After a year of scandals involving some of the biggest names in life insurance, consumers finally are waking up to churning. This abusive sales practice occurs when agents dupe customers into replacing perfectly good cash-value policies. While agents reap big commissions, switching policies costs consumers more than $6 billion annually, the Consumer Federation of America estimates.
So far, most of the advice for policyholders boils down to a simple "just say no" to replacement. If an agent or broker tries to persuade you to cash in your variable-, whole-, or universal-life policy in order to buy a new one, run the other way. Once a policy is purchased, it's generally best to hold on to it because the upfront costs are so steep--the first year's entire investment can go to fees and commissions. But lost in the current antireplacement fervor are the rare occasions when policy replacement actually is the best course.
BOND BOMB. When does it make sense? If you were an overweight chain-smoking heart patient when you bought your policy and you're running marathons today, replacement might save you money in the long run. That's because health is a major factor in determining premium rates. Certain estate-planning gambits, such as shifting ownership of a policy to an irrevocable trust, could legitimately involve replacement. In such cases, it could reduce tax obligations enough to compensate for the upfront costs of a new policy. Financial woes at the company backing a policy also could be a reason. Customers of Executive Life, the industry's No.1 junk-bond victim, for instance, have been enduring a drawn-out process to recover the funds they're owed.
Navigating replacement waters means swimming with the sharks. It's notoriously difficult for nonprofessionals to analyze and compare policies. And considering the recent churning allegations against Metropolitan Life, Prudential, and other insurance companies, it's hard to know who to trust for advice. "Some of the things being done are blatant thievery. Clients need to become educated," says Richard Sabo, a former MetLife agent in Pennsylvania whose 1993 whistleblower complaints on churning and related fraud led to a state investigation, resulting in a $1.5 million fine plus restoration of old policies.
The life-insurance industry, stung by adverse publicity, is beginning its own education campaign. MetLife and Prudential have sent anti-churning notices to millions of policyholders, conducted internal reviews, and laid down the law to agents. The American Society of Chartered Life Underwriters & Chartered Financial Consultants is offering one of the most ambitious new tools. The Bryn Mawr (Pa.) trade group has developed a six-page worksheet aimed at identifying pitfalls in replacement proposals. The worksheet is supposed to be used by agents, who wouldn't necessarily share the results with their clients. But a savvy consumer can uncover trouble by insisting on its use, says Millard Grauer, past president of the society. Predatory agents confronted with the worksheet "would have a lot more trouble making their cases," says Grauer, an Equitable Life agent who has replaced policies "just a few times" over a 40-year career.
With the worksheet, which is available free by calling 800 392-6900, agents begin by listing possible advantages of a new policy, such as higher death benefits, lower premiums, or stronger issuer finances. A series of questions smokes out some of the biggest risks of replacement. Since issuers may contest claims made in the early years of new policies, for instance, consumers who surrender their old policies can lose protection. And because the growth in cash-value insurance is tax-deferred, you may owe taxes if you replace your policy.
TOUGH NUT. The worksheet covers grandfathered tax rules that apply to policies purchased in the 1970s and 1980s. Still, the worksheet is "too long-winded and too complicated" for routine use, says Sabo. And he doubts it could deter every dishonest agent.
For extra protection, consumers should seek a second opinion whenever they are considering replacing their life insurance. The Consumer Federation offers a $40 policy-analysis service, available by calling 202 387-6121. In those rare cases where replacement is warranted, people should investigate companies that sell cash-value policies at a low upfront cost directly to the public, such as Ameritas (800 552-3553) and USAA (800 531-8000). Replacement through these companies still carries the usual downsides, but at least a commission rip-off isn't among them.
Before Replacing a Cash-Value Policy
BE WARY: Replacing a variable-, whole-, or universal-life insurance policy is usually bad for you but good for your agent.
STUDY THE ILLUSTRATIONS: Agents sell cash-value policies with illustrations--documents charting projected investment growth. Be sure to review the projections on your existing policies as well as those for proposed new policies.
INSIST ON FULL DISCLOSURE: Compare the first-year cash value of the new policy with the cash value of the existing one. It often takes years for a policy to break even after all the initial commissions and fees.
SEEK A SECOND OPINION: And before dropping your present policy, give the carrier a chance to explain any advantages of keeping it.