to Existing Insurer
The replacing insurer must send written notice to the existing insurer containing:
- Applicant's name and new policy details
- Information about the existing policy being replaced
- Copy of any sales material used in the replacement
Consumer Disclosure Requirements
Important Notice Regarding Replacement
Consumers must receive a clear notice explaining:
| Information | Details |
|---|---|
| Definition | What constitutes a replacement |
| Potential Disadvantages | Risks of replacing coverage |
| Comparison Rights | Right to receive policy comparison |
| Free-Look Period | Right to return new policy |
| Contact Information | How to reach existing insurer |
The Comparison Statement
When replacement is involved, consumers should receive:
- Summary of existing policy benefits and values
- Summary of proposed policy benefits and costs
- Analysis of surrender charges or penalties
- Tax implications of replacement
- Any loss of guaranteed insurability
Duties of the Existing Insurer
When notified of a potential replacement, the existing insurer must:
| Duty | Requirement |
|---|---|
| Provide Information | Send in-force illustration or policy summary |
| Respond Promptly | Within 30 days of request |
| Assist Consumer | Help consumer understand existing coverage |
| Conservation Attempt | May contact consumer (ethical limits) |
When Replacement Rules Don't Apply
Replacement regulations typically do not apply to:
| Exception | Description |
|---|---|
| Group Policies | Employer-sponsored coverage |
| Credit Insurance | Tied to specific loans |
| Same Insurer/Same Plan | Internal exchanges or upgrades |
| Term Conversions | Converting term to permanent with same company |
| Qualified Exchanges | 1035 exchanges (specific rules apply) |
Key Point: Even when formal replacement rules don't apply, producers still have ethical duties to act in the client's best interest and provide accurate information.
Which of the following is considered a replacement transaction?
When a replacement is involved, the replacing insurer must notify the existing insurer within:
One disadvantage of replacing a life insurance policy is:
35.2 Suitability Requirements
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