Risk insurance and addressing takeover terms concerns

Takeover terms often raise concerns in the risk insurance market, with critics questioning the benefits to consumers. Col Fullagar considers the debate.

The mere mention of the words ‘takeover terms’ tends to cause the ears of all within hearing distance to prick up. Various reasons are given to justify them:

• The original policies are out of date or too expensive and the use of takeover terms is a fast, efficient and convenient way to upgrade those policies to the benefit of the client; and
• The relationship between the adviser and the existing insurer has broken down, the administration of the existing insurer is not satisfactory or other insurers have gained a competitive edge such that takeover terms again enable the transfer to a ‘better’ insurer.

The suspicion is, however, that takeover terms exist because they enable:

• The movement of a block of business receiving a low rate of renewal commission to an insurer that will pay a higher rate of commission; and
• By utilising takeover terms, the insurer promoting the movement of the block of business can increase their in-force portfolio at a fraction of the upfront cost that would have applied if full underwriting were undertaken.

While there is nothing wrong with an adviser wanting to improve their financial position or with an insurer wanting more risk insurance on their books or reducing costs, there are a number of issues associated with the use of takeover terms that should be kept in mind.

Deterioration of portfolio experience

Having access to the facility to underwrite new business applications assists insurers to charge an appropriate premium to each person who applies for cover.

Applicants that are likely to have a ‘normal’ life expectancy will pay a rate of premium as set out in the insurer’s premium rate table.

People who are exposed to higher risks in areas such as health, occupation or hazardous pursuits will in turn pay a higher premium, have the area of additional risk excluded or be declined entry to the insurance pool altogether. In this way, a fair and equitable result is achieved for all lives insured.

An alternative to underwriting is automatic acceptance under group insurance.

By ensuring, for example, that a set percentage of eligible lives take up the offer of insurance on a predetermined basis, the insurer is able to mitigate the lack of individual underwriting because, while some lives will have a relatively poor claims experience, others will have a better than average claims experience.

Thus, the group as a whole will achieve an ‘average’ claims experience so that, again, an equitable result is achieved for all lives insured.

While transferring a book of business under takeover terms might appear to hold a similar logic to group insurance, this is not the case.

Advisers and clients still make decisions on an individual policy and as such the opportunity for and results of anti-selection exist.

Without the ability to implement proper and prudent underwriting procedures, it is inevitable that the claims experience of the portfolio will deteriorate — which in turn will lead to higher premium being paid for all lives.

In brief, those who undertook to be underwritten will be penalised by those transferring into the portfolio under takeover terms.

Lack of client research

Because policies are being transferred en masse, it is often the case (or it will be perceived as being the case) that a full and thorough examination of the client’s circumstances and needs is not undertaken.

Without a proper needs analysis, there is a greatly increased chance that the client’s position could be compromised, which in turn could have an impact on the risk exposure of the adviser.

The same would apply if the relative merit of the new insurer’s product were not properly considered, not just in general terms but specifically for each client.

An appropriate benefit comparison should ideally be undertaken for both the sake of the client and the adviser.

The only reasonable exception might be where the nature of the product being transferred into is so clearly and broadly superior or the risks associated with maintaining cover with the current insurer are such that a generalised approach is warranted.

A good example of the latter might be where the existing insurance is in a closed and reducing book of business such that the risks of an adverse claims experience leading to dramatically higher premiums clearly warrants the business being moved to a larger, open portfolio.

Public perception

There is always the nagging doubt that if the practice of utilising takeover terms became common knowledge, the perception of financial services as a professional, client-focused industry could well suffer or there could be the risk of involvement by a regulatory body.

While takeover terms may be expedient, as an industry we should think carefully before becoming involved in practices that could in any way be seen to be inappropriately motivated by self-interest. What we do must stand up under scrutiny.

Time-based exclusions

Advisers and clients should be conscious of the impact of takeover terms on time-based exclusions within the policy.

If suicide is excluded in the first 13 months of a term insurance policy, this period of exclusion may well recommence when an old policy is transferred to a new one.

The same situation may occur for facilities such as:

• Initial exclusions for certain insured events under trauma insurance policies; and
• The requirement to prove fraudulent rather than material non-disclosure for policies that have been in force for longer than three years.

Claims complications

It is not difficult to imagine the complications that might arise if, at the time of a claim on the new policy, the claims manager suspected something untoward about the original policy.

The complications only multiply if the appropriate paperwork had not been thoroughly or properly completed at the time the business transferred to a new insurer.

And the problems naturally get worse when there is takeover of taken over business involved, which has been known to occur.

Then of course there is the complication of the new insurer not necessarily being able to gain access to the original policy file.

Safeguards are essential such as a policy declaration that makes it clear that the basis of the new policy is the personal statement of the original policy.

Abridged underwriting

The phrase ‘takeover terms’ is used to describe two distinct types of situations: firstly, the movement of policies with no underwriting at all; and secondly, the requirement for policy movement subject to abridged underwriting.

The risks of abridged underwriting are probably greater than the risks of no underwriting simply because the latter would remove any need for the reintroduction of a requirement to comply with a duty of disclosure.

When abridged underwriting applies, there is a risk that information material to the client’s duty of disclosure will be missed, simply because there are fewer questions to jog the memory of the insured as to what information should be disclosed.

This in turn increases the risk of claims complications and adviser involvement in any subsequent dispute.

Underinsurance and growth

Two issues that have dogged the risk insurance market for years and which continue to be relevant are underinsurance and the lack of net growth in the amount of in-force risk insurance premium.

To the extent that time and energy are spent on the flat movement of business from one insurer to another, time and energy are not being spent on recommending and implementing benefit increases.

Insurer expenses

For the original insurer there is the cost associated with the loss of business, including the inability to recover upfront commission payments.

As takeover terms are utilised by different insurers, there is a considerable chance they will all incur some of these losses.

When insurers incur losses, they will eventually recoup them by increasing premiums. Once again, everybody suffers.

Summary

Some may feel that the advice process has become weighed down with compliance and other administrative requirements such that they have little choice but to look for improved efficiencies.

Insurers are also looking for ways in which to increase their in-force book of business. There is nothing wrong with either of these goals.

The challenge for advisers, licensees and insurers is to achieve the desired goals of safety, simplicity and profitability in the advice process as well as growth in the risk insurance market — but to do so in a way as to avoid more serious problems.

Takeover terms may not be the answer.

Col Fullagar is national manager for risk at RI Advice Group.