Financial advisers have seen significant change in the past few years and while many have been dealing with the Future of Financial Advice reforms, changes have been made to disclosure requirements in life insurance.
BT Life’s Jeff Scott has examined these changes and in this report from a recent presentation to the NSW chapter of MDRT he details what advisers need to know, including that insurers now have a third way of cancelling policies, and that advisers may be liable when clients are not truthful when applying for insurance.
About 18 months ago changes were made to the duty of disclosure requirements of the Insurance Contracts Act and it may not be surprising if you missed those changes, claims BT Life Senior Manager, Product Development, Jeff Scott.
The reason these changes slid under the radar for many risk advisers is they were busy bedding down a far bigger set of changes brought on by the Future of Financial Advice reforms. Now these have passed, advisers need to be aware of the “sneaky bits that slipped through” as well as those changes that will benefit clients.
These changes, however, need to be seen in the context which preceded them, since they require a significant shift to some well-established practices and Scott said advisers who used to recommend clients use group life cover where retail policies would not work should be particularly mindful of the changes.
“There were some advisers in the market that had customers sit in their office to be told they could not get a typical life insurance policy because the client was overweight or too old or too sick or in the wrong occupation. The adviser said they could send the client to an industry fund with automatic acceptance limits that don’t ask any questions, and they would slip in and get cover and no one would be the wiser,” Scott said.
“That was the case until a year and a half ago when the legislation changed. If you join a super fund now and you have a particular condition that you should be able to disclose, such as being terminally ill or having suffered a TPD event elsewhere, and you know for a fact you can’t get any additional cover, when you join that super fund under a group policy there is an obligation to tell the trustee.”
if your client is about to join a super fund, especially an industry fund, read the fine print!
The reasonable person test
Scott said the reason for the change is that Section 23 of the Insurance Contracts Act 1984, which relates to life insurance, states ‘what would a reasonable person do’. In practice this means that if someone has gone to a particular insurer and could not get cover through them and has done the same with another insurer and decides to take the path of least resistance and go to a superannuation fund, there is a duty for that person to disclose they could not get insurance from other providers.
“This is a big issue because there were advisers who were saying to clients ‘I know you can’t get cover via a typical policy, so we will send you to a super fund’,” Scott said.
“Those funds have now also added clauses over the past two to three years, and these state that if a person is suffering from a terminal illness or has the ability to claim on a terminal illness condition or has ever been paid a TPD benefit or is eligible to claim a TPD benefit, then those benefits will not be covered under this new policy,” he added.
“What this means for advisers is that if your client is about to join a super fund, especially an industry fund, read the fine print!”
Scott said this kind of ‘reasonable person’ disclosure would exclude someone who has been explicitly informed they have a terminal illness and yet, intentionally, aims to secure insurance via a superannuation fund. It would not apply where the condition was obscure or where it was uncertain that it would lead to a claim.
“If a person has some obscure medical condition where they are not sure, then they don’t have an obligation to disclose it because the question is ‘what would a reasonable person have done in the same circumstance?’, where ‘reasonable’ is what another average person would know or do in the same situation,” Scott said.
“So, if someone suffers a condition that may lead to TPD then this circumstance does not apply, as most people don’t know when this is going to occur and so does not match the reasonable person test and there is no need to disclose it.”
The implications of this shift in disclosure and the failure of many consumers to recognise it is demonstrated in the underwriting that happens at claim time with direct insurance, and is now starting to appear in some group life policies, according to Scott.
group life policies that have automatic acceptance limits (AALs) may also require people to disclose pre-existing conditions under the reasonable person test
“The direct insurance ads say ‘no questions asked’ but the fine print has ‘new events’ cover or pre-existing condition clauses and these are nasty and are buried on page 84 of the policy document, which most customers don’t read beyond the first few summary pages. These conditions state that if an insured person has a pre-existing condition that showed itself prior to taking up the policy then for any claim that happens afterward they will not get paid,” Scott said.
“Once again, if a client has a direct style policy or they are starting to come into group life, get them to read the fine print,” he stated, adding that group life policies that have automatic acceptance limits (AALs) may also require people to disclose pre-existing conditions under the reasonable person test.
“If you look at the insurance forms of a superannuation fund that has an AAL they will have a duty of disclosure that applies to group insurance contracts. This is a nasty shock for some people because many of them assume they are part of the group and are therefore automatically covered. Yet, if you knowingly join the group with those conditions there is a chance may not get cover at claim time,” he said.
Conversely, Scott said these risks strengthened the case for advised insurance even though underwriting could be difficult for clients during the application process, but it provided certainty at claim time.
“We sell a promise every time we sell a policy and that promise gets called in when a person has an accident, illness or dies. We don’t want to go to that person or their grieving family and say that due to some particular clause that was not looked at you are not being paid. That is an awful outcome.”
Flow on Effects
The reason the changes to Section 23 of the Insurance Contracts Act 1984 is so important relates to what follows in Sections 27A, 29 and 59A, according to Scott, who states that non-disclosure and fraud can lead to variations in an insurance policy or even cancellation at the discretion of the insurer.
However, there are some upsides to the changes and an examination of Section 27A of the Act (Appendix 1) shows a shift from past practice where non-disclosure on one part of a combined policy led to the cancellation of both.
“Under the old situation with combined policies, if a person had a combined death and TPD policy or a combined death and trauma policy and had made a non-disclosure on the application form, that would have caused the insurer to not only decline the TPD or trauma policy but to also cancel the death policy at the same time,” Scott stated.
“Section 27A dismantles that and says if, due to the non-disclosure, the TPD policy would not be put in place, the insurance company can break the policies apart and still accept the death policy component.”
the three year rule is dead for everything other than death benefits
While Scott sees this separation as a good result for consumers, Section 29 of the Act (Appendix 2) moves in the opposite direction and gives insurers more scope in assessing whether an application was fraudulent.
“Under the old rules, if a person fraudulently put information on an application form the insurer could cancel it from inception and pay nothing with no premiums returned with the timeframe for making modifications to that policy set at three years,” Scott said.
“That timeframe now only applies to death benefits; not for TPD, trauma and income protection benefits. If the person did not disclose appropriately up front then at any time in the future the insurance company has the right to change, modify or cancel that policy. Simply put, the three year rule is dead for everything other than death benefits,” he added.
Scott said this has important implications for advisers who have taken out a policy for a client without underwriting. In the event this was done because the client answered negatively to questions around pre-existing conditions and the adviser, after a review, discovers they should have answered positively, the adviser is obligated to notify the insurer, even if it limits the client’s ability to secure life insurance.
“If there is any change to the risk profile of a client and its causes the insurer to do something different, such as apply loadings, exclusions or decline the policy, then an adviser has to disclose it. If the reason for changing the risk profile is discovered later but should have been disclosed earlier, the insurer will have the right to claim it was a potential fraud or the non-disclosure rules of the Act would allow them to modify, change or alter the policy,” Scott said.
“Advisers also have obligation to change this because if a client gets to claim time and was aware of this stuff there will be issues and there have been court cases where advisers have been caught up and sued for being negligent when the insurer denied the claim.”
There is now a third way insurers can cancel policies
While Section 29 extends the scope of time under which insurers can act, Section 59A of the Act (Appendix 3) heavily penalises those who engage in fraudulent behaviour by allowing insurers to cancel any and all policies held with them.
Scott said this is an important change and the modifications to Section 59A add a third way that insurers can cancel a policy, which until a few years ago, were limited to non-payment of premiums or fraud at the application stage.
“There is now a third way insurers can cancel policies and that is if, at claim time, there is a fraud, the insurer has the right to cancel the policy on which the fraud is being committed as well as every other policy with that same organisation,” Scott said.
“If a client has trauma, death, income protection and TPD and falsifies documents only on a trauma claim the insurer can cancel all the other polices because they are held with the same insurer. However, this does not affect policies held with other insurers”, he added, stating that while the change has been in force since June 2014 it would apply when claims are lodged, even to policies in force before the change.
For advisers or their clients who may be concerned about this clause, Scott said there was a difference between fraud and having a claim not proceed, and that came down to the validity of the claim, the paperwork that went with it and the terms and conditions of the policy.
“If someone claims they have cancer and has the right documentation but the insurer states it is not a high enough grade to pay a benefit, it is not fraud. It is just not meeting the terms and conditions of a claim.”
Insurance Contracts Act 1984 – Significant changes
Section 27A – Certain contracts of life insurance may be treated as if they comprised two or more separate contracts.
Section 29 – Failure to comply with the duty of disclosure or make misrepresentations prior to entering into the contract may result in an insurer:
- Altering the sum insured at any time (Death cover limited to within first three years)
- Avoiding the contract within first three years
- Varying the contract at any time (except for Death cover)
Section 59A – An insurer under a contract of life insurance may cancel the contract if the insured has made a fraudulent claim
A client’s duty of disclosure
If it is fraudulent an insurer can avoid the contract at any time
If it is innocent non-disclosure beyond three years the contract stays but, from 28 June 2014, no limit applies to non-disclosure (except on Death cover)
If is it innocent non-disclosure within three years an insurer may:
- Vary the contract or
- Avoid the contract
Insurance Contracts Act 1984 – Section 27A – Life Insurance
Certain contracts of life insurance may be treated as if they comprised 2 or more separate contracts of life insurance
(a) a contract of life insurance includes 2 or more groups of provisions (for example, provisions that are grouped into 2 or more separate parts); and
(b) each group of provisions could form a single contract of life insurance; then this Division applies as if each group of provisions were a separate contract of life insurance.
(a) a contract of life insurance includes 2 or more groups of provisions (for example, provisions that are grouped into 2 or more separate parts); and
(b) because of subsection (1), this Division applies as if each group of provisions were a separate contract of life insurance; and
(c) the contract also includes provisions (related provisions) that relate to or affect the operation of one or more of the groups of provisions referred to in paragraph (a);then the related provisions are, for the purposes of this Division, to be regarded as provisions included in each relevant separate contract of life insurance referred to in paragraph b).
(3) If a contract of life insurance provides insurance cover in relation to 2 or more life insureds, this Division applies as if the insurance cover provided in relation to each life insured were provided by a separate contract of life insurance.
(4) If a contract of life insurance provides:
(a) insurance cover in relation to a life insured that is underwritten on particular terms; and
(b) insurance cover in relation to that life insured that:
(i) is not underwritten; or
(ii) is underwritten on different terms; then this Division applies as if the insurance cover referred to in paragraph (a) and the insurance cover referred to in paragraph (b) were each provided by a separate contract of life insurance.
Note: The effect of this section in relation to a contract of life insurance to which subsection (1), (3) or (4) applies is that different remedies may be available to the insurer in respect of each separate contract of life insurance that is taken to exist by virtue of the relevant subsection.
Insurance Contracts Act 1984 – Section 29A – Life Insurance
(1) This section applies where the person who became the insured under a contract of life insurance upon the contract being entered into:
(a) failed to comply with the duty of disclosure; or
(b) made a misrepresentation to the insurer before the contract was entered into;
but does not apply where:
(c) the insurer would have entered into the contract even if the insured had not failed to comply with the duty of disclosure or had not made the misrepresentation before the contract was entered into; or
(d) the failure or misrepresentation was in respect of the date of birth of one or more of the life insureds.
Note: If subsection 27A(1), (3) or (4) applies to the contract of life insurance, different remedies may be available to the insurer in respect of each separate contract of life insurance that is taken to exist by virtue of the relevant subsection.
Insurer may avoid contract
(2) If the failure was fraudulent or the misrepresentation was made fraudulently, the insurer may avoid the contract.
(3) If the failure was not fraudulent or the misrepresentation was not made fraudulently, the insurer may, within 3 years after the contract was entered into, avoid the contract.
Insurer may vary contract
(4) If the insurer has not avoided the contract, whether under subsection (2) or (3) or otherwise, the insurer may, by notice in writing given to the insured, vary the contract by substituting for the sum insured (including any bonuses) a sum that is not less than the sum ascertained in accordance with the formula (S x P) / Q
“S ” is the number of dollars that is equal to the sum insured (including any bonuses).
“P ” is the number of dollars that is equal to the premium that has, or to the sum of the premiums that have, become payable under the contract; and
“Q ” is the number of dollars that is equal to the premium, or to the sum of the premiums, that the insurer would have been likely to have charged if the duty of disclosure had been complied with or the misrepresentation had not been made.
Note: This subsection applies differently in relation to a contract with a surrender value, or a contract that provides insurance cover in respect of the death of a life insured (see subsection (10)).
(5) In the application of subsection (4) in relation to a contract that provides for periodic payments, the sum insured means each such payment (including any bonuses).
(6) If the insurer has not avoided the contract or has not varied the contract under subsection (4), the insurer may, by notice in writing given to the insured, vary the contract in such a way as to place the insurer in the position (subject to subsection (7)) in which the insurer would have been if the duty of disclosure had been complied with or the misrepresentation had not been made.
Note: This subsection does not apply in relation to a contract with a surrender value, or a contract that provides insurance cover in respect of the death of a life insured (see subsection (10)).
(7) The position of the insurer under a contract (the relevant contract) that is varied under subsection (6) must not be inconsistent with the position in which other reasonable and prudent insurers would have been if:
(a) they had entered into similar contracts of life insurance to the relevant contract; and
(b) there had been no failure to comply with the duty of disclosure, and no misrepresentation, by the insureds under the similar contracts before they were entered into.
(8) For the purposes of subsection (7), a contract of life insurance (the similar contract) is similar to another contract of life insurance (the relevant contract) if:
(a) the similar contract provides insurance cover that is the same as, or similar to, the kind of insurance cover provided by the relevant contract; and
(b) the similar contract was entered into at, or close to, the time the relevant contract was entered into.
Date of effect of variation of contract
(9) A variation of a contract under subsection (4) or (6) has effect from the time when the contract was entered into.
Exception for contracts with a surrender value or that provide cover on death
(10) If the contract is a contract with a surrender value, or a contract that provides insurance cover in respect of the death of a life insured:
(a) the insurer may vary the contract under subsection (4) before the expiration of 3 years after the contract was entered into, but not after that period; and
(b) subsections (6), (7) and (8) do not apply in relation to the contract.
Insurance Contracts Act 1984 – Section 59A – Life Insurance
Cancellation of contracts of life insurance
(1) An insurer under a contract of life insurance (the first contract) may cancel the contract if the insured has made a fraudulent claim:
(a) under the first contract; or
(b) under another contract of insurance with the insurer that provides insurance cover during any part of the period during which the first contract provides insurance cover.
(2) If an insurer has cancelled a contract of life insurance under subsection (1) because of a fraudulent claim by the insured under that contract, then, in any proceedings in relation to the claim, the court may, if it would be harsh and unfair not to do so:
(a) disregard the cancellation of the contract; and
(b) order the insurer to pay, in relation to the claim, such amount (if any) as the court considers just and equitable in the circumstances; and
(c) order the insurer to reinstate the contract.
(3) If an insurer has cancelled a contract of life insurance (the cancelled contract) under subsection (1) because of a fraudulent claim by the insured under another contract of insurance with the insurer, then, in any proceedings in relation to the claim, the court may, if it would be harsh and unfair not to do so:
(a) order the insurer to pay, in relation to the claim, such amount (if any) as the court considers just and equitable in the circumstances; and
(b) order the insurer to reinstate the cancelled contract.
(4) If an insurer has cancelled a contract of life insurance under subsection (1), then, in any proceedings in relation to the cancellation, the court may, if it would be harsh and unfair not to do so, order the insurer to reinstate the contract. This subsection does not limit, and is not limited by, subsection (2) or (3).
(5) In exercising the power conferred by subsection (2), (3) or (4), the court:
(a) must have regard to the need to deter fraudulent conduct in relation to insurance; and
(b) may also have regard to any other relevant matter.