With the speed of risk insurance product change having increased dramatically, guarantees of upgrade have become a vital tool for financial advisers.
It is not unusual to hear people say that ‘risk insurance policies are all much the same these days’.
The statement may be backed up with some learned logic that all sounds fair and reasonable, but this is misleading because many subtle and not-so-subtle material differences in cover still exist.
Some are important to all clients (eg, different definitions of total permanent disability [TPD] and trauma insurance related events such as heart attacks and strokes).
But for some clients, the differences may be of little or no consequence (eg, the definition of prostate cancer for a female client or pregnancy exclusions for a male client).
Putting aside the debate about contractual differences for a moment, it would certainly make an adviser’s and client’s life easier if the non-strategic components of risk insurance policies were presented in a consistent way.
For example:
- the manner of treating of premiums and, subsequently, the lapse procedure;
- claims requirements and management; and
- definitions such as ‘medical practitioner’ and ‘earned income’.
Some might believe that an area where consistency across the market already exists is the so-called ‘guarantee of upgrade’.
Evidence of this is the fact that it does not appear in one of the insurance industry’s main risk research comparators — possibly because if all these guarantees were the same, they would not warrant comparison.
Unfortunately, the reality is not the same as the perception.
To understand the nature and importance of this policy feature, it would help to briefly travel back in time.
Before the 1970s the only insurance products agents had to contend with were the traditional whole of life and endowment contracts.
These insurance dinosaurs lumbered along, growing slowly as they fed on a diet of capital guarantee investments.
The nature of the products never changed, and, as a result, agents could be confident that the only adjustments needed would be an increase or decrease in cover.
But the 1970s ushered in more than just hippies and psychedelic music.
The process of wealth creation became far more widespread and dynamic. In order to protect the wealth created, people required insurance products that were more flexible than those previously available.
This eventually led to the extinction of whole of life and endowment policies as they were replaced by a new species of life insurance: term, trauma, TPD, income protection and business expenses insurance.
These policies were quite different in appearance, and they underwent continual metamorphosis at an increasing rate. Bi-annual product upgrades gave way to annual, and eventually semi-annual upgrades.
To cope with these changes, agents evolved into advisers.
But a new threat to survival was identified: when an insurer announced contractual improvements to its product range that would apply to policies subsequently issued, advisers had mixed feelings.
On the one hand, the adviser was pleased that improved benefits would be made available to them so they could present an even better product range to clients but, on the other hand, there were questions that needed to be asked in regards to existing policies.
(i) Should the adviser leave these policies in place with the existing, and possibly inferior benefits, and only offer the improved benefits to new clients and to existing clients when a review was undertaken?
If the adviser did this, there was a concern that the client may be lured away by another adviser offering the improved benefits; or the client may be disadvantaged if a claim situation arose that was not payable under the existing policy but would be have been paid under the improved benefits.
(ii) Should the adviser go back to all existing clients and replace their policies with a new policy incorporating the benefit improvements?
This would take a long time and would generate little or no remuneration for the adviser, as many of the rewritten policies would be replacement business.
Then there was the inconvenience to the client and the risks associated with matters such as time-based exclusion (eg, the 90-day initial exclusion for some trauma events and the three years material versus fraudulent non-disclosure issue).
Other potential problems associated with periodic benefit improvements were:
- level premium policies would be less attractive because the benefits of taking a level premium would be lost if policies were rewritten when benefit improvements were made; and
- replacing policies not only placed a strain on the financial position of the adviser’s business but it would also have a negative financial impact on the insurer, eventually leading to premium increases being passed onto clients.
Initially, to overcome these problems, some insurers gave advisers verbal assurances when a product upgrade occurred (eg, ‘the improvements will be passed back to existing policy owners’).
But these assurances were vague, light on detail and not guaranteed because they were not incorporated within the policy document.
Eventually, to provide the appropriate detail and written guarantee, and in so doing, to simplify and make the advice process safer, a guarantee of upgrade was encapsulated within the policy document in the mid-1990s.
This guarantee included the following features:
- the guarantee of upgrade was included in the policy terms and conditions rather than simply being an unpublished company guidelines;
- the upgrade was automatic — it did not require the approval of the insurer’s actuary, and it did not require forms to be completed and returned to the insurer. The upgrade wording stated that benefit improvements ‘would’ be passed on to existing clients rather than ‘may’ be passed on to existing clients;
- the upgrade was immediate (ie, it applied as soon as the benefit improvements were announced rather than at some future date); and
- the upgrade provided the client with the choice, at the time of claim, of the new or the old policy conditions — just in case an unforseen situation arose whereby the new conditions would disadvantage the client.
In order to protect the insurer, the guarantee of upgrade had three provisos:
- it did not apply if improved conditions were accompanied by a premium increase directly related to the improved conditions as this would breach the non-cancellable guarantee;
- it did not apply if a new series of policies was issued; and
- it did not apply in respect of pre-existing conditions at the time of the upgrade as this may not be equitable to other policy owners (eg, if someone who was blind held a trauma insurance policy and ‘loss of sight’ was subsequently added as an insured event, the person could not claim for ‘loss of sight’).
The inclusion of a comprehensive guarantee of upgrade provided a further advantage, consistency, leading to clarity of cover over an extended period.
Good contemporary examples are insurers such as MLC and CommInsure, which can be rightfully proud of the fact that risk insurance policies going back as far as 12 years have the current policy terms and conditions.
As suggested above, there may be a general belief that the terms of the guarantee of upgrade are consistent across the market. The table included clearly illustrates this is not the case.
To the extent that any of the features of the guarantee are not present, the adviser’s position is exposed.
This is particularly true if the adviser has assumed that all guarantees of upgrade are created equal, and has advised the client accordingly.
Col Fullagar is national manager — risk insurance at RetireInvest.
