Michigan Life Sales Rules: Replacement, Illustrations, Policy Summary, Buyer's Guide and the Guaranty Association

Every life sale in Michigan passes through rules about what the buyer must be handed, what the producer must collect and what the producer may say. They come here in the order a sale meets them: replacement, illustrations, the policy summary and buyer’s guide, and the guaranty association. Michigan’s own text governs wherever it speaks. Where the Michigan provisions discussed here do not state a requirement, the NAIC model regulation is described as a national model, not as Michigan law. Older rule text says “commissioner.” The Director of the Department of Insurance and Financial Services (DIFS) holds that authority now.

What Counts as a Replacement

R 500.601(c) defines a replacement of life insurance as any transaction in which new life insurance is bought and, as part of that transaction, something happens to existing life insurance. The rule lists five things:

• The existing policy lapses, is forfeited, is surrendered or is terminated.
• It is converted to reduced paid-up insurance, continued as extended term insurance, or reduced in value by using nonforfeiture benefits or other policy values.
• It is amended to reduce benefits or the term for which coverage would otherwise remain in force.
• It is reissued with any reduction in cash value.
• It is pledged as collateral or borrowed against, whether in one loan or a schedule of loans, for amounts that in the aggregate exceed 25% of the loan value stated in the policy.

The definition looks at what happens to the old coverage, not at what the producer intended. A client who keeps a policy but, to pay the first premium on a new one, borrows more than 25% of its loan value has a replacement under the fifth item.

A sales proposal is an individualized, written sales aid used to compare existing and proposed insurance in order to recommend replacing or keeping the existing insurance. Generally descriptive material in the insurer’s advertising compliance file is not one (R 500.601(d)). Conservation is any attempt by the existing insurer or its agent to keep the existing insurance in force after it has received the replacing insurer’s information statement. Routine late payment reminders and reinstatement offers are not conservation (R 500.601(a)).

R 500.601(b) says “life insurance” in these rules does not mean fixed or variable annuity contracts. The replacement procedure described below is a life insurance procedure. It does not attach to exchanging one annuity for another, and the definition looks only at existing life insurance.

The 25% Test

Suppose a policy shows a loan value of $31,000. Twenty-five percent of that is $7,750. A client who borrows $7,000 stays under the line, because $7,000 is 22.6% of $31,000, and no replacement has occurred on that ground alone. A client who borrows $9,000 has crossed it, because $9,000 is 29.0% of $31,000. The test counts all borrowing in the aggregate, so two loans of $4,500 each over the course of the transaction cross the line just as one loan of $9,000 does.

What the Producer Must Do

R 500.602 assigns the producer three layers of duty.

On every life application, replacement or not. The producer obtains, with or as part of the application, a statement signed by the applicant saying whether the insurance applied for will replace existing life insurance (R 500.602(1)). The producer also gives the insurer a statement of whether, to the best of the producer’s knowledge, replacement is involved (R 500.602(2)). The insurer must require both statements (R 500.603(2), (3)).

When replacement is involved. The producer must do all of the following (R 500.602(3)):

1. Obtain, with the application, a list of all existing life insurance policies proposed to be replaced.
2. Present to the applicant, no later than the time of taking the application, a completed information statement signed by the producer and a notice to applicants regarding replacement of life insurance, in the forms the Director prescribes, and leave both with the applicant.
3. Leave with the applicant the original or a copy of every sales proposal used.
4. Have the applicant acknowledge receipt of the information statement and the notice.
5. Submit to the insurer, with the application, a copy of any sales proposal, the completed information statement and the name of each insurer that issued a policy to be replaced.

The Director prescribes both forms. In practice, the replacing insurer supplies the current versions.

When conserving. A producer who uses a sales proposal to keep an existing policy in force leaves a copy with the applicant and submits a copy to the existing insurer (R 500.602(4)).

What the Insurer Must Do

The replacing insurer’s duties under R 500.604 set deadlines the producer’s paperwork has to meet. The insurer:

• Requires the list of policies to be replaced, and obtains any sales proposal, the completed information statement, proof that the applicant received the information statement and the notice, and the name of each insurer whose policy is being replaced.
• Notifies the existing insurer, and sends it a copy of any sales proposal and the completed information statement, within 3 business days after the application reaches its home or regional office, or on the day it issues the policy, whichever is sooner.
• Examines the proposal and statement, and verifies the substantial accuracy of the information given to the applicant about the proposed policy.
• Keeps copies of the proposal, the information statement, the proof of receipt and the applicant’s signed replacement statement at its home office for at least 3 years or until the conclusion of the next regular examination by its domiciliary regulator, whichever is later.

When the Procedure Does Not Apply

R 500.605 removes three kinds of transaction from the duties in R 500.602 to R 500.604:

• The application for the new insurance goes to the same insurer that issued the existing policy, or to its affiliate (R 500.605(1)).
• The new insurance is provided under a group term life policy, a mass-merchandised employee, debtor or association policy with no direct contact between the covered person and an agent, or a policy issued in connection with a pension, profit sharing or other benefit plan qualifying for tax-deductibility of premiums, provided full and complete disclosure of all material facts is made to the administrator of any plan being replaced (R 500.605(2)).
• The existing policy is a nonconvertible term policy that cannot be renewed and would expire within 5 years after the transaction begins (R 500.605(3)).

The exceptions remove the procedure, not the honesty duty. MCL 500.2005(f) forbids a misrepresentation made to induce the lapse, forfeiture, exchange, conversion or surrender of a policy, and it does not depend on a second company being involved.

Consequences

A producer who fails to comply with R 500.601, R 500.602 and R 500.605 is rebuttably presumed to have given cause for license revocation or suspension, or for a civil penalty for each failure, under MCL 500.1242 and MCL 500.1244 (R 500.606). “Rebuttably presumed” means the producer can answer the presumption with evidence, and the best evidence is the signed statements and acknowledgments in the file.

A Replacement File, Step by Step

Marisol Danvers, 44, owns a $150,000 whole life policy from Birchfield Life. She bought it at 34. It has a loan value of $31,000 and no loan against it. Its annual premium is $2,140. Quillon Life offers her a universal life policy of $150,000 at an annual premium of $2,960, and she asks you whether she should switch to get flexible premiums.

1. Classify the transaction. She would surrender the Birchfield policy as part of buying the Quillon policy. Surrender is on the list in R 500.601(c)(i), so this is a replacement, and the procedure applies. The same-insurer and expiring-term exceptions do not fit, because the companies are unaffiliated and the Birchfield policy is permanent.
2. Collect the statements. She signs the application statement that the new policy will replace existing insurance. You sign your statement that, to your knowledge, it will (R 500.602(1), (2)).
3. List what is being replaced. The Birchfield policy goes on the list with the insurer’s name (R 500.602(3)(a), (e)).
4. Deliver the forms by the time of application. She receives the information statement you signed and the notice, and she acknowledges receipt. Waiting until delivery is late (R 500.602(3)(b), (d)). Because the Quillon policy is universal life, you also furnish the statement of policy information (MCL 500.4038(3)).
5. Leave your proposals. She keeps a copy of any side-by-side comparison, and Quillon gets another with the application (R 500.602(3)(c), (e)).
6. Test the comparison for honesty. Her premium would rise by $2,960 less $2,140, or $820 a year. Over 10 years that is $8,200 in extra premium for the same face amount, and she would leave a policy with $31,000 of loan value for one whose values start over. The Birchfield policy has also passed its 2-year incontestability period (MCL 500.4014), and a new policy starts a new period from its own date. A comparison that shows only the flexible premium leaves out material facts, and knowingly leaving them out to induce a surrender is itself a violation (MCL 500.2005(f), 500.2005a(a)). An honest comparison shows every item on both sides.
7. The insurer’s clock. Quillon’s home office receives the application on a Thursday. It must notify Birchfield within 3 business days, which is the following Tuesday, or on the day it issues the policy if that comes first. If it issues the policy on Monday, notice is due Monday. If Birchfield’s agent then uses a sales proposal to conserve the policy, Marisol must receive a copy (R 500.602(4)).
8. After issue. The policy she receives has a free look of not less than 10 days from receipt (MCL 500.4015), or 15 days if it is delivered sooner than 5 days after the statement of policy information (MCL 500.4038(5)). The replacement rules in R 500.601 to R 500.606 add no separate longer period. She can still change her mind in that window, but surrendering Birchfield before the free look ends would leave her with no policy to return to if she cancels. Waiting for the free look to pass before the surrender is final protects her.

Illustrations

An illustration shows how a policy’s values could behave over time, using elements the insurer does not guarantee. MCL 500.2005 reaches any “estimate, illustration, circular, statement, sales presentation, or comparison” that misstates or omits a material fact about a policy’s terms, benefits, advantages or conditions. That applies to every illustration a Michigan producer shows, whatever its format. For universal life, MCL 500.4038 adds Michigan’s own statement of policy information and illustrated-rate limits.

Beyond those, the Michigan rules discussed here do not set out a general life illustration format. The national reference is the NAIC Life Insurance Illustrations Model Regulation (Model 582). What follows describes that model, not a Michigan rule.

Key Terms in the Model

The illustrated scale may not be more favorable to the owner than the lesser of the disciplined current scale, a scale reasonably based on recent actual experience and certified yearly by an actuary, and the currently payable scale (Model 582, section 4G). A basic illustration is the ledger or proposal showing both guaranteed and non-guaranteed elements. A supplemental illustration is an added presentation using only a scale a basic illustration could use. An in force illustration is given once the policy has been in force a year or more (section 4H).

What a Basic Illustration Must Show

• Labeled “life insurance illustration,” with the insurer, the producer’s name and business address, the insured’s name, age and sex, the rating class, the generic name and form number, and the initial death benefit (section 6A).
• Guaranteed death benefits and surrender values, labeled as guaranteed and shown before any non-guaranteed figures (section 7A(6), (8)).
• A statement that the benefits and values are not guaranteed, that the assumptions can change, and that actual results may be more or less favorable (section 7A(12)).
• A numeric summary at policy years 5, 10 and 20 and at age 70, on three bases (section 7C).
• Signed acknowledgments. The applicant signs that he or she received the illustration and understands the non-guaranteed elements can change and that the agent said so. The producer signs a certification that the illustration was presented, the non-guaranteed elements were explained as changeable, and nothing inconsistent with it was said (section 7D).

The Three Bases, Worked

The numeric summary’s third basis is a deliberate stress test. It uses the insurer’s illustrated scale with each non-guaranteed element pulled partway toward its guarantee (section 7C(1)(c)). With these example figures:

Element	Guaranteed	Illustrated scale	Third basis
Credited interest	3.0%	5.2%	average: 4.1%
Annual dividend	none	$600	50%: $300
Cost of insurance per $1,000	$1.80	$0.90	average: $1.35

A prospect who sees only the 5.2% column is seeing the best case.

Prohibitions and Delivery

Model 582 forbids describing non-guaranteed elements misleadingly, implying they are guaranteed, handing over an incomplete illustration, showing performance better than the insurer’s illustrated scale, implying premiums will stop being required unless that is true, and using the term “vanishing premium” (section 6B).

A signed copy goes to the insurer with the application and a copy to the applicant. If the policy is issued other than as applied for, a signed “Revised Illustration” is delivered by the time of policy delivery. If no illustration was used, the producer certifies that in writing (section 9).

Sidenote

Variable Life Uses a Different Standard

Model 582 excludes variable life insurance and annuities from its scope, and Michigan sets separate illustration rules for variable life, which prohibit projecting past investment results into the future.

The Policy Summary and the Buyer’s Guide

Michigan itself prescribes one policy-information statement, for universal life. At the time the producer takes the application, the producer furnishes the applicant a statement of policy information in a format the Director approves. Its illustration of premium, death benefit and cash value may use only an interest rate no higher than the current rate actually being paid and the rate guaranteed in the policy (MCL 500.4038(3)). If it is not given at application, it must be delivered within 15 working days after the application is taken and at least 5 days before the policy is delivered (MCL 500.4038(4)). A policy delivered sooner than 5 days after the statement extends the free look to 15 days (MCL 500.4038(5)).

For other life policies, two disclosures come from the NAIC Life Insurance Disclosure Model Regulation (Model 580). As with illustrations, the Michigan rules discussed here do not restate them. The Michigan advertising rule itself acknowledges that other rules govern “life insurance cost comparison indices, deceptive practices in the sale of life insurance, and replacement of life insurance policies,” and says disclosures required by them are not advertisements (R 500.1387). A producer takes the insurer’s compliance instructions as the authority on which documents a particular sale requires.

The Buyer’s Guide

The model defines the buyer’s guide as the current Life Insurance Buyer’s Guide adopted by the NAIC, or language approved by the regulator (section 4A). The insurer provides it to every prospective purchaser before accepting the initial premium. If the policy contains an unconditional refund provision of at least 10 days, it may instead be delivered with the policy or before delivery (section 5A(1)). In practice, hand it over at the start of the presentation, not at delivery.

The Policy Summary

For a policy form the insurer has identified as one not marketed with an illustration, the insurer provides a policy summary showing guarantees only (section 5A(2)). It is a separate document titled STATEMENT OF POLICY COST AND BENEFIT INFORMATION (section 4F(1)) and shows:

• The producer’s name and address, or the procedure for inquiries if no producer is involved.
• The insurer’s full name and address, and the generic name of the basic policy and each rider.
• For the first 5 policy years and representative years after, including at least one age from 60 through 65 and policy maturity: the annual premium for the basic policy and each rider, the death benefit, the guaranteed cash surrender values, and any endowment amounts.
• The effective policy loan interest rate, stating whether it is applied in advance or in arrears.
• The date prepared.

Amounts are shown in total, not per $1,000 (section 5A(2)). The model treats failure to deliver a buyer’s guide, in force illustration, policy summary or policy data as an omission that misrepresents a policy’s benefits, advantages, conditions or terms (section 8).

Annuities

Annuities have their own model, the NAIC Annuity Disclosure Model Regulation (Model 245), which pairs an insurer disclosure document with an annuity buyer’s guide. For a face-to-face application, the applicant receives both at or before the time of application. For other applications, both are sent no later than 5 business days after the insurer receives the application (section 5A(1), (2)). If both are not provided at or before application, the applicant gets a free look of at least 15 days that runs concurrently with any other free look (section 5A(2)(d)). The disclosure document must cover guaranteed and non-guaranteed elements, how an index credit is determined through participation rates, caps or spread, value reductions from withdrawals or surrender, the death benefit, a federal tax summary, and specific charges (section 5B). Michigan’s own annuity rules on the free look and the variable annuity refund are in MCL 500.4073.

The Life and Health Insurance Guaranty Association

MCL 500.7702(1) states the purpose of Chapter 77: to protect, subject to limitations, persons specified in the chapter against failure in the performance of contractual obligations under covered policies and annuity contracts because the issuing insurer is impaired or insolvent. An association of insurers is created to guarantee payment of benefits and continuation of coverage as the chapter limits them. Member insurers are assessed to provide the funds.

Who and What Is Covered

Coverage extends to a resident owner or certificate holder of a covered policy, and to the beneficiary, assignee or payee of that person. A nonresident is covered only in narrow situations, such as when the insurer is domiciled in Michigan, the person’s home state has a similar association, and the person can’t get coverage from an association in another state because the insurer wasn’t licensed there (MCL 500.7704(1)). The law aims at coverage by one association, never two (MCL 500.7704(4)). Covered contracts are direct, nongroup life, health, annuity and supplemental policies, certificates under direct group policies, and certain unallocated annuity contracts issued by member insurers (MCL 500.7704(2)).

Member insurers are those authorized to transact the covered kinds of business, with exceptions. Fraternal benefit societies and health maintenance organizations are not members (MCL 500.7705(k)). A policy from one of those issuers is not covered by this association.

Several things are specifically excluded (MCL 500.7704(5)):

• The part of a policy or contract where the owner bears the risk, including the nonguaranteed portion of a variable or separate account product.
• Dividends and experience rating credits, and amounts based on crediting rates above a formula tied to Moody’s corporate bond yield average.
• Self-funded or uninsured parts of employer plans, such as administrative services only contracts.
• Obligations that do not arise under the written terms of the policy, including a claim based on marketing materials, a claim based on misrepresentations of policy benefits, punitive damages, and bad faith claims.

The last item matters to a producer. A buyer who relied on a producer’s promise that is not in the policy cannot ask the association to honor it.

The Limits

The association’s obligation is the lesser of the contractual obligation and the statutory ceiling for one life, regardless of the number of policies (MCL 500.7704(6)(a), (b)). For life insurance the ceiling is $300,000 in death benefits but not more than $100,000 in net cash surrender and net cash withdrawal values. For annuities it is $250,000 in present value of annuity benefits, including surrender and withdrawal values. Across life, health, annuity and disability and long-term care benefits combined, the association is never obligated to cover more than $300,000 for one life (MCL 500.7704(7)(a)), with a separate $500,000 limit for basic hospital, medical and surgical benefits. For one owner of multiple nongroup life policies, the ceiling is $5,000,000 regardless of the number of policies (MCL 500.7704(7)(c)).

Ibrahim Nasser, a Michigan resident, owns a $250,000 whole life policy and a deferred annuity with a present value of $200,000, both from the same member insurer. The insurer becomes insolvent.

1. The life policy is under its $300,000 death benefit ceiling, so it is within the life limit.
2. The annuity is under its $250,000 ceiling, so it is within the annuity limit.
3. Combined, $250,000 plus $200,000 is $450,000, which exceeds the $300,000 aggregate for one life.
4. The association’s obligation is capped at $300,000, and $150,000 is not guaranteed by the association.

If instead Ibrahim owned a $400,000 whole life policy, the $300,000 death-benefit ceiling would leave $100,000 uncovered, and a surrender request would be limited to $100,000 of net cash surrender value.

What a Producer May Say

MCL 500.2005(i) makes it an unfair method of competition to misrepresent the nature or extent of coverage afforded by the Michigan life and health insurance guaranty association, by an omission or incorrect statement of a material fact. A former section on prohibited advertisements, announcements and statements, MCL 500.7719, was repealed by 1989 PA 302, and MCL 500.2005(i) states the rule today.

In practice that gives a producer a clear line:

• Accurate. Michigan has a guaranty association that, within stated limits, protects residents who own covered policies if a member insurer is impaired or insolvent. The limits and exclusions are real.
• Not accurate. “The state guarantees this policy no matter what.” “Coverage is unlimited.” “Your whole annuity is protected,” when it exceeds the ceiling or is a variable account value the owner carries the risk on.

Sidenote

Variable Products and the Association

A variable life policy or annuity’s cash value in the separate account carries investment risk that belongs to the owner, and the association does not guarantee it. Only the insurer’s guaranteed portion, such as a minimum death benefit, can fall within coverage.

Lesson summary

• A replacement under R 500.601(c) is any transaction that buys new life insurance and, as part of it, lapses, surrenders, converts, reduces or reissues existing life insurance, or pledges or borrows more than 25% of its loan value. Annuities are outside this rule’s definition of life insurance.
• On every application the applicant and the producer each sign a statement about replacement. When replacement is involved the producer lists the policies, delivers the signed information statement and notice by the time of application, leaves all sales proposals, and obtains the applicant’s acknowledgment.
• The replacing insurer notifies the existing insurer within 3 business days of receiving the application, or on the day it issues the policy if sooner, and keeps its replacement records for at least 3 years or until the next regular examination, whichever is later.
• A same-insurer or affiliate transaction, certain group and plan policies, and an expiring nonconvertible, nonrenewable term policy are exceptions, but a misrepresentation made to induce a lapse or exchange is a violation regardless (MCL 500.2005(f)).
• For universal life, Michigan requires a statement of policy information at application or within 15 working days and at least 5 days before delivery (MCL 500.4038). The NAIC models, not Michigan text, describe the three-basis illustration, the policy summary for no-illustration forms and the buyer’s guide, so take the insurer’s compliance instructions as the authority for a particular sale.
• The guaranty association covers residents who own covered life, health and annuity contracts up to statutory limits, and it excludes the nonguaranteed variable portion and anything based on marketing statements or misrepresentation.
• A producer who describes the association must describe it accurately, because misrepresenting its coverage is an unfair practice under MCL 500.2005(i).