Replacement business is no joking matter

Some friends were sitting around a campfire with Mike who has joined them for the first time. One looks up, smirks and says quickly “62”. Everyone, except Mike, laughs. A few minutes later, another, with a mischievous smile pipes in “24”. Again, all laugh except Mike.

Eventually, a puzzled Mike asks what is happening.

“Well, we have known each other for many years and have told jokes so many times that we now just ascribe numbers to them to speed up the process.” Makes sense, thinks Mike ……. “Do you mind if I try”, he asks. “Of course, go for it.”

Mike waits for what he believes is the right moment, takes a deep breath, looks around and says loudly “37”. Not a sound. He tries again, “42”. Still no reaction.

Perplexed, Mike asks what is wrong.

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“Oh, the jokes are great, and your timing was perfect but it was the way you told them ….. !”

When telling jokes, the three things that must be present are:

•  Timing;
•  Content; and 
•  Delivery, 

When advisers are considering the crucial issue of replacement business in the context of risk insurance advice, funnily enough, the same three things also need to be present:

•  Timing - when should the subject be raised with the client;
•  Content - what factors might be relevant to a replacement decision; and
•  Delivery - if insurance is to be replaced, what is the most appropriate way to proceed?

1. WHEN SHOULD THE SUBJECT BE RAISED WITH THE CLIENT?

The short answer is: “there is no one correct answer as the subject may come up at various times”.

(i) Prior to advice process beginning

In the judgement for Swansson v Harrison (VSC 118, 2014), the following was recorded:

“On about 26 February 2012, AXA sent Mr Swansson a renewal notice requiring payment of the annual premium. The premium  …. had increased by about $800 from the previous year. Shortly after receiving the notice, Mr Swansson telephoned Mr Harrison.” (Paragraph 9)

The content of the call was essentially that Swansson was unwilling to pay the increased premium and he instructed his financial adviser to source alternate and less expensive cover.

Thus, even prior to the formal advice process beginning, replacement of existing business was being considered.

Of the choices open to an adviser in this situation, the two most obvious are:

•  clear instruction had been given and it was not up to the adviser to question the client unnecessarily; the adviser should proceed in line with the client’s stated wishes and, as per compliance requirements, implement a No Advice Sale; 

or, notwithstanding clear instruction,

•  when considering the client’s best interests, the adviser may feel it appropriate to go beyond compliance requirements and ensure the client is acting on an informed basis.

Judgement extracts in a separate case, appear to support the latter alternative by citing the adviser as having a “duty to ensure the (client) was adequately informed of the consequences…”, and “there should have been a full explanation of the risk(s)…” (Commonwealth Financial Planning v Couper (NSWSC 444, 2013), paragraph 79).

Even if a client rejects the adviser’s suggestion that due diligence investigations be undertaken, there appears no downside in at least making the offer.

(ii) During completion of the fact find

If, when completing the fact find, existing insurance is identified, replacement might be a consideration, but it is only one of several and, as such, if the subject is raised, it should be done so in context. This could be done through the below.

During the analysis and research process, I need to consider your existing insurances within the framework of five generic advice scenarios: replacement of cover, i.e. retain

• the existing level of cover but place it with a different insurer;
•  retention of cover, i.e. make no change to the existing cover;
•  increasing of cover, i.e. increase the insured benefit amount under the existing policy;
•  alteration of cover, for example a longer waiting period or a change in the TPD definition; and
• cancelation of cover, without replacement with a different insurer.”

Going further, the adviser might point out that “cover” refers individually to each of the five generic risk insurance types:

•  term insurance;
•  trauma insurance;
•  total and permanent disability insurance;
•  income protection insurance; and
•  business expenses insurance.

In other words, what might initially appear to be a simple process to the client is, in effect, the undertaking of an analysis process involving up to 25 different outcomes; a clear indication that the risk insurance advice process is not something to be laughed at.

(iii) When presenting the Statement of Advice

The adviser’s presentation of the Statement of Advice (SOA) is the designated time for discussion of the outcomes of the above analysis.

This discussion would be undertaken bearing in mind the need to ensure the client is “adequately informed of the consequences” and provided, not only with a “full explanation of the risks” but also of the “advantages” of a particular action.

Thus, discussion might include not only the outcome of the adviser’s behind the scenes deliberations but the nature of the deliberations as well, i.e. what factors were considered in reaching a decision regarding existing cover – refer to section three below. 

Additionally, any mention of replacement should consider that new cover is yet to be underwritten and, as such, a final decision needs be deferred. To do otherwise, might be to risk engaging in “deceptive and misleading conduct” as per the Couper judgement:

“First, the advice that was given wrongly supposed that a comparison could be made between (the new) and (existing policy). That could not be done, because whether (the new insurer) would insure Mr S, and if so with what exclusions and at what premium, was not known. The unequivocal advice that the (new) policy was cheaper on a like for like, dollar for dollar basis was incomplete. That was merely the best case, and could not be assessed definitively at that stage.” (Paragraph 94)

(iv) Completion of the application

If there is a recommendation to replace some or all existing cover, and the recommendation is accepted, that decision is reaffirmed when the application is being completed.

The application is likely to include a question concerning the presence or otherwise of existing cover and whether that cover is to be replaced. Closed ended questions such as these by definition only include two answer alternatives i.e. “Yes” or “No”. 

Whilst “No”, of itself may be a satisfactory answer, strictly speaking “Yes” is not, with the reason being that which was identified in (iii) above, a final decision may well be contingent on the outcome of the underwriting process; what might have been a compelling argument for replacement may be less so if new insurance is the subject of a loaded premium or an exclusion clause. 

Thus, even if the application form makes no provision for it, an adviser might see merit in making a handwritten amendment to the form so that there can be no uncertainty in the future about a robust process being followed. By way of example, the amendment might simply state “Replacement of cover is subject to underwriting”. 

If nothing else, this places the insurer on notice that the underwriting pencil needs to be sharp.

(v) Subsequent to underwriting of new cover

Again, if the underwriting of the application results in something other than a standard acceptance, the subject of replace existing cover may need to be revisited. 

If the underwriting of the application results in a standard acceptance and the new cover is issued, the subject of replacement of cover will next move to how this is to be actioned – again, refer to section three below.  

2. WHAT FACTORS MIGHT BE RELEVANT TO A REPLACEMENT DECISION?

Before deciding the fate of existing cover, there are several factors that potentially need to be taken into account. Some of these are listed below but in no set order; and, as mentioned earlier, these factors should be applied to each of the risk insurance types for which there is existing cover.

(i) One, or more than one, insurer

When considering the position for each risk insurance type, the merit or otherwise of having all insurance types with one insurer, as distinct from spreading the different insurance types across more than one insurer, comes into play. 

Premium discounts may be activated by the placement of multiple covers with one insurer; however, insurers may have different product type niche areas which can best be accessed by spreading cover. 

(ii) Quantum of cover

Even if insurance types are spread across more than one insurer, a decision still needs to be made about where to place cover for an insurance type.

If large benefit amounts are involved, what are the ramifications of having all cover with one insurer, and potentially one reinsurer, versus spreading cover across different insurers and reinsurers:

•  the impact of underwriting delays associated with exceeding non-medical limits; and
•  rumoured mandatory reinsurance treaty requirements and claims vigilance for larger insured benefits possibly leading to claims delays and disputes; versus
•  access to premium discounts for larger benefit amounts; and
•  ease of claim’s administration if all cover is with one insurer.

(iii) Insured’s health

Changes in the health, occupation and pursuits of the insured, either potentially beneficial or detrimental to the underwriting outcome, should be identified.

The most obvious impacts of these will be in the policy premium, taken up further in (iv) below and also the presence or otherwise of cover exclusions. 

By using insurer pre-assessment facilities, A pre-application should be  of the likely outcome can be obtained.which in turn, whilst not necessarily being a determinant, would certainly be a material consideration in the replacement analysis.

The impact may, however, go beyond the above in that it could affect the overall policy terms by opening or closing the door to matters such as:

• product eligibility, for example, premier (v) standard contract;
• policy terms and conditions, for example, different income protection offset provisions; and
• definitions, for example, Own (v) Any Occupation TPD.

(iv) Premium 

One of the most consistent considerations is premium cost and what factors are relevant in this regard.

In the Couper case, the judge specifically referred to the need to consider not just Year One costs but costs beyond Year One:

“(The adviser’s) comparison of premiums was confined to the first year. But he was attempting to sell a product designed to last a lifetime. It was misleading to confine his comparison to the first year’s premiums.” (Paragraph 98)

In fact, premium comparisons might go even further and consider the likely duration of the client’s specific need and, following on from this, the adviser might undertake a premium comparison for the equivalent term.

Thus, if cover for a 45 years old client is needed to protect a 10-year mortgage, premium comparisons should consider this differently to a situation where cover is needed through to retirement.

Other factors impacting premium might be access to multi-policy, health and other discounts, and favourable occupation categories.

Having a general guideline could assist here, for example, am overall premium reduction of less than 10 per cent might be ignore in the  absence of other supporting evidence, whereas a difference in excess of this, might be considered as sufficiently significant to dictate an action, in the absence of anything else of relevance.

(v) Legacy v Retail

An added complication regarding premiums is the position of a legacy product versus a retail product. The former resides in a closed book of business with attrition of policy numbers more likely creating premium volatility than what should be the case within a retail product. 

Again, the duration of the need for cover may be relevant; a policy with a need-duration of 10 years in a recently closed book of business may be treated differently to a policy with a long-term need duration in a long-standing legacy portfolio.

Additional to premium considerations with legacy policies is the matter of flexibility of cover:

•  will it be possible in the future to move the policy between superannuation and non-superannuation without having to undergo fresh underwriting and the issuing of a new policy; and
•  will changes to waiting/benefit periods and premium type changes be possible.

An adviser may even feel it necessary to enquire with the insurer of the existing cover to obtain an informed view as to the current performance of the legacy book and/or to see if there is an appetite for some form of conversion option to that insurer’s retail product.

(vi) Policy terms and conditions

The Couper judgement noted:

“ … there should have been a full explanation of the risk, rather than just in a perfunctory manner in fine print in a disclosure statement that was swamped with information.” (Paragraph 79)

The client needs to be enabled to make an informed decision; the downloading of a many-page policy comparison with the inclusion of this within the SOA, may well fall into the category of Client Swamping.

To facilitate an informed decision, it may be better to extract the important and relevant aspects of a comparison with the highlighting of these together with a general context statement; “The matters listed below are those most relevant to your circumstances and/or the product itself. Whilst other differences exist, they appear of lesser consequence”.

Having worked out the material differences, the issue then becomes how to make an assessment of the relative merit of one set of differences over another. It is one thing to have ten areas of material difference that are all are in favour of one policy but it is quite another if six are in favour of one policy and four, the other.  

(vii) Insurance Contracts Act

Then there is the impact of section 29(3) of the Insurance Contracts Act.

Referring back to the Swansson judgement:

“One of the effects of entering into a new contract of life insurance was to re-expose (the insured) to the risk of his policy being avoided for innocent non-disclosure. By contrast, that risk had long since passed in relation to the (previous) policy.” (Paragraph 14)

Even if the existing insurance has been in force for less than three years, it will still have been in force for a period closer to three years than any new insurance.

Not only is this likely to be a material replacement consideration, to complicate matters further, the Insurance Contracts Act was amended in 2016/17 with the now-current Act arguably less favourable to the insured than was previously the case. Thus, the assessment of a policy starting post-2016/17 in replacement of one issued pre-2016/17 may need to take this into account.

(viii) Time-based exclusions

A term policy in force for longer than 13 months would generally no longer be subject to a suicide exclusion. Similarly, a trauma insurance policy in force for longer than 90 days should no longer be subject to the exclusion regarding heart attack, cancer, etc.

Any new policy, however, may have cover subject to these and similar exclusions.  

If time-based exclusions cannot be removed from replacement cover, their presence should be taken into account.

Again, it may be that judicious adviser enquiry with the potential new insurer could result in a satisfactory way forward being negotiated; i.e. the endorsement of the policy to effectively remove the offending exclusion clause.

(ix) Policy facilities

A lesser consideration, but potentially one nonetheless, is the relevance of policy facilities.

By way of example, an insured under an existing policy may have used the full entitlement under the Guaranteed Insurability Option whereas a move to a new policy may provide fresh access to this facility.

These matters, whilst not universally relevant, still need to be considered even if only to be eliminated.

(x) Client preference

The last client-focused factor but my no means the least important one, is the client’s own preference which may be influenced by:
previous personal experiences; experiences of trusted third parties such as the financial adviser and/or friends and/or relatives; and
media reports.

The strength and reasons for any preference should be assessed and balanced against other relevant factors.

(xi) ASIC reporting

There is one final factor which, whilst not directly client-focused, has become an indirect adviser consideration for some and that is the need for licensees to report so-called adverse adviser lapse rates to ASIC.

3. HOW SHOULD REPLACEMENT DECISION BE IMPLEMENTED?

Simplistically, but by no means always, once new cover is in place existing insurance can be replaced. There are several ways in which this might be done.

(i) Undated cancelation letter

A popular way to implement the replacement of existing cover is to obtain an undated, but signed, cancelation letter from the client when, for example, the fact finder is being completed. This is held on file until new cover is in place, at which time it is sent to the insurer of the existing cover.

Whilst this may be a seamless way to proceed, there are potential problems associated with it, such as:

•  will the client perceive this as ‘best practice’; i.e. the effective signing of a blank cheque regarding the continuation of existing cover;
•  the process is prone to error in that, occasions have arisen where the cancelation letter was lodged notwithstanding new cover either did not commence or was subject to cancelation subsequent to the lodgment of the letter; and 
•  there is always the risk that, obtaining a cancelation letter prior to the appropriate analysis of the facts, will be perceived as pre-empting an outcome.

(ii) Dated cancelation letter

A safer course to that detailed in (i) might be to wait until the new policy has been accepted and issued, and then contact the client to advise that:

•  the new policy has been issued and, as such, the existing insurance can now be cancelled;
•  to enable the existing insurance to be cancelled, a letter to this effect is to be emailed to the client for signing, returning and then lodging with the existing insurer; but
•  prior to signing the letter, the client should carefully consider whether or not there have been any changes to their circumstance between when the application was completed and the start date of the new policy, that might be relevant to the now concluded duty of disclosure.

If there has been a change, the cancelation of existing cover should be put on hold to enable appropriate discussions to be had and actions agreed upon.

(iii) Existing insurance allowed to lapse

The third, and arguably a favoured alternative in many instances, is to hold the discussion detailed in (ii) above, but rather than obtain and lodge a cancelation letter, the client should instead be asked to cancel any premium paying authority on the existing insurance such that the policy can be allowed to lapse.

This is so that the client will have the benefit of the duration of the lapse cycle of the existing insurance in case anything should go awry with the new cover. Examples are a problem with premium payments to the new insurer or a question being raised about compliance with the duty of disclosure should an early claim arise under the new policy.

If there are concerns about what the new insurer’s position might be if the above action is taken, bearing in mind the ‘warning’ provided that replacement cover will not honour a claim if existing cover has not been cancelled, the new insurer can be advised of what is being done and why, such that sign-off or otherwise can be obtained.

IN CONCLUSION

When all the above, and arguably more, is considered, two things become clear:

•  the advice process surrounding the replacement or retention of existing cover involves much analysis and thought and, as such, is a significant value-add provided by the adviser; and
•  it will be difficult to impossible to provide definitive advice to the effect that existing insurance should or should not be replaced and, herein lies the irony, this provides a safety net of sorts to the adviser.

If, notwithstanding the difficulty/impossibility, definitive advice was provided to the effect that “it is appropriate for existing insurance to be replaced and then cancelled”, there is always the chance that future events might render this to be erroneous; the advice and adviser are exposed to criticism.

If, however, there is acknowledgement of the reality that exists, a more cautious yet appropriate course might be followed:

“In considering the position of your existing insurances, I have taken into account the following matters …”

A bullet point list of the factors considered could follow, together with an explanation of outcomes for and against replacement/retention, and the highlighting of the factors crucial to a decision. The advice would then continue:

“Because it is unknown what is going to occur in the future, it is not possible to say with complete certainty whether it is better to replace or retain your existing cover; however, on balance, the most appropriate course would appear to be (replace/retain) for the reasons highlighted above.”

As per the heading of this article, the matter of replacement business is no joking matter and from the adviser’s perspective, considerable rumour and innuendo has been directed towards them about the subject.

It is certainly not the intention or place of this article to dictate a process but more to float some ideas to possibly expand the current horizon of thought and generate discussion on the subject. 

When all is considered however, this component of the risk insurance advice process is yet another demonstration of the merit of advice when it comes to risk insurance.   

Col Fullagar is the principal of Integrity Resolutions